Lest We Forget

This past week we saw violent protests in Charlottesville, USA. They deserve our attention.

A rally called “Unite the Right” had formed to prevent a statue of Robert E. Lee from being torn down. Lee was a General during the American Civil War who fought for the Confederacy, a collection of southern states that supported the continued existence of slavery.

Racial tension remains an ongoing issue within America, and in that context some have called for visible public symbols, like Confederate statues, which call to mind past conflicts and fan the flames of ongoing tensions be moved to museums or elsewhere.

Some would say this is the wrong thing to do because where do you draw the line? When do you stop removing statues? George Washington, the first President of the United States, was a slave owner. Should all of Washington’s statues also be moved to museums?  Obviously this is a nonsense argument, since the American Founding Fathers are central to America’s identity. Although, it does highlight some key questions. Is it appropriate to pull down statues? And, what is the best way to reduce racial tensions?

On its face, removing a statue might be seen as erasing history, destroying cultural heritage, or censoring ideas. Clearly it is not something that should be done lightly. However, it would seem appropriate in certain circumstances, for example if a statue is being used as a rallying point by racists, bigots, or extremists. It might be argued that pulling down a statue will in time help people to forget past conflicts and thus move forwards together. However, it is worth remembering that removing statues does not by itself remove social tensions. Ultimately, the only antidote to conflict is not collective amnesia but community forgiveness and reconciliation. It is not necessary to forget the past in order to forgive others and move forwards, and it may not even be sufficient. Research suggests that animosities can linger on long after the original facts that caused hard feelings are forgotten.

Unfortunately, these issues are highly politicised, and moving forwards together is not what most people engaged in the issue are focused on right now. The Washington Post reported that at the Charlottesville protest “[a] lone figure stood inside Emancipation Park, offering water and holding a sign that said, “Free Hugs.” Tyler Lloyd said he came hoping for a peaceful solution. The rallygoers accepted his water but declined the hugs.”

Shortly after the protests, President Trump poured gasoline on the fire by failing to clearly denounce hate speech (including pro-Nazi, anti-black, and anti-Semitic slogans) chanted by many of the protesters. In his initial address he condemned “hatred, bigotry, and violence on many sides.” While pulling down statues may not be the solution to racial tensions, it is hard to see how this amounts to hatred or bigotry when its intent is the opposite. And so, what Trump was actually doing was drawing a moral equivalence between the protesters engaging in hate speech and the counter-protesters opposing them. In response to Trump’s comments, David Duke, former Imperial Wizard of the Ku Klux Klan, tweeted “[t]hank you President Trump for your honesty & courage to tell the truth about #Charlottesville…” As if being endorsed by the KKK weren’t bad enough, a dozen CEOs also stepped down from Trump’s advisory councils in protest. As a result, the Strategy & Policy Forum and the Manufacturing Council are to be disbanded.

Are we living in base level reality, or is this one of Elon Musk’s distopian simulations?

The events surrounding Charlottesville give us a glimpse into the way Donald Trump thinks. He did not clearly denounce hate speech in his initial address, and while some have taken this to mean that Trump is a Nazi sympathiser it seems unlikely. He denounced the KKK and neo-Nazis as ‘repugnant’ two days later. However, he later defended his original morally ambiguous comments.

Trump’s willingness to spin on a dime and play fast and loose with tightly held American values highlights what many people already knew: Trump is a narcissist. He is more interested in his own agenda than what anyone else thinks. This means he is willing to tacitly support those who support him (remember that the alt-right was part of his support base during the election), and will viciously attack anyone who attacks him (CNN, the Washington Post, and other ‘fake’ news organisations). Trump’s narcissism is dangerous not because he intends to hurt others, but because he is casually indifferent to the agenda of anyone who is not Trump. What this means is that there is no way to understand or predict his behaviour, expect by knowing that he will at each step along the way reliably do what suits him best at a given point in time.

So where does that leave us?

The world finds itself at a delicate moment in history when the President of the most powerful country in the world clearly prefers expediency to morality, and has publicly demonstrated a casual indifference towards overt prejudice and discrimination.

In a heartening show of resistance, during the week a video released by the US War Department in 1943 went viral. It encourages Americans not to fall for the fascist rhetoric of prejudice and division. It is a positive message and if you haven’t already watched it, I encourage you to take a look. Lest we forget.

The Far Reaching Impact of Blockchain

Blockchain, the underlying technology used by Bitcoin, has implications that reach far beyond the financial services community and banks. This is where new development and implementation may have focussed so far. However, as the technology and its implications become better understood, it will rapidly expand to new industries and verticals.

Blockchain systems operate as a kind of distributed database that store immutable (that is, non-changeable and verifiable) transactional records stored as “blocks” of information. Each block contains a timestamp and is linked or referenceable to a previous block and hence forms part of a larger “block chain”. Blockchains can either be public, private, or a combination of the two, with information accessible to users via “keys”.

Blockchain also works very much like a large distributed, non-centralized network. Each “node” of the network is a processor (or computer server in other words) that stores each block of information processed by that node. Once processed or verified, a transaction record can then be shared with other nodes in the network. This could be anyone in the case of a public blockchain, or only authorized users in the case of a private blockchain.

Blockchain technology has been applied in the finance industry in the payments space. Ripple, for example, allows banks to transact between themselves and with individuals globally by creating a payment platform that allows banks to settle payments in different currencies in real time. Individual payments and currency settlement calculations are made by a decentralized network of processors located at the banks and clients all over the world using Ripple’s payment protocol.

However the technology has many other uses – starting with the ability to better monetize alternative energy to the digitisation of insurance contracts. The insurance industry, in particular, is starting to get serious about investigating, if not yet implementing, blockchain solutions in order to streamline paperwork, manage supply chain issues if not insurance contracts overall, accelerate the processing of insurance claims, and improve the auditability of transaction records.

In fact, the real juice behind blockchain is not bits and bytes, but in fact how events are triggered by electronic code that translates contractual relationships into action – or so-called “smart contracts” that are executed within blockchain networks.

Smart contracts – or the computer protocols that facilitate, verify and enforce agreements – are actually the heart of this revolution. They represent a unique blending of technology and law, usually with regard to payments – but not limited to them. Smart contracts are actually coded binary language triggers along the network that cause certain things to happen when specific conditions are met. For example, Customer A authorizes payment to buy a convertible bond. When market conditions warrant, the bond “smart contract” will then automatically pay Customer A the required coupon payment, convert the bond into a certain pre-determined number of shares, or take some other required action.

Despite the hype, however, there are still vast unknowns – namely the ability of coders to accurately translate legal requirements into transactions that can be understood and retranslated by people – starting with regulators. In terms of payment or other easily defined contractual obligations (such as trade confirmations), the concepts are relatively straightforward. However, as anyone who has looked at even the simplest contract knows, there are many parts of a contract that are not easy to translate into code from natural language – much less decipher downstream. This includes everything from indemnities, warranties, covenants, confidentiality, digital signatures and enforceability if not other pieces in between.

What happens, for example, when the convertible bond bought by Customer A does not react to the right market conditions? Or what happens if the electronic triggers in the smart contract for this convertible bond are activated by the wrong set of market conditions? How will lawyers without coding experience be able to catch such errors? And how will coders without a legal background know what to look for to find them?

While understanding whether payment has been made (for example) is relatively easy to understand by all parties, understanding whether a service has been correctly provided, particularly when translated into and out of digital code, represents a quagmire that is already coming – and with no easy answers.

The legal enforceability of at least part of what smart contracts represent is not far away. Payment and exchange of services or data is the easy part. Redefinition of contractual relationships, however, is where the entire conversation starts to get murky. That is nowhere more obvious when applied to a specific part of “contract” law – namely civil rights.

For those who do not believe that civil rights are in fact a contractual relationship relating to basic property rights (including payment), values, and perhaps even the meaning of citizenship itself, then look no further than perhaps one of the most overlooked parts of civil rights and contract law in the United States.

The Civil Rights Act of 1991, also known as 42 U.S. Code §1981, is a United States labour law and the most recent codification of civil rights in America. In effect, it equates the contractual value of minorities and people with disabilities with that of white men.

In other words, civil rights are the mandatory equalizing of the contractual value of individuals enforced by the state. But that state is only one country.

What happens if there is a contract, for example, between an English multinational and an American citizen for work being performed in Hong Kong?

Do American civil rights laws apply?

Which set of laws should govern a smart contract?

If smart contracts expressly choose New York law, for example, this could mean that the best of American labor and civil rights laws are automatically exported to other countries. But it could also mean that contractual inadequacies, due to a failure to expressly choose a governing law, lead to unexpected results and ultimately undermine basic notions of equality and civil rights.

Further, what is the appropriate forum for resolving disputes under a smart contract?

In a world where contracts that affect payments as well as the terms of employment are becoming increasingly undecipherable, will smart contracts, which can also be used to govern labour agreements, be literally rewritten to eviscerate the concept of equal pay, access to healthcare, and perhaps even the right to negotiate a contract in the first place? And if smart contracts hide or distort important contract terms, how will consumers actually be able to tell if they have gotten what they paid for?

These are some of the big issues which face the entire discussion around blockchain. They are not widely part of the vernacular so far. However, just as bitcoins are electronic “digital currency”, block chain, the master regulator of such systems, could easily become a place where the contractual elements of pay, consumer and civil rights are either enshrined, or eviscerated.

Marguerite Arnold is an entrepreneur, author and third semester EMBA candidate at the Frankfurt School of Finance and Management.

Frankurt: Europe’s New Fintech Hub?

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This is a guest post from Marguerite Arnold.

Frankfurt is one of the oldest business centres in the world. From at least Roman times, the low-lying city, bifurcated by the welcoming River Main, has been a hotspot for global endeavours that changed the nature of many industries – including but not limited to banking. Mayer Rothschild, a courtier to the German king of Hessen at the time, used the famous freedoms of the city to launch a global banking empire in the 1760’s.

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These days, Frankfurt is not just Europe’s banking centre and home to the European Central Bank. It is also on the verge of leading another revolution – in Fintech.

Why?

The first is just geography. In no other city where Fintech has taken hold are the presence of financial types and large banks so concentrated in such a small place. Frankfurt is roughly the size of Charlotte, North Carolina (the second largest banking centre in the U.S.) However, its residents, few in number compared to other large and influential cities and banking hubs, are both highly international (40% of the city is from somewhere else) and highly financially literate.

Further, with Fintech taking hold as a revolutionary force in banking and insurance, the large banks here are considering how to transition in a digital world which will change their business operations and market footprint – and that is not limited just to corporate banks, but global powerhouses like the ECB itself.

Frankfurt is an increasingly dynamic hub of Fintech start-ups, with unparalleled access to large banks. Even in London and New York, both financial superpowers in their own right, Fintechs do not have the same ability to reach power brokers and decision makers so easily and directly.

Frankfurt is also home to a well-heeled group of investors – whether they be individual “angels” or family offices – who are looking, at this point, for the next digital growth story. That makes the city one of the best places to both live and pitch on a regular basis. The start-up scene itself here is relatively tightly knit but, critically, also open to newcomers. Most advertise meetings on the Meetup Platform. It is possible to go to (at least) one event every day of the week.

Cross promotion of different kinds of events is also beginning to happen as the scene begins to mature. While the opening of Accelerator Frankfurt marks the first of such entities, it won’t be the last. Free office space for promising start-ups is relatively easy to find.

Unlike Berlin, Frankfurt also promises to be a city that promotes the growth of more B2B financial endeavours. While there are digital entrepreneurs here with start-ups of every kind, the mix in Frankfurt promises to see an increasing slate of innovative business models challenging every part of the banking and insurance business (which in Germany are more tightly linked than almost anywhere else in the world).

The impact of Brexit is also likely to give the Fintech start up scene here a boost, although it is uncertain at this juncture how much of one and in what form. What it is likely to do, however, besides sending a flood of British expats, is create a banking industry itself that is ripe for change and innovation.

Frankfurt is also (relatively speaking) far cheaper to live and work in (certainly comparable to Berlin). There are regional trains, subways that line up with station platforms and even street trains (plus busses) that make this little gem on the Main a potential start up paradise.

Four hundred years after Rothschild revolutionized banking, therefore, on the banks of the Main, another age dawns that promises innovations that are just as earthshattering, albeit this time, digital.

Marguerite Arnold is an entrepreneur, author and third semester EMBA candidate at the Frankfurt School of Finance and Management.

(Image Source: Wikipedia)

Political Correctness Killed the Republic

political-correctness-killed-the-republic

Six months ago I predicted that Trump would most likely win the US election. The official opinion polls told the opposite story, that Hillary was the preferred candidate, but my reading of the situation was different.

It was mid-July, and I was attending a talk given by Elizabeth Economy, Director for Asia Studies at the Council on Foreign Relations in New York. Economy gave a wonderful speech, and she shared her view that a Trump victory would be truly unthinkable. This was the consensus in the room. However, despite her convictions, and the pro-Hillary audience, Economy couldn’t help smiling broadly every time she mentioned Trump’s name.

This was extremely telling.

It has been said that emotion makes people act, and logical makes them think. Trump is a man who clearly knows how to connect with people’s emotions, while Hillary is woman with a lot of knowledge, experience and intellect.

And so, it occurred to me that if a thoughtful intellectual type who strongly opposed Trump’s candidacy was having trouble resisting his charm, brand, charisma, call it what you will, then what hope had everybody else?

What hope indeed.

Donald Trump is now president-elect of the United States of America.

Who is to blame?

No single person or event is to blame, perhaps, but I believe a culture of political correctness in the West is one of the causes that has contributed towards America’s current predicament.

Let me share a brief anecdote.

A few days before the US election I shared with friends on Facebook my view that both candidates were bad choices for president.

On the one hand, Donald Trump, a man who hurls abuse at Mexicans, Muslims and anyone who tries to challenge him, inspires fanatical devotion in his followers and, based on everything we know about his behaviour, given the opportunity Trump will not hesitate to make a show of strength or take steps to enhance his own power. A potentially dangerous temperament.

On the other hand, Hillary Clinton, an intelligent, hard-working and ambitious career politician who has survived and thrived in a broken political system by adopting a public and private persona, and at times appears to have placed pragmatism over principle (shown by her decision to accept donations to the Clinton Foundation from Qatar and Saudi Arabia, known funders of terrorism, while she was Secretary of State).

Wonderful! Two wonderful choices!

I didn’t want Trump to win, but both candidates had clear weaknesses, and I thought I had a right to comment.

Shortly after sharing these thoughts on Facebook, I deleted the post. I was under attack from a number of my pro-Hillary friends, and so I ducked for cover.

How dare I say anything negative about Hillary!!!???

How dare I indeed.

My feeling is that the political thought police are doing America and the West a grave dis-service and causing more harm than good.

What kind of societies do we want to live in?

Ones where people have to tip-toe around and only share their true thoughts in private or at the ballot box?

Or ones where ideas and issues are openly and candidly debated and discussed?

Hopefully you will agree that openness and debate are the best option.

But don’t just take my word for it. Have a listen to the wise and amusing words of Jonathan Pie (the satirical news reporter played by Tom Walker). Foul language warning! You might not want to play this if you are in the workplace, or if you are sensitive to the F-word.

(Image Source: Odyssey)

Bitcoin, Digital Currency and The Future of Banking

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This is a guest post from Marguerite Arnold.

When news broke in late October that some of London’s largest banks were investing in Bitcoin, cryptocurrencies in general got another boost. According to reports, however, this latest move to embrace Bitcoin was not a positive embrace of the digital currency per se, but rather a move to stockpile Bitcoin to fend off denial of service attacks from hackers.

Beyond hoarding digital currency as a defensive move in the age of DDOS bank robbers, banks are beginning to think about ways that bitcoin could be used within the banking industry globally. This is not limited to thinking about how Bitcoin could function as a new kind of currency – although that is an ever-present idea on the horizon. Bitcoin itself was created by technologists and programmers with a deep-seated mistrust of central banks themselves. These days, central banks in places including the US, UK and China, are also considering how the underlying technology – blockchain – might be used to record transactions in the real economy more efficiently and with greater transparency.

Blockchain – a system of distributed databases that exist on either private or relatively “public” decentralized computer nodes all over the world – may in fact be the most powerful and influential legacy of Bitcoin. The technology allows multiple users, including competitors, to keep an accurate tracking of events or financial transactions in a way that can be accessed and tracked by multiple users at any given time. The technology is frequently referred to as a “digital ledger”.

The time is ripe for innovation both on the digital currency front and in the use of “digital ledgers” for everything from basic currency tracking and F/X transactions to more sophisticated clearing and reconciliation processes. According to a recent report in the New York Times, the Bank of England has recently produced a report that the economic benefits of issuing a digital currency tracked by a blockchain could add as much as 3% to a country’s economic output. During a time of unprecedented globalization as well as new business models that look set to disrupt entire industries, including banking, the idea of having a digital currency that offers both greater accuracy as well as independence from central banks and government interference is also gaining greater and greater appeal.

There is also the issue of reducing costs as well as the larger question of how to transform banking service provision in the age of “digital” personal services. Everything from sourcing loans to personal banking services, particularly in an age of negative interest rates, is potentially up for grabs – enabled by digital services and the technological backbone they rely on.

According to most industry analysts, the impact of all of these forces is likely to create a tipping point within the next 10 years, leading to wide ranging transformation of all banking services and the companies that provide them. Cryptocurrencies and blockchain are likely to be major pieces of the puzzle, however they are ultimately configured, integrated and used. What is still uncertain at this juncture is exactly how this future world will look – from consumer interactions to the most sophisticated back office clearing procedures and reconciliation measures at the world’s largest banking institutions.

What is certain however, is that digitalization has hit the banking sector – and there is no turning back.

Marguerite Arnold is an entrepreneur, author and third semester EMBA candidate at the Frankfurt School of Finance and Management.

(Image Source: Flickr)

Brexit & The Future of Startups In Europe

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This is a guest post from Marguerite Arnold.

Since 1972, Britain has been part of the European continent. I remember the opening very well. I was a kid, living in London. The new openness meant we could afford oranges from Spain. Every week, an old French farmer would also peddle through London with strings of onions hanging from his bicycle. I thought the arrangement was unbelievably cool and more than romantic.

Fast forward forty years, and the situation is now reversing, and that is not only a shame, but I predict it will have dire and unforeseen consequences for the British.

The England I knew as a child was a fascinating place. It was a country struggling to keep together the concept of a social state, still wounded by the war, and losing the last pieces of its Empire. You could still travel to central parts of London and see unreconstructed bomb sites left over from the war. I will never forget seeing one, incongruent with the bustling scenes around it, and asking my father what it was from. He answered “The Blitz.”

Today, of course, London is a different city, and England is a different country – transformed, much like the U.S. into an economy which may be again calling itself “shared” – but in fact is premised on something very different.

After WWII, most European countries, as well as significant parts of the U.S., believed the future was only attainable by creating a strong social platform upon which the other parts of life would work. “Regular” jobs. A middle class life. A steady pay check. A system to take care of the sick. Retirement funds to take care of the old.

That system is gone now – or at least fading, and we are on the cusp of something else. Thus the explosion of start-ups, start-up culture and the new entrepreneurialism. This is part of the reason that start-ups have thrived in the U.K. – particularly high tech start-ups. The country has been, for a generation, trying to define itself. There is no way the island can survive independently. No country can. The British train system uses German trains. The auto industry is hurting. Oil is an uncertain energy source. Overpriced British real estate in London fueled by foreign investment does not an economy make. Britain, right now, is much like the U.S. Casting off the old very quickly in an attempt to create something that works better (although for whom and how many is still an open question).

However start-up culture is not the same everywhere.

Across the Channel, things are different. There is more social integration and infrastructure. Every country east of France still has a streetcar system that works. There are still national healthcare systems which strive to provide health care for the oldest and sickest. And the approach to start-ups is a lot more cautious – in part because things still work the way they were designed to. People here just do not understand how, for example, a presidential candidate who did not pay his taxes for 20 years can even be credible.

This reliance on a broader superstructure, which the Europeans are loath to destroy in search of something “new”, does not mean there is no innovation. As a professor of mine said to me recently, mobile payments (a particularly hot area of Fintech innovation elsewhere) are just not a priority in Germany because of the continual upgrades and improvements to the customer banking experience (also known as SEPA), that has already created a workable middle way.

However, Europeans in general and Germans in particular, are not deaf to innovation. They too are looking for ways to innovate as the older systems become increasingly outdated. It is just moving a bit more slowly here – and frankly a bit more humanely. Chaos might provide a lot of exciting booms, but that is not a place where most people want to live their lives. And as Britain shuts its doors to the rest of the continent, there are many now who are looking increasingly to both Berlin and increasingly Frankfurt, to be a new platform for innovation.

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In Frankfurt, there is a steadier (and much cheaper) platform for innovation in the form of cheap rent, transportation and an overall standard of living. And it is provided by the security and infrastructure that comes when countries do not throw the baby out with the bathwater in search for “something” if not “anything” new.

Marguerite Arnold is an entrepreneur, author and third semester EMBA candidate at the Frankfurt School of Finance and Management.

(Image Source: BBC and Tripadvisor)

Levered Monkeys

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As Oxford’s poet-philosopher Ludovic Phalippou once put it, “we are all just levered monkeys!”

What did Phalippou mean by this comment?

Well, as I explained to my corporate finance students this week, the use of debt by companies is called “financial leverage”. That is, debt acts like a lever which can magnify the size of both gains and losses.

Imagine that you are the CEO of Apple Corporation and require a return on investment of 10%. There is a new venture you can undertake that will generate a return on assets of 2%, but you can currently borrow money at an interest rate of 0%, and so you can use debt to help you achieve your required return.

You decide to go ahead with the project, and the numbers look something like this:

Venture     – Debt           = Investment
$1 million – $800,000 = $200,000

EBIT        – Interest = Income
$20,000 – $0           = $20,000

ROI = Income/Investment = 10%

Bravo!

In this very simple example (which ignores things like taxes and capital gains), you have successfully used debt to increase your return on investment from 2% to 10%.

As I mentioned in an earlier post, central banks in some of the world’s major economies are keeping interest rates at record low levels. And in a few places (like Japan, Europe, and Switzerland) interest rates are negative.

Since debt can be used to magnify investment gains, central banks are no doubt hoping that businesses will take advantage of lower interest rates to increase investment and thereby stimulate the economy.

However, record low interest rates can’t last forever.

When will central banks return interest rates to more normal levels?

This past week there was talk about whether the Fed would raise interest rates in September. Jamie Dimon, CEO of JPMorgan Chase, argued that the Fed should raise rates sooner rather than later. However, Goldman Sachs reduced the chance of an interest rate hike in September from 40 percent to 25 percent; while at the same time increasing the odds of an increase in December from 30 percent to 40 percent.

Nobody knows exactly when central banks will start to increase interest rates again, but it seems that it could happen in the not too distant future.

As the CEO of Apple Corporation, you had managed to achieve your required rate of return of 10%, and you were feeling pretty pleased with yourself. However, imagine now that the central bank decides over the course of a few short years to increase interest rates back to a more normal level of, say, 4%.

What happens to your return on investment?

Venture     – Debt           = Investment
$1 million – $800,000 = $200,000

EBIT        – Interest  = Income
$20,000 – $32,000 = -$12,000

ROI = Income/Investment = -6%

Bazinga!

As a result of rising interest rates, the return on investment for your venture has fallen to minus-6%. This is below the return on assets of 2%, and even further below your required return of 10%.

What can we learn from this simple example?

Well, one of the goals of central banks, in keeping interest rates at record low levels, is to stimulate the economy. This should work because lower interest rates reduce the required rate of return, as we saw in our example. However, by encouraging business leaders to undertake projects that offer low returns, it may be that central banks are sowing the seeds of the next downturn.

They have to raise interest rates at some point, and when they do, businesses who have taken advantage of financial leverage to pursue projects with low returns will have their losses magnified.

The more debt a business has used, the more pain it will feel.

Silly monkeys!

(Image Source: Flickr)

Capital For You and Me

capital-for-you-and-meThis past Friday marked the 40th anniversary of the passing of Mao Zedong, the founding father of the People’s Republic of China.

Most notable here in China was the absence of discussion or commentary.

This is perhaps understandable since it is Chinese government policy to celebrate past leaders’ birthdays rather than the anniversary of their passing. However, it also seems to be quite telling. According to the Wall Street Journal, one Weibo user contrasted the occasion to the 2014 anniversary of the death of Communist Party leader Hu Yaobang for whom “all kinds of media and officialdom [paid] unbridled tribute. But this year on the 40th anniversary of Mao’s death, it’s this quiet. Especially today, you don’t even see a few comments here or there.”

Why the silence?

Well, for one thing, Mao was a communist revolutionary responsible for the Great Leap Forward and the Cultural Revolution. Putting the merits of communist theory to one side, it could be argued that these initiatives were not exactly a run away success.

The Great Leap Forward (1958 to 1961) aimed to transform China by establishing agricultural collectives and pursuing rapid industrialisation, and ended up causing a period of economic decline and tens of millions of deaths.

The Cultural Revolution (1966 to 1976) aimed to maintain the communist ideology within China; a decade of violence and instability ensued.

Despite all of this, Mao remains a complex historical figure, widely regarded as the greatest Chinese figure of the 20th century, and the official government line remains that Mao was “70 percent correct and 30 percent wrong”.

It is understandable though if China’s government may want to distance itself from Mao as the years go by.

For one thing, Mao was a revolutionary, and the Communist Party would prefer to maintain stability and growth.

Over the last year, China’s GDP grew by around 6.7 percent; slow compared with historical growth rates over the last twenty years but still more than three times America’s GDP growth rate. At the current rate, the size of China’s economy will double in around ten years. This will open up new opportunities for Chinese workers, and help to lift millions of people out of poverty. At the same time, however, there are suggestions that China’s growth is being fueled by increasing amounts of debt. This could mean that current growth is unsustainable, and that lower growth and higher unemployment may be likely in future. The Communist Party are wise not to inspire a revolutionary sentiment.

Mao was also a communist, and advocated collective ownership and ideas like the removal of the class system; policies which sought to alienate people from capital assets like land and social status. These policies would have made it difficult for people to be productive or creative, resulting in economic stagnation.

China’s current growth and development depend on it embracing quite a different philosophy, one that allows people to develop and accumulate capital (whether it be intellectual, social, financial, natural, physical, or technological capital).

There is a common misconception that if China embraces the value of “capital” in helping people become more productive and creative, then it will need to adopt the American free market version of capitalism. This is of course not true. Germany and the Nordic countries have their own unique versions of capitalism. And China has embraced a version of state capitalism which seems appropriate given its culture and historical perspective.

Capital for you and me (and the state).

(Image Source: Wikipedia)

Cheap money, what is it good for?

Cheap money, what is it good for

Cheap money should help to stimulate the world economy, but is it working?

Following the leave campaign winning the Brexit referendum, which will see the UK leave the EU two years after the Prime Minister notifies the European Council of its intention to do so, there was much fear about what this would mean for the strength of the UK economy.

Mark Carney, Governor of the Bank of England, issued a statement immediately following the result in which he aimed to calm market sentiment.

He acknowledged that Brexit would result in a period of uncertainty and adjustment, but there would be no initial changes in the way people are able to travel, or in the way that products and services are sold.  In a calm demeanor, he reassured us that the Bank of England would not hesitate to take additional measures, as required.

What kind of additional measures did he have in mind?

Well, Carney went on to say specifically that “… as a backstop, and to support the functioning of the markets, the Bank of England stands ready to provide more than 250 billion pounds of additional funds through its normal market operations.”

What did he mean by this?

Well, traditionally, central banks have aimed to control monetary policy by influencing interest rates. By lowering interest rates a central bank hopes to stimulate the economy by lowering the required rate of return on business investments, which should increase the total amount of investment in the economy.

As recently as ten years ago, it was unthinkable that a responsible central bank would try to stimulate the economy by turning on the printers and pumping new money into the economy. But this is what Carney was suggesting, “the Bank of England stands ready to provide more than 250 billion pounds of additional funds“.

Since the 2008 financial crisis, central banks have increasingly resorted to this new and unconventional policy known as quantitative easing. The US has engaged in three rounds of quantitative easing, purchasing an estimated $4.5 trillion in financial assets. And the UK has also been busily printing money, purchasing more than £375 billion in financial assets.

QE is new and unconventional, but notice how carefully Carney finessed his words.

“The Bank of England stands ready to provide more than 250 billion pounds of additional funds through its normal market operations.”

There is absolutely nothing “normal” about printing money in order to prop up the economy. This behaviour was traditionally the province of banana republics like Zimbabwe and the Weimar Republic, and in both of those cases it led to rampant hyperinflation. The Bank of England’s website even acknowledges this, stating “Quantitative easing (QE) is an unconventional form of monetary policy where a Central Bank creates new money electronically to buy financial assets, like government bonds.” (emphasis added)

However, mid-last week, Carney’s “normal market operations” appear to have finally hit a bump in the road.

The FT reported that the Bank of England’s new programme to buy long-dated UK government bonds had run into trouble as pension funds and insurance companies were refusing to sell. “The Bank of England fell £50m short in its gilt purchase target … , and even then only secured [as much as it did] by paying well above market price,” said Darren Bustin, head of derivatives at Royal London Asset Management.

Is the Bank of England’s money no good?

Why might these institutions be refusing to sell their long-dated bonds?

A few reasons.

Firstly, by printing money and lowering long term interest rates, the Bank of England is, in effect, siphoning money out of the pockets of old people.

Pension funds have long term liabilities which will not fall due for many years. In order to be able to provide for their members during retirement, these institutions need to buy long-dated assets, which will provide revenue over a long period of time. With interest rates continuing to fall, it makes sense that these institutions would prefer to hold onto their long term bonds, which will provide a steady stream of fixed coupon payments.

Already this year, 10-year gilt yields have fallen from 2% to a staggering low of 0.56%, which has led to worsening funding shortfalls for UK pension funds. Lower interest rates mean that pension funds expect to earn less from their bond portfolios in future, and so will be less able to pay their members’ pension entitlements. This means that employees, worried about their standard of living during retirement, are now under pressure to save even more than before (exactly the opposite of what the Bank of England is hoping to achieve).

The second reason that these institutions may be reluctant to part with their bonds in exchange for cash is that, as central banks continue to engage in quantitative easing, money is becoming increasingly worthless.

If we think of interest rates as the “price” of money, then we can see that in many countries money has never been less valuable.

Here is a list of prevailing central bank interest rates in some of the world’s major economies (as of today, August 14th 2016):

  • Bank of Japan: -0.1%
  • European Central Bank: -0.4%
  • Swiss National Bank: -0.75%
  • Sweden’s Riksbank: -0.5%
  • U.S. Federal Reserve: 0.4%
  • Bank of England: 0.25%
  • Reserve Bank of Australia: 1.5%

Cheap money should help to stimulate the world economy, but is it working?

The evidence doesn’t seem too positive.

Low rates are meant to encourage business investment, but in a low growth world where companies and governments are already heavily indebted it is easy to understand why this may not happen.  Moreover, if banks absorb the cost of negative interest rates themselves, then this lowers their profit margins and may make them less likely to lend money.

As we saw in Germany on Friday, one bank has now decided to pass on negative interest rates to its retail clients. In other words, it will now penalise thrifty individuals for having savings in the bank. If enough other banks follow this lead and make more customers pay to hold their money in the bank, then customers may start putting cash under the mattress or stashing it in a safe. This would reduce the total amount of deposits held in banks and could potentially set off a bank run.

Cheap money, what is it good for?

(Image Source: Flickr)

End of the Republic

If I were a betting man, at this stage my money would be on Trump to win the American presidential election.

This is not an endorsement, or a show of support of any kind. I think a Trump victory would be a horrible outcome.

So, why do I think Trump has more than a 50/50 chance? And what might the implications be if he wins?

The world is currently experiencing turbulent times economically and politically.

On the economic front, things look a little grim. Government debt as a percentage of GDP in America, Japan and at least nine other countries currently exceeds 100%, and other countries like the UK, Ireland, Spain, Canada and the EU are not far behind. Add to this the unprecedented levels of disruption to the workforce that will result when driverless technology automates millions of trucking jobs and technology like Kiva automates the work of millions of factory workers. High global debt levels combined with systemically higher unemployment levels are not two things that scream “economic stability and smooth sailing ahead”.

Politically, there appear to be more than a few explosives in the tinderbox. The UK held a referendum, the result of which will almost certainly see it leave the EU (and who knows which countries might follow).  The recent attack in Nice on Bastille day led to 84 deaths when an Islamic militant drove a truck through a crowd gathered to watch some fireworks (and this is just one in a series of attacks in France and Belgium in recent months). And militants in Turkey are now trying to stage a coup.

May we live in interesting times.

Trump has already surprised the analytical and political community in America by gaining enough delegates to win the Republican nomination. He is yet to be officially nominated but tensions are mounting. Politico reports that “nearly half of GOP insiders in key battleground states … believe there’s a good chance violence will break out around next week’s Republican National Convention in Cleveland.”

In a short blog post that I published in June last year I mentioned that Donald Trump “… has announced his intention to run for the White House in 2016 … Trump is a master at manipulating media attention and getting people to talk about him …”

At that stage I thought of him merely as a reality TV star, someone who was entertaining, a famous self-promoter. The prospect of him running for President seemed like it would make for good television. Little did I consider or realise the hateful ideas he would put forth in order to whip his faithful followers into a frenzy.

As I said last June, Trump is a master of building the Trump brand. He has authored multiple books, and put his name on everything from high-rise buildings to golf courses and casinos. His years of effort in building a branding juggernaut appear to have created a seemingly unstoppable force. This view was acknowledged (and more comprehensively discussed) by Politico back in October last year.

The problem for Hillary (and the Republican candidates who Trump has already defeated) is that while she might be a strong candidate, Trump is a candidate backed by the power of a global brand that conjures an alluring tale of “unstoppable and never-ending success”. His followers are not merely supporting Trump’s candidacy, they are supporting his story. They are supporting the brand.

This might sound like a subtle distinction, but it’s not.

Let me give an example.

I recently attended a talk in Beijing entitled “Advising the Next U.S. President on China” given by Elizabeth Economy, Director for Asia Studies at the Council on Foreign Relations in New York. Ms Economy gave a wonderful speech and her view, along with the consensus in the room, was that a Trump victory would be truly unthinkable. However, despite her intellectual knowledge and conviction that Trump would be an absolute abomination, she couldn’t help smiling every time she mentioned Trump’s name.

This is extremely telling.

Trump is a man who is hurling hurtful and disgusting abuse at Mexicans, Muslims, judges, and anyone who would oppose him. And yet, when a well-meaning intellectual who opposes Trump’s candidacy mentioned his name in front of a packed audience, she smiled broadly every time.

This is not Ms Economy’s fault, but what it tells us is that the power of the Trump brand has infected even his staunchest opponents.

Intellectually she knows he is bad news, but even still she can’t resist.

And if thoughtful intellectual types are having trouble resisting Trump’s brand, what hope has everybody else?

If Trump does win, then what might the implications be for America?

Well, as I mentioned, we are living in turbulent times.

France has been in a state of emergency since the terrorist attacks in Paris last November, and plans to extend the state of emergency following the Bastille day attacks. What this means is that normal rules of law do not currently apply.

I am by no means an expert on the American political and legal system, however it is possible to imagine a similar state of emergency being called by Trump (following another inevitable terrorist attack). Conveniently, Trump might decide never to re-institute the normal rules of law and subsequently appoint himself as Emperor.

One of my colleagues here in Beijing is a Texan, and he explained to me that such a wild idea could never happen in reality because Congress would never allow it.

Maybe.

But, if the Bush family and Republican Party are collectively unable to prevent Trump from becoming the Republican nominee, then I really don’t think that Congress will be able to stand in Trump’s way.

[Please let me know your thoughts on this issue. Do you agree with me? Or are you strongly opposed?]

Harnessing Creative Energy

China comes up for criticism in modern times for stealing software technology from the West.

Software is a language (or a set of languages) which can be used to make computer hardware do marvelous things, and because software is easy to copy (or reverse engineer), it’s easy to steal.

But if there is software stealing going on in China and elsewhere, should we really be concerned about it?

Software development is currently a fertile ground for creative minds to explore because the leverage provided by billions of computers and smartphones networked over the Internet means that a single piece of software can be used to solve problems and delight millions of people. And the additional cost of reaching one extra person is basically zero.

This presents a wonderful opportunity for creative minds to make a big impact.

And when it comes to stealing software, the reality is that creative types have been stealing from each other since the dawn of time.

In ancient times, travelling minstrels would borrow each others words, using the principle that “he writeth best who stealeth best all things both great and small, for the great mind that used them first from nature stole them all.”

In more modern times, Steve Jobs adopted the philosophy of a travelling minstrel, and is well known for stealing many of his best ideas including the idea for the computer mouse which he discovered at Xerox park.

Legal protections for intellectual property like patents and copyright remain important. But not for the reasons that most people will tell you.

The common line in the media is that patents and copyright are important because they protect the innovator’s profits, and therefore protect the innovator’s incentive to invent new technology and continue innovating.

This may be part of the story, and it is certainly true that many people are interested in profit. However, the biggest innovators in history have been the people who have pushed the boundaries because they were interested in the work. People like Galileo Galilei, Leonardo Da Vinci and Steve Jobs. They were not driven by profits but by a passion for the work.

And so, if the most creative people are driven by passion, and will do the work whether they get paid or not, then why are legal protections required?

Well, at the heart of the issue would appear to be the concept of “fairness”.

Discovering new technology is difficult, but copying a technology once it exists is often a task that any fool can accomplish. And once a new technology has been copied, the production process can often be scaled up quite quickly.

What this means is that, in the absence of legal protections, a fast follower might be able to scale up more quickly than the original innovator and thereby take most of the benefits from innovation.

This seems like a very unfair outcome.

And it is not the kind of outcome that is encouraged in countries that champion innovation such as Australia, America, or the UK.

By making legal protections available for new technology, a community can give the original innovator time to scale it up and the chance to make an impact. And this is the community’s way of saying thank you for the gift of a new creation.

An issue arises though when multiple countries are innovating concurrently, each playing by a different set of rules.

Should we be concerned if new technologies are being created in America, say, and then copied and scaled up overseas?

On the one hand, this seems quite unfair. The reason that firms in Silicon Valley are able to innovate and develop new technology is that they are located in a country that supports innovation and provides appropriate legal protections. Having secured these protections, though, many of these firms then turn to foreign companies to help them scale up production. Thereby transferring employment, productive capacity and tax revenues overseas.

It is easy to see how some people might view this as unfair.

On the other hand, most Economists would argue in favour of technology transfer and the offshoring of production to low cost jurisdictions. Average labour costs in China, for example, are low relative to developed countries, and so increased production in China allows the rest of the world to benefit from cheap imports (and Chinese workers to benefit from rising wages). Many young people in China aspire to study in Western countries and buy Western products, and successful Chinese firms are likely to invest overseas. And so, by helping China to become more prosperous, America and other developed countries are helping themselves in a kind of positive feedback loop.

One thing that seems clear is that the creative process involves two separate components. Firstly, it requires some kind of creative leap, which might involve discovering a new technology, or combining existing technology in a way that people really love. Secondly, it requires a viable business model that allows the organisation to provide the new offering at a price which exceeds the cost of production, which is likely to require economies of scale and production experience.

The role of Silicon Valley firms in making the creative leap and pushing the boundaries of innovation is crucial for the creative process.  At the same time, however, it might be argued that the role played by low cost manufacturers in places like Shenzhen, China is equally crucial because it allows new offerings to be created at sufficiently low cost to allow for viable business models.

Successfully harnessing humanity’s creative energy clearly requires high levels of cooperation. Lots of people in many different organisations working in various countries across the globe.

Thinking as an Economist, I would argue without hesitation that the more globalisation, foreign direct investment and international trade we have the better it will be for everyone.

However, we need to bear in mind that organisations and their respective country governments will typically care more about their own self interest rather than obtaining the theoretical optimal solution for the world as a whole.

Thinking as a strategist, I would provide some words of caution. When an organisation is thinking about outsourcing activities that provide value for the end customer, it is important to consider how strategically important those activities might be. Will outsourcing lead to the loss of crucial knowledge that will be difficult to re-learn? Is it possible that the supplier will become a future competitor? What are the firm’s competitive advantages and will these be strengthened or weakened as a result of outsourcing? Will the new supplier benefit from economies of scale and so be difficult to compete with later if necessary?

Thinking as a government policy maker, there are some other issues that might be relevant. For example, how many jobs and how much tax revenue might be lost as a result of local firms sending production overseas? Instead of providing welfare payments to unemployed people, would it make more sense to provide subsidies and tax incentives to encourage firms to incorporate and build production capacity locally rather than overseas? Is the outsourced knowledge important for national security? Are domestic firms outsourcing production to a country whose government is uncooperative or hostile to the values of the domestic country?

We live in a world where robots and the automation of work could lead to unprecedented levels of unemployment over the coming decades.  And so, it has never been more important for individuals, firms, government and the world at large to think about how we can harness our collective creative energy.

Globalization will have a large role to play, but it will also be important for individuals, firms and our respective governments to act independently and work for the benefit for their respective stakeholders. Through cooperation, we can all be made better off.

Efficiency vs Fairness

On Thursday 23rd of June, the British people voted by a majority of 52% to 48% to leave the EU.

This is a monumental event, and it is worth trying to piece together what happened, and what some of the implications might be.

The voter turnout was strong with around 72% of voters casting a ballot. However, the results showed significant division within the UK, with different regions and demographics supporting different sides of the argument.

In England and Wales, a majority voted to leave the EU (53% and 52% respectively). However, within England itself, voters in London overwhelmingly opted to remain. Similarly, 62% and 56% of voters in Scotland and Northern Ireland voted to stay in the EU.

Perhaps even more interestingly, there were significant divides between key demographics. Regions that had a greater percentage of young people, residents with higher education, and higher median income levels were much more likely to vote to remain in the EU. Whereas, areas with older, poorer and less well educated residents overwhelmingly voted to exit the EU.

What does this tell us?

Well, some of the key arguments put forward by the “remain” campaign were about the economic benefits of staying in the EU. Leaving the EU, it was argued, would lead to increased unemployment, lower levels of investment, and lower levels of growth for the UK economy.

On a basic level, these arguments make sense. Economic theory suggests that free trade can increase the overall surplus available to producers and consumers. And investors are also much less likely to invest in a country when there is a lot of uncertainty. Reduced investment can reduce economic growth, and lead to a self-fulfilling prophecy of reduced investment, lower growth and yet still lower investment.

If these economic arguments are valid, and staying in the EU is better for the UK economy overall, then why would 52% of voters opt to leave the EU?

Well, putting the lies of the “leave” campaign to one side, I don’t believe it is particularly helpful to characterize all of the more than 17 million British people who voted to leave the EU as either stupid or racist.

If staying in the EU is good for the UK economy overall and would increase the size of the economic pie, then it may be that many of the people who voted to leave the EU don’t believe they will receive a fair slice of the pie (or any pie at all).

The referendum result highlights a growing tension in the UK and worldwide between the neo-liberal model which favours free trade and deregulation of markets, and a more social-democratic model (practiced in the Nordic countries) which aims to reduce poverty and support universally accessible public services like child care, education, old-age care, and health services.

Even large investment houses are starting to appreciate the risk posed by inequality.

Joachim Fels, a global economic adviser at Pimco, an international investment firm, wrote in a research note: “As I see it, the vote in the UK is part of a wider, more global backlash against the establishment, rising inequality and globalisation.” And Pimco has advised its clients that “… investors must start to anticipate new populist policy responses.”

Immigration was a big issue during the Brexit referendum, however I don’t believe, unlike some of my esteemed friends, that pretty much everyone who voted to leave the EU in order to limit immigration is a racist.

Lack of jobs, rising levels of economic inequality and uncertainty about the future can easily explain why many people might have wanted to limit new immigration to the UK.

That being said, economic stress can lead to high emotions and the desire to find a scapegoat for ones problems. Following the Brexit result being announced, the UK appears to have experienced an increase in racial abuse. For example, London’s metropolitan police say that they have seen a 57% increase in reporting to the “Stop Hate Crime” website.

Racism is a serious problem, but I believe it is a symptom rather than a cause of the division that we are currently witnessing in the UK.

People in the UK with the money and power to do so need to look for ways to reduce inequality and provide opportunities for the most marginalized members of their respective communities. And in doing so, they might benefit by taking a closer look at the social-democratic model adopted in the Nordic countries.

Increasing the size of the economic pie is an admirable goal, but if the system is set up in such a way that a growing number of people get no pie at all, then we shouldn’t be surprised if hungry people manage to find a way to spoil the party.

Taking Profit

I am currently living in Beijing, lecturing strategy and finance courses to undergraduates.

One observation I’ve made is that the people here are good at identifying opportunities for profit.

And I use the word profit not in a financial sense, but with the broader meaning of the French verb profiter, which means “to make the most advantage of”.

This can have positive, negative and hilarious consequences.

Here are three examples:

  1. Food is a religion here in China. There is no better example of making the most out of life than having a true appreciation of good food. (Peking duck, jiaozi and baozi are my three current favourites.)
  2. People often say that the Chinese are hard bargainers, which is true. They see how big the pie is, and, with a friendly smile, they ask for all of it. This is obviously a generalization, but I have witnessed it enough times for it to have become a familiar pattern. It can be extremely positive, for example, if the person is your friend and is helping you to bargain for a big ticket item. It can also have calamitous consequences, such as the traffic jam which is frequently caused at an intersection near my apartment because every driver tries to gain a small edge by cutting through the intersection without waiting for a green light; a complete traffic meltdown typically ensues.
  3. Opportunity knocks at the door only once (机不可失,时不再来). I was recently at a large French retail store called Auchan. I left my shopping trolley at the end of a long isle, with a few items in it, and walked down the isle to see if I needed anything. When I returned to my trolley, I noticed that my items had been neatly placed on a shelf, and the trolley was gone. It took me a half a minute to figure out what had happened … someone had stolen my trolley! The experience was so bizarre. Five minutes later and a few isles further along I spotted a middle aged Chinese lady with a huge carry bag sitting in a trolley that looked suspiciously like the one I had lost.

Sometimes you have to laugh.

We would do well though to follow the Chinese example of trying to always make the most out of life, particularly where it involves a shared positive experience or the chance to create something valuable for others (like the wonderful Chinese cuisine!).

Profite!

Disclaimer: Creating traffic jams, and stealing shopping trolleys should generally be avoided.

In Search Of Returns

The wonderful thing about financial markets is that they help to get funds from people who have them to people who have a productive use for them. In other words, they help to make things more efficient by enabling money to be put to good use.

The problem with financial markets, though, is that more often than not participants insist on measuring everything based on “return on investment”.

Why is this a problem?

Well, return on investment is a measure which is interested in how much cash you will get back, and how quickly. If you assume a fairly conservative required rate of return of 7%, then cash received ten years from now would be worth about half as much as cash received today.

As a result, this way of thinking focuses the mind on short term gains, and encourages us to ignore the future.

A similar problem can occur in a social setting.

The wonderful thing about community organisations is that they can bring people together, and give people with particular talents an opportunity to contribute towards a constructive goal. In other words, they make communities more effective by enabling people to put their talents to good use.

The problem with community organisations, though, is that more often than not the people who lead them insist on measuring everything based on a “social return on investment”.

What does this mean? And why is it a problem?

Well, if you are willing to come with me on this thought experiment and assume that all human life has value. Or more broadly, that all life has value, then we can quickly see how measuring things based on their “social return on investment” can lead to questionable outcomes.

Imagine, for example, that you are the bishop of a Catholic diocese based somewhere in America and a Muslim community based somewhere in the Middle East has recently been bombed by American troops causing a large number of civilian casualties.

This is certainly a human tragedy, but you may be less likely to make a public outcry than you would have been if the affected community were Catholic. In other words, since your actions earn you less social returns, you may be less likely to act.

A focus on financial returns encourages us to ignore the future, and a focus on social returns encourages us to ignore the needs of people who might benefit from our assistance the most.

In either case, by thinking about what we might get from the deal, rather than about how we can contribute, we limit our freedom to act and the chance to make the world an easier, better and more enjoyable place to live.

Scarcity or Abundance

Not enough, or more than you need.

It’s generally one, or the other.

Are you working for the money, with grand plans for what you will do when you one day finally have “enough”?

Or are you just happy to be here, every day, because you can’t believe they are paying you to do what you’d happily do for free?

Are you waiting until you have the money you think you need, before you start living the life you want?

Or, do you look each day for new ways to increase the impact you can have with the resources you already have available to you?

Do you believe that the only way for you to win is if other people lose?

Or, do you view life as a chance to collaborate, and strangers just as friends who you haven’t yet had the chance to meet?

In some sense, wealth is a mindset.

And since a mindset is something which is free for each of us to adopt, then why not choose the way of thinking which ensures that you will always have more than you need. The approach which says “I love what I do!”, “I love finding new ways to contribute!” and “tomorrow is a new chance to do it all again!”.

The sky is falling

Back in September last year, the Wall Street Journal wrote an article about how low oil prices could lead to a global recession. An article by the Guardian last Friday repeated the sentiment with a suggestion that low oil prices could hurt the stock market.

Look out, Chicken Little, the sky is falling!

The doom and gloom argument appears to be based on two factors:

  1. Falling oil prices will hurt oil producers like Exxon and Chevron. Since these firms are large, falling profits will lead to lower share prices which in turn will pull down the market index and lead to a drop in the overall market. This would bad for shareholders;
  2. Secondly, the falling oil price will make it more difficult for oil companies to repay outstanding debts. When oil prices were high many Wall Street banks lent money to finance new drilling expeditions, and Dealogic estimates that the oil and gas industry has roughly $500 billion in outstanding debt. Increased levels of distressed debts could lead to stress in the banking sector.

Oil producers and the banks who backed their optimistic projects during the boom years will stand to lose in the new reality of low oil prices.

Luckily though the economy is composed of more than just banks and oil producers.

Richard Branson, the billionaire entrepreneur and philanthropist, provided some sound wisdom at Davos recently when he said that “oil prices are good for the consumer, they are good for most businesses. They are very good for the airline businesses. And obviously if you are an oil company they are not so good for you. But I think what the market has missed is that with oil below $30 a barrel and likely to stay there for a long time, that there is no need to try to make up a recession. This is going to be the greatest boost to the economy that you can imagine.”

In support of Branson’s view, The Economist reported on Saturday January 22nd that “the economies that have enjoyed the strongest GDP growth in the past year have .. been oil importers: India, Pakistan and countries in east Africa.” Similarly, in the IMF’s latest forecast, published on Tuesday January 19th, the economies that were spared a GDP growth downgrade — China, India, Germany, Britain, Spain and Italy — were all net oil importers.

While it is true that a slump in oil prices will produce winners and losers, and there are likely to be stormy waters ahead for countries like Brazil, Saudi Arabia, Russia and Nigeria, the good news is that the sky is not falling.

Attitude vs. Aptitude: What’s More Important?

Attitude vs Aptitude What is More Important

This is a guest post from Sarah Smith.

In many areas of today’s economy, numerous jobs go unfilled due to a lack of people with the proper qualifications. However, as this dilemma continues, more and more employers are starting to re-examine the typical business thinking that aptitude must always take the lead over attitude when it comes to new hires.

As Human Resource managers everywhere start to take a second look at typical hiring practices and begin to implement policies that put a greater emphasis on attitude, some supervisors and other management personnel still hesitate to adopt the belief that attitude carries more weight than aptitude.

Despite the growing debate, it appears attitude is slowly but surely moving its way to the front of the hiring line.

Employment Aptitude Tests

While tests such as these have been around for generations, fewer employers today rely on them when making hiring decisions. Instead, employers are much more interested in getting to know their employees and having them be excellent communicators with a wide variety of people.

While technical skills can be taught to new employees, having the right attitude cannot. Therefore, when employers find employees who may have great attitudes but not as much aptitude, they instead rely on such measures as online training and assessment courses to determine just how much they will need to teach the employee in order for the person to be considered competent within that field.

Training, especially in technical fields, will always be an expensive and time-consuming experience for employers, and so it’s vital that only those people who exhibit the right attitude be hired.

Communications and Business Acumen

In addition to hiring employees who have the ability to learn technical skills in a timely fashion, employers also look for people who have excellent communications skills as well as a certain amount of business acumen.

Looking for traits that would make one coachable is a vital key to the success of hiring attitude over aptitude, with most employers believing that the majority of people exhibiting these traits would be ones who would become good employees once taught the necessary skills.

However, because the line between attitude and aptitude is so very thin, some employers worry that these potential employees would not be good long-term prospects due to a lack of interest in the job. They argue that even though the person may exhibit desirable traits, if they don’t already possess the specific skills required for the job then that could indicate a lack of interest in that field of work.

So Which Is More Important?

Naturally, the question of attitude versus aptitude is not an easy one to answer. Different employers will have varying outlooks on the issue, so it ultimately rests with each individual hiring manager as to what is more important to them. However, as today’s economy demands having a workforce that exhibits a combination of technical skills and the ability to communicate well with others both verbally and in writing, it is becoming more accepted to hire those who are deemed to be coachable in both areas.

While always nice to have an employee who already possesses the skills needed to step into a job and pass a personnel performance evaluation, more employers are realizing those possessing a degree from the school of hard knocks have plenty to offer their companies as well.

Sarah is a small business owner, and is currently learning about marketing, using the internet. Aside from working on her own business, she likes to use social media, and read travel books.

Types of Capital

Types of Capital

(Source: Flickr)

There are different kinds of capital that individuals and organisations use to pursue their goals and deliver value.

Employees usually trade human capital (their individual time, talent and efforts) and intellectual capital (their thoughts and ideas) in exchange for financial capital (money).

Effort, ideas and money are not, however, the only forms of capital that exist.

There are at least six (6) different types of capital that individuals and organisations can use to achieve their objectives:

  1. Financial Capital – money, stocks and bonds. These are the most obvious forms of capital and some people focus on acquiring them to the exclusion of everything else.
  2. Human Capital – the time, energy and effort of individuals. Management consulting firms hire the best and brightest students and use them to produce new insights (and charge clients correspondingly high fees).
  3. Intellectual Capital – Ideas, knowledge, literature, software, proprietary technology and trade marks. Intellectual capital might be used as a substitute for human capital or to augment human capital and make it more productive and valuable.
  4. Material Capital – plant, property, equipment and computer hardware. The manufacturing industry often uses a lot of material capital in order to turn raw materials into finished products in an efficient way.
  5. Natural Capital – the farmland, hills, valleys, rivers, fresh air and oceans. Natural capital is the first and most fundamental type of capital upon which the other kinds are built. Unfortunately, profiteering capitalists and short sighted financiers often destroy natural capital in order to produce financial capital and maximise short term profits for shareholders.
  6. Social Capital – relationships, connection, recognition and prestige. Universities and religious institutions often produce large amounts of social capital. This form of capital would appear to be the glue which holds individuals, families, organisations and communities together.

Proven vs Actionable

You don’t always need proof that a threat exists in order to take action.

You don’t need to know everything, you just need to know enough to get moving.

In behavioural economics the common human bias towards doing nothing is called the “status quo bias”.

Faced with a difficult decision in the midst of uncertainty, people prefer to delay. And while non-action may sometimes make sense, the logical fallacy with the status quo bias is that a choice to do nothing is still a decision, and inaction can often be the most risky and costly choice of all.

One example of an existential threat faced by humanity is climate change.

Scientists first proposed the existence of human induced climate change some time during the 19th century, but it wasn’t until the late 20th century (a hundred years later) that scientists started to form a consensus view that greenhouse gases have been involved in most climate changes throughout history, and that human emissions are causing serious global warming.

If scientific predictions are borne out, then climate change could have serious effects including rising sea levels which threaten coastal cities, increasing incidence and severity of floods and droughts that threaten the food supply, and increasing levels of species extinction.

Despite the clear message coming from the scientific community (97% of climate scientists agree), and the significant damage that climate change could cause, policy makers and business people are slow to act.

The Kyoto Protocol, which was an international agreement that committed the governments of member nations to set binding emission reduction targets, was signed in 1997. However, it didn’t enter into force until 2005 and was never even ratified by the United States. Almost two decades later governments and business people continue to move slowly.

The problem is caused in part by what economists call “the tragedy of the commons”. Since each nation benefits directly in the short run from tax revenues derived from industries that emit CO2 emissions, and since the cost of environmental degradation will be borne by everyone and only in the long run, there is a strong short term incentive for each nation to pollute too much.

The other part of the problem though, which economists rarely talk about, is lack of leadership.

If we agree on balance that human induced climate change is a reality, and that the risks could be severe, then it logically follows that we will need to live in a much more carbon constained future; a future in which energy can be generated through clean technology which doesn’t produce CO2 and which doesn’t continue to put the global climate at risk.

Fortunately, there are a small number of leaders like Elon Musk (CEO of Tesla Motors and Solar City) who are pursuing new technologies with the goal of driving us forwards into a cleaner future.

Hopefully companies like Shell and others will start to take some action too.

Trust Based Business

I recently bought a coffee from Quarter Horse Coffee, my new favorite Oxford coffee house.

Not having exactly the right change, I asked the friendly bearded hipster behind the counter whether they accept card payments.

He told me that they accept payment by card, but they charge a 20P surcharge for amounts under five pounds.

I hesitated for a moment, to which he smiled and suggested, “oh, don’t worry, if you want to save the 20P, just pay me when you walk by here tomorrow.”

This was surprising to hear but at the same time wonderful. To meet someone genuinely helpful gave me a utopian glimpse of how life should be, but typically isn’t.

Large corporates typically don’t operate this way because the value of trust can’t be measured, and is therefore either undervalued or overlooked. Corporate executives and senior managers who studied discounted cash flow models and the CAPM model as part of expensive MBA programs from prestigious institutions of higher learning never stopped to learn the value of human connection, or the value of generating customer delight.

How are you connecting with your customers?

What are you doing to delight them?

Immediacy Bias

Immediacy bias

(Source: Flickr)

Whether it be pictures of cats on the Internet, a phone call from a friend asking you to come to the movies tonight, or a university assignment due tomorrow morning, we all suffer from it.

We tend to perceive immediate emotions much more intensely when making decisions about what we should do right now.

Three examples:

  1. People tend to view a charitable cause as more deserving if it arouses more immediate emotions. This helps to explain why scary diseases like cancer attract more donations;
  2. People tend to prefer hot chips with gravy over a healthy salad (although this might just be me); and
  3. People have a tendency to procrastinate, leaving the majority of the work until there is only just enough time to complete it. This is why projects typically set false deadlines (well in advance of the real ones).

The good news is that you can overcome the immediacy bias by exerting your willpower.

Donate to the most deserving charity!

Eat healthy today!

Get it done now!

Unfortunately, though, willpower appears to be a finite resource, and exerting self-control in one activity will reduce the amount of mental energy available for self-control in other activities.

Research conducted by Roy Baumeister and others in 1998 showed that people who initially resisted a temptation of chocolates were subsequently less able to persist on a difficult task.

Psychologists call this “ego depletion” and it has real implications for your performance and productivity in the work place.

How can you fight its effects?

Five suggestions for overcoming ego depletion and maintaining willpower in daily life:

  1. Regular snacking: A number of experiments have connected reduced blood sugar levels with reduced levels of willpower. Instead of having three big meals per day, with blood sugar levels dropping in between, it may be more helpful to graze throughout the day;
  2. Good vibes: People with a positive mood have been shown to exhibit improved willpower and self control. This is an interesting insight because it suggests that motivational speakers and positive affirmations (while seeming hokey) are actually valuable in helping us remain in control of our lives;
  3. Grit: Research has also shown that people who believe in their ability to persist stand better odds of doing so.
  4. Practice: Willpower is thought to be like a muscle. On any given day, exercising your self control will lead to fatigue. But over a longer time period, regular exercise will increase your stamina.
  5. Know your limits: Sometimes you have to know your limits and avoid temptation. Odysseus ordered himself bound to the sails to ensure that he could not be seduced by the Sirens song. In a similar way, you need to know your weaknesses and find ways to restrain yourself. If you have a weak spot for cookies, don’t place a large cookie jar on your desk at work.

You, Humans and Life

When a baby is born it knows nothing about the world.

So little, in fact, that it has no concept of self.

The baby, its mother, and the world are one.

As the baby grows it discovers the world for the first time. Hands, feet, pee, poop, mumma and dada. 

The baby’s mother whispers “you are special!”, and the baby establishes a sense of self.

I exist!

A few years later, the education process begins and the young child learns that she is part of a larger human community.

We exist!

And we are great!

For thousands of years though, the “we are great!” part was not assured.

Terrifying and wild beasts roamed the countryside. And men, the natural protectors of the family, could establish their courage and manhood by going out to hunt them.

The problem though is that times have changed.

The greatness of humanity is no longer in question, and our numbers are now 7 billion strong and counting.

Hunting no longer represents courage or manhood, any more than dueling, jousting or sword fighting.

Wild animals were once a threat to humanity, but it is now we who threaten them.

And as the times continue to change, we need to evolve our thinking if we hope to continue thriving.

We would do well to adopt a more balanced approach, and appreciate that while humans may be pretty great, we’re not half as great as life is!

Cannibalisation Is Not A Useful Choice Of Language

Phil Libin, CEO of Evernote, doesn’t like the word “cannibalisation” because it’s zero sum. It implies that you’re the guy doing the eating or being eaten.

He says being in business is not like playing a sport or being in warfare. It’s more like music, it’s more like art. It’s not a zero sum game.

I absolutely agree with Libin, and in the long run his view is the only healthy and constructive way to think about business. However, this doesn’t account for the popularity of books among business people like Sun Tzu’s “The Art of War” or Machiavelli’s “The Prince”.

What’s going on here?

Why does Libin think about business as music, whereas many others think only of warfare?

A first explanation is that most people who think and write about business are not C-suite executives or founders of successful companies, and so they are typically exposed to the hostilities that are inevitable in trying to rise upwards. Even in the friendliest of work environments employee performance will be reviewed annually and productivity will be compared against other employees working at the same level.

Large professional service firms typically place employees in a kind of tournament like dynamic where they are shown the promise of a small number of well-paid managerial roles and the implicit threat of being fired if they fail to perform better than their peers.

A second explanation is that some industries are more zero sum than others.

Any industries dealing in the real world of atoms (for example, mining, farming or transportation) are likely to see the world in a more zero sum way. The customer either buys my coal, corn or transportation or they buy someone else’s.

Industries dealing in the virtual world of information on the other hand (for example, tech start-ups) are likely to see the world in a more collaborative way. After all, there is always more information and goodwill to go around.

That being said, I would suggest that Libin’s view of business should apply not just to the technology industry but to all sectors.

Economists have coloured our thinking by painting traditional business as a place where firms compete to maximise profits through the sale of goods and services, forgetting of course that businesses can only sell their products by first engaging in some form of marketing. And what is marketing, if not the pure and free exchange of information.

Libin is in the technology industry, but in a strange and unexpected way, so are we all. And as a result, talk of “cannibalisation” is not a useful choice of language.

Free Services vs Privacy Online

Big data (combined with data analytics and machine learning) offers exciting opportunities to decipher patterns and solve complex problems more quickly and cheaply than ever before, but it also has the potential to infringe the privacy of individual users.

Looking at a company like Evernote, which uses a freemium business model to help tens of millions of people be more productive at work, it would be easy to think that there is an inherent trade off between providing a free service and dealing with issues like surveillance and data oversight.

CEO Phil Libin rejects the idea that there has to be a trade off between free services and privacy online.

“We don’t have a big data problem”, he told Stephen Chambers in 2013, “we have millions of small data problems … Everything that people put into Evernote is yours, is private and it should be completely up to you what you want to do with it.”

A few years ago, Evernote published three principles of data protection:

  1. Your data is yours,
  2. Your data is protected (that is, it is not data mined or used for affiliate marketing), and
  3. Your data is portable (that is, you can easily take your data and leave).

Libin’s principles for data protection are admirable, and they certainly provide a level of comfort for Evernote users that doesn’t exist everywhere elsewhere.

Facebook, for instance, has been pretty cavalier with user data over the years. Whether it be adding features that share a user’s location, preventing users from easily downloading their own data, or it’s recent and widely criticised Internet.org initiative to provide a limited number of free internet services in developing markets which digital rights groups have argued undermines net neutrality, freedom of expression and the privacy of users.

While Evernote actively favours data protection, there are strong indications that Facebook definitely doesn’t.

Why do Evernote and Facebook have such a different approach to data protection?

The answer appears to lie in the different business models that the two companies have chosen to adopt. Facebook is a free service and apparently always will be. It makes money through ads, and exploits user data in order to serve those ads more effectively. On the other hand, Evernote has adopted a freemium model. It offers a free product to all users and offers a more premium version of the product to paying customers. Happy customers can upgrade if they want to, and this is where Evernote makes all of its money.

There is money to be made online through targeted ads, and this is how Google and Facebook make money. There is also money to be made by providing products that people are willing to pay for, and this is how Netflix, Audible and Evernote make money.

The issue with the targeted ad approach is not that it lacks profitability, but that it requires the companies involved to harvest and analyse user data, and these companies are often elusive about exactly what data they are collecting and how they are using it.

Transparency would restore a lot of trust.

Do you have assets?

Do You Have Assets

(Source: Flickr)

When can you consider something that you have to be an asset?

This may sound like a funny question, but it is particularly important for the success of organisations and your success as an individual.

The answer turns out to be largely a matter of perspective.

If you are an accountant, then your goal is to categorise resources into groups: assets, liabilities, and equity.

From this perspective, assets will be resources that are owned or controlled by an organisation, and which can be used to better operate the business. These might include things like cash, inventory, property, plant and equipment.

If you are a financier, however, then your goal is a little bit different.  You are not trying to categorise resources into groups but rather to maximise your return on investment.

Looking at it this way, assets will be resources that increase in value or generate cash flow. This would include things like stocks (preferably dividend paying), interest bearing loans, bonds, and rental property. However, this perspective will tend to undervalue assets that don’t produce returns sufficiently quickly, and will basically ignore any value produced more than five years in the future.

If you are a strategist, then your goal is different again. You may have one eye on cash flows, but you are basically trying to ensure your organisation’s long term survival and prosperity.

With this in mind, assets will include resources that help the organisation maintain and strengthen its position over the longer term. This will include things like brand recognition, scale of operations and proprietary technology.

If you take the perspective of the financier, then you would rightly conclude that the paid subscriber base of media companies like The Australian, The New York Times and The New Yorker are assets since they undoubtedly generate a healthy stream of short term cash flows.

If you take the perspective of the strategist, however, then you may start to feel slightly uneasy.  In the world of digital media scale of operations is a critical strategic asset, and so steps that artificially limit subscriber numbers (by, for example, charging a subscription fee) are likely to inflict damage on the value of these organisations over time.

An asset may be an asset, but from whose perspective?

It may be a good time to take stock.

Impending Grexit?

Greek Exit

(Source: Flickr)

We have seen this week some heated negotiations between Greece and its European lenders.

Here are some of the issues facing Greece at the moment:

  1. Technical default: Greece is due to repay €1.6bn (£1.2bn) to the IMF at the end of June. On Wednesday, Athens announced that it is stony broke and will not be able to pay up. As I understand it, this amounts to a technical default.
  2. Troika withholds money: The Troika (i.e. the European Commission, European Central Bank and the International Monetary Fund) are withholding the last tranche of money from Greece’s second bailout until Athens agrees to make a number of painful economic reforms.
  3. Political deadlock: Alexis Tsipras, Greece’s prime minister, came to power on an anti-austerity ticket in January and is refusing to accept calls from the Troika for new austerity measures.
  4. Emergency Liquidity Assistance in doubt: Emergency Liquidity Assistance (ELA) is support which the ECB has been providing to Greek banks as they suffer from dwindling deposits as worried Greek savers continue to pull money out of their accounts. As the name suggests, ELA was intended to be a temporary measure; will the ELA scheme be continued?
  5. Greek Exit?: If debt negotiations remain unresolved by the end of the month, Greece will default on its repayment obligations. If this happens, one possible scenario is that emergency liquidity assistance will come to an end, there will be a run on Greek banks as people scramble to withdraw their money, and the Greek government will impose capital controls to prevent money from leaving the country. Chaos is likely to ensue, and Greece may exit the currency union and the EU. Since the Greek economy is small in relative terms (around 1.4% of EU GDP), failure by the Troika to contain the Greek debt crisis may lead to reduced confidence in the European project and the spread of financial contagion to other highly indebted EU member countries.

Watch this space.

Libin’s Law

Libin's Law

(Source: Techworld)

Phil Libin, founder and CEO of Evernote, was one of the guest speakers during Silicon Valley Comes to Oxford which was hosted at Oxford’s Said Business School a fortnight ago.

As part of the conference there was a debate held at the Oxford Union, the world’s oldest debating society, the motion being “This House Believes that Humanity’s Augmentation with Technology Creates a Better World”.

The debate was a heated one, and Libin was a speaker for the proposition.

In making the case for technological progress in general (as you would expect from a tech founder), and for human augmentation in particular, Libin argued that “[t]he upsides of making people better and making people smarter will far outweigh the downsides.”

At the same time he was quick to acknowledge that some of the potential risks associated with human augmentation are likely to come true, and we will need to be prepared to minimise and mitigate these risks.

These risks were variously acknowledged to include (a) the creation of an unrivalled and potentially immortal tech elite, (b) the creation of artificial intelligence which has been characterised by Stephen Hawkings and Elon Musk as a technology with extreme downside risks, and (c) the creation of greater inequality worldwide since only the wealthy will be able to purchase augmentation technology in the early stages, and so they may gain a self-sustaining advantage over everybody else.

In response to the risks outlined by the opposition team including their references to Murphy’s law, Libin proposed a law of his own.

“The opposition talk very intelligently about Murphy’s Law … but there’s an alternative to Murphy’s Law, which I’d like to propose here. In fact, I would very much like from here on out, for this to be known as Libin’s Law … It’s the combination of Murphy’s Law and Moore’s Law. It says that the number of things that go wrong will roughly double every year and it’s for this reason that we need technology and that we need augmentation.”

Whether it be artificial intelligence, or some other form of existential threat like climate change or nuclear proliferation, are you inclined to agree with Phil Libin? Do we need to augment humanity in order to protect and save it from these escalating risks?

What’s Going On At FIFA?

What's Going On At Fifa 2

(Source: Flickr)

Seven senior FIFA officials were arrested on Wednesday at a high end Swiss Hotel as part of a larger two decades long investigation by the FBI into corruption at FIFA. The alleged wrongdoings include racketeering, wire fraud and bribery to the tune of more than $150 million.

The arrests occurred just prior to FIFA’s presidential election, in which current president Sepp Blatter was expected to be re-elected. Blatter should have known about the problems at FIFA, and only through his complacency could any wrongdoing continue to run rampant.

The Economist, Richard Branson and other high profile figures have been quick to call for a cleansing and reinvention of football’s world governing body. If Blatter was a corporate CEO then he would surely be fired for his negligence or complicity in the corruption; why should the consequences be any different just because he is the head of the world’s governing body for football?

The reason that FIFA may fail to reform (and Blatter may fail to resign) is that FIFA is a very powerful organisation.

Football is an international game and universally loved by millions of people from a diverse range of cultures and backgrounds. For many people football is more akin to a religion than a sport, and the institution at the center of the football cult is FIFA. It controls television and marketing rights to the World Cup which are worth billions of dollars, and the concentration of so much power in one organisation has led to what the concentration of too much power typically leads to, endemic bribery and corruption.

It is also unclear whether sponsors will withdraw their backing.

Sponsors pay for marketing, and the World Cup has millions of fans worldwide. The problem of course is that sponsorship dollars, coming from the likes of Adidas, Coca-Cola, Visa and Hyundai, help to support and enrich a corrupt organisation.

Being associated with scandal puts the reputation of sponsors at risk, and so the more people who talk about what’s happening the more likely they will be to reassess their involvement with FIFA.

Australia Is An Innovation Laggard (Nigel Lake, Part 10 of 10)

Australia, The Innovation Laggards

(Source: Flickr)

This is the tenth instalment of my conversation with Nigel Lake, CEO of Pottinger, a global corporate advisory firm based in Sydney, Australia. Nigel is the author of The Long Term Starts Tomorrow, a must have book “for any manager, leader or Minister.” The Hon Mike Baird MP, Premier of NSW

Tom: There has been a lot of support given to entrepreneurs in the UK in the last few years which seems very promising. Do you think that Australia is perhaps falling behind in that area?

Nigel LakeNigel Lake: Australia is 11 hours ahead of GMT, and about 10 years behind at least.

It is not a question of “is Australia falling behind?” Australia is massively behind.

I moved [to Australia] in 2003 and was amazed by the almost complete lack of online anything. Wind the clock forward and the online businesses of the big companies are still terrible. So there has been an amazing lack of innovation.

[Pottinger is] quite plugged into the entrepreneurial universe here through the universities, through some of the people who have invested in those companies, and through the incubators and so forth. We have put a fair amount of time into trying to support the evolution of that whole ecosystem because we think it’s amazingly important.

[Australia has] a political environment where there is a significant disaffection with science in general. There is a real love of things which are steeped in the past. There is a great unwillingness on the part of business here to embrace things which are new.

The poster child for success is Atlassian, the tech company, which sold its product in 10 or 15 countries to dozens of large companies before an Australian company would buy any of its products.

They are based in Sydney and had a fantastic platform for making your own wiki. They had a similar platform for managing agile software development programs, which is now used in many large companies around the world. Australian companies were at the end of the queue, despite the fact that the company is actually based in Australia.

Tom: So it sounds like there may be a cultural issue that Australia needs to overcome. I know that after finishing university a lot of the smartest people either leave Australia or take plum jobs in the established order of things. There appears to be a missing segment of the economy which exists in the UK and the U.S. And that is, young people trying to change things and create new businesses.

Nigel Lake: You just need to look at the university world. In most countries around the world, university students are pretty radical and protest about everything all the time. I have never heard an Australian student protest about anything apart from whether the temperature of their cappuccino is quite right.

There is an endemic acceptance of the status quo as being nice and comfortable and really quite reasonable, which to a significant degree it is. But you don’t have a change the world mentality, and people who want to change the world, as you said, they just get on a plane and they go somewhere else where they feel more welcome.

The only way you can change Australia is by changing its leaders. And that is about political leadership and business leadership. It’s an absolutely massive endeavour to attempt to do that. The challenge is that the political leadership comes out of the party system, which is breaking down in Australia as it is in the UK, but it is hard to see where that inspirational change the world leader will come from in Australia.

Price and Value

Price and value, there is a difference.

Price is what you pay for something; the number of dollars that you need to part with in order to obtain it. Value is what you receive; the positive feelings or practical utility that the object or the experience imparts.

I recently had my birthday, and I was delighted to receive a wonderful birthday present from my family in Sydney.

I logged onto Facebook in London, and found that my family had posted the following picture.

Price vs Value

The price of a piece of cardboard and some crayons: $1.

The value of receiving a “Happy Birthday Tom!” poster from all the family: priceless.

The death penalty is cruel

I Stand For Mercy

(Source: Virgin.com)

It was very sad to hear about the eight people executed by firing squad by the Indonesian government, including two Australians.

The death penalty is cruel. People who traffic drugs may be desperate, reckless, foolish, greedy or a combination of all of these things, but they are still people.  And killing people is barbaric.

The evidence has shown that the death penalty is ineffective as a deterrent.  Drugs are a problem in many countries, but executing drug mules and distributors misses the broader perspective that drugs are a social problem caused by supply and demand.

The people who traffic drugs don’t control the supply.  They are caught in the middle of a larger game and killing them won’t put an end to the drug trade. It also does nothing to improve public health, educate young people or rehabilitate drug addicts.

#IStandForMercy

Anchoring

Anchoring

(Source: Flickr)

Anchoring is a common psychological effect whereby people tend to rely too heavily on readily available information (the “anchor”) when making decisions involving uncertainty.

To illustrate the point, let me ask you two questions:

  1. Is the population of Argentina greater or less than 80 million?
  2. How many people do you think live in Argentina?

Write down your answers to these two questions, and then continue reading.

Have you written down your answers?

If you are like most people, then you probably have no idea how many people live in Argentina. In order to take a guess, it helps to have some kind of reference point and my first question gave you a clue: Is the population of Argentina greater or less than 80 million?

The population of Argentina is actually around 41 million, about half of the anchor I provided.

How far off were you?

If you are like most people then your guess probably overshot the mark by quite a bit. You couldn’t help but be influenced by the information that I provided, even though the information was arbitrary and extremely inaccurate.

Anchoring is a quirk of human psychology that can be used to entertain first year psychology students, but more importantly it is a common and pervasive cognitive bias that affects the way in which people make decisions and is relevant in many business contexts.

Here are just three (3) examples:

1. Price Negotiations

A sophisticated buyer in a price negotiation will always want the seller to name the first price. By making the seller name her price this sets an anchor, a maximum price from which the buyer can negotiate downwards.

If the seller names an unrealistically high price then the buyer will want to emotionally reject the price, perhaps by exclaiming shock, disgust or pretending to walk away.

The buyer may still be interested in continuing the negotiation but by emotionally rejecting the initial offer the buyer hopes to break the anchor so that negotiations can begin afresh.

2. Sales

I once bought a Helmut Lang sweatshirt retailing for $400, which happened to be on sale for $80.

Up until sitting down to write this article I had always believed that I had scored an incredible bargain, but the reality appears to be quite different.

Retailers use the “recommended retail price” as an anchor. At sporadic intervals they can then offer a far more reasonable “sale price” which draws shoppers to the store in the belief that they are obtaining a bargain.

The sale price may in fact be a bargain, but only in the same sense that my Helmut Lang purchase was a bargain; a reduction in price from an artificially high starting point.

3. Stock Trading

Algorithmic traders can use their knowledge of anchoring to gain a statistical edge in the stock market.

Many traders will use a recent high or low price as an anchor to determine whether prices are “too high” or “too low” and an algorithmic trader can use this fact to develop trading systems that allow her to trade with positive expectation over the longer term.  (For a good book on this subject, get yourself a copy of Way of the Turtle by Curtis M. Faith.)

The Connection Economy

Connection Economy

(Source: Flickr)

Traditional strategic thinking, the kind championed by HBS Prof Mikey Porter, says that real economic value is only created when a company can sell a product or service to customers at a price that exceeds the cost of producing it.

In other words, companies are entities that sell products or services, and strategic thinking is all about figuring out how to do this profitably. End of story.

This view seems to make sense, and in a world before the Internet it definitely made a lot of sense.

The problem though is that business on the Internet is not primarily about selling products and services.

The Internet allows people to connect with each other at pretty much zero cost, and successful Internet-based companies like LinkedIn, Facebook and eBay have accepted this reality.

By building business models that enable people to connect around a common interest or shared purpose in a way that can be scaled these Internet-based companies have produced significant economic value in a way that is often sustained not by the sale of products or services but through advertising, commissions, memberships and distribution fees.

The Internet enables connection, and an economy where people produce economic value by building markets and communities.

For tech founders monetisation is often a second-order problem, and while part of the solution may involve selling products and services, this will not always and not necessarily be the case.

Part of good strategic thinking involves accepting the world as you find it, and adapting your approach.

Is your business connecting with people, or helping people connect with each other?

Should it be?

Gatekeepers vs Enablers

OVER the past weeks we have been reaching out to various university career services teams to let them know about the free consulting resources that we have produced for students.  If you missed this development, you can access all the resources here.

The interesting thing about this process of reaching out to different universities is the vastly different responses that we have received.

And it’s basically the opposite of what you would expect.

Before reaching out we expected that, if responses differed at all, then it would be the most prestigious and well endowed universities whose career services teams would be the most reluctant to consider new career resources. After all, these universities are already well resourced and are hardly in need of help.

Strangely, we experienced the opposite.

Schools such as Wharton, LSE and HKU responded promptly and with thanks for letting them know about the new resources that we have made freely available for students.

In contrast, career services teams at some lesser known schools, which will remain nameless, seemed a bit put off by the new resources. Adding a link to the website or sharing an email takes about 1 minute, but perhaps that’s more work than they are accustomed to?

What exactly explains the difference in response?

The answer, it seems to us, lies in the distinction between gatekeepers and enablers.

If you are the director of career services at a prestigious university, then you probably quite qualified, motivated, well resourced, and see it as your role to help students with their careers as much as possible, even if that means referring them to a third party resource. In short, you are an enabler.

In contrast, if you are in the career services team at a lesser known school, you might be slightly under funded, and trying to make do the best you can. You are constantly juggling for time, and when new demands are placed on you, the best response is usually to to defer, delay or say ‘no’. In short, you are a gatekeeper.

A fair assessment, or are we being too harsh?

Do you have any experience dealing with gatekeepers? What strategies have you developed to get around them? (or to go over, under or through them?) Please share your thoughts in the consulting forum.

Wealth

Where do you place value?

Wealth

(Source: Flickr)

ONE of our heroes, New York based consultant Alan Weiss, has a unique perspective on wealth. He regularly shares the view that “wealth is discretionary time”.

The reason his approach to wealth is so striking is that most people, at least those of us living in Western market based economies, tend to think of wealth as money.

To be wealthy is to have a lot of money, no?

Well, it depends on what you value.

If we take a broad definition of wealth, then we might say that wealth means “an abundance of valuable possessions”.

The catch with this definition is that you get to decide what’s valuable.

Here are a few options that you might want to consider:

  1. Reputation
  2. Skills
  3. Capacity to delight and solve problems for other people
  4. Free time
  5. Memories and experiences
  6. Friends and family
  7. Cars, houses and boats
  8. Fame and fortune

It’s your story, and you get to make choices.

Where do you place value?

William Black on Global Financial Stability

WILLIAM Black, former bank regulator and Professor of Economics and Law at the University of Missouri, witnessed first hand how banks took control of the banking system to commit fraud on a colossal scale.

In his TED Talk from last year (watch it below) Black talks about “liar’s loans” and other tactics that the banks used to bring the global economy to its knees during the 2008 financial crisis.

Black makes a clear argument that the way to prevent future banking failure is to prevent “control fraud”, the situation where a CEO takes control of a legitimate entity (for our purposes, a bank) and uses the entity to commit fraud and get rich in the process.

Black provides a bleak outlook for the ongoing stability of the global financial system, arguing that a number of key regulatory reforms are needed (including shrinking “too big fail” banks so that they no longer pose a systemic risk).

The Emperor’s New Clothes

THE Emperor’s New Clothes, the famous fairy tale by Hans Christian Andersen, tells a story of a vain Emperor who enjoys parading his fine clothes around town.

One day a pair of swindlers promise to weave a magnificent suit of clothes for him which are so fine, they tell him, that they are invisible to anyone who is unfit for his position or unusually stupid.

The Emperor and his ministers couldn’t see the clothes but each of them pretends that he can in order to avoid appearing stupid. The townspeople, upon hearing the story of the clothes, also pretend to see the clothes.

The story ends with the Emperor parading his new clothes through the streets until an innocent child shouts “the Emperor has no clothes!” and everyone suddenly realises the truth.

The Emperor’s New Clothes is just a fanciful children’s story. Surely nothing this silly could happen in real life, could it?

Apparently it can, and examples abound of social situations that revolve around a convenient fiction. This often leads to hardship and misfortune.

You may have heard people say some of the following:

  1. Property prices always go up (hint: they sometimes go down and quickly)
  2. The purpose of business is to maximise profits (hint: the aim is actually to provide value to other people in a way that allows the activity to be sustained or scaled)
  3. Money is real (hint: money is social fiction backed by trust – it used to be backed by gold but that got expensive)
  4. Quantitative easing is a legitimate monetary policy tool which is not the same as printing money (hint: quantitative easing is ipso facto exactly the same as printing money, and is the kind of activity that led to hyperinflation in Weimar Germany and Zimbabwe)

Can you think of any other examples of “the Emperor’s New Clothes”? Share your thoughts in the forum.

Learning From Experience

A natural and unstructured process that results from doing the work

Learning from Experience

(Source: Flickr)

LAST week we looked at the value of breaking with experience, which followed on nicely from our initial article on the Experience Curve.

This week we focus on learning from experience. What does it mean to learn from experience? And what role does management have to play, if any?

In his book Competitive Advantage, Michael Porter states that “learning does not occur automatically but results from the effort and attention of management and employees … Management must demand learning improvements and establish targets for them, rather than simply hope that learning will occur.”

What is Porter talking about? Is he suggesting that a firm should be run like a university where management lays down a clear curriculum and set of learning outcomes?

Yes, it certainly seems that way. Porter appears to be suggesting that learning is a top down process which management can decree with a snap of its fingers and a pithy incantation, “let there be learning”.

He appears to have things backwards.

If you think of a school curriculum as a pre-planned course of directed study taught as an end in itself rather than developed in response to the pressure of market forces, then learning from experience is exactly the opposite.

People and organisations learn naturally, and often serendipitously, as they gain production experience. This process of natural learning is what Nassim Taleb calls convex tinkering, the option-like trial and error process where people make lots of low cost “mistakes” (that is, discoveries which don’t lead to improved performance) and a handful of breakthroughs.

Convex Tinkering

In other words, learning is a natural and unstructured process that occurs as a matter of course when people show up and make an effort. As people gain experience they observe what works and what doesn’t work, and are thereby able to learn and improve.

People learn from experience. This is a pretty intuitive idea, but it leads to a strange result.

In our article on the Experience Curve we highlighted research showing that, for any given firm, the performance improvements resulting from production experience tend to occur at a predictable rate. That is, a firm’s rate of learning appears to remain fairly constant over time.

This is surprising.

If learning is a natural, unstructured, and somewhat serendipitous process then the last thing we would expect is for the rate of learning to be predictable.

What could be driving this phenomenon?

A possible explanation is that, while the chance of learning something valuable on any given occasion is uncertain, the rate of learning for a group of people over a period of time converges to a stable average (assuming of course that the business landscape and management policies remain unchanged). In other words, any randomness in the learning process may just cancel itself out.

If you are a statistics buff, then you will know that this sort of thing happens all the time when dealing with large amounts of data. So much so that it is has been given a name, the law of large numbers, a property by which the average result from a large number of observations of a random event should be pretty close to what you would expect. For example, if a large number of six sided dice are rolled then the average roll should be quite close to (1+2+3+4+5+6)/6 = 3.5 .

This is all very well, but why should we expect a firm’s rate of learning to be stable over time or, for that matter, to follow any predictable pattern?

We were at a total loss to answer this question, until yesterday that is, when we made a  happy and unexpected discovery by complete accident: a Youtube video about slime mould.


In the Youtube clip, Heather Barnett shares a fascinating story about how Physarum Polycephalum, otherwise known as “slime mould”, has demonstrated an ability to discover food, map territory, navigate a maze by the shortest route, and anticipate temperature changes.

Slime mould is a collection of single celled organisms with no brain, no nervous system, and no language. But despite these limitation, it has shown an ability to learn, remember and solve problems.

From single celled organisms on one end of the spectrum to large multinational corporations on the other, an ability to learn from experience appears to be an innate property of life itself. This is a tantalising and slightly torturous discovery since it means that the constant rate of learning revealed by the Experience Curve effect may defy a deeper explanation. It may be a shadow cast by something unseen and unknowable.

When Porter stated that “learning does not occur automatically but results from the effort and attention of management and employees” he was almost right. What he should have said, and what he perhaps meant to say, is that “learning does occur automatically and might be enhanced by the effort and attention of management and employees”.

Which brings us to the second question, how can learning be enhanced by the efforts of management?

A very good question, and one that deserves careful attention.

If you are interested to come with us as we continue to explore the field of organisational learning, please read next week’s article which will look at the 5 ways management can foster learning within a firm.

Breaking with Experience

Innovation involves breaking with the past to create something even more remarkable

Innovation Experience

(Source: Flickr)

THE traditional Experience Curve focuses on increasing production experience which leads to predictable cost reductions.

This kind of experience is relevant in industries that are relatively stable, competitive, and production-intensive.

Experience Curve Example

(Source: Wikipedia)

But what about high tech and creative industries where the lifecycle of a new product is only a couple of years? And what about pretty much every industry nowadays from music distribution to taxi services, which are open to disruption from fast moving well-funded digital entrepreneurs?

In many industries production experience is becoming less important than innovation experience, the track record of being able to consistently break with the past to create something even more remarkable.

To highlight the distinction between “production experience” and “innovation experience” you only need to look at Apple.

Under the leadership of Steve Jobs the company created a string of amazing products which opened up entirely new product categories: the iPod, the iPhone, the iPad. Apple’s strength does not rest on its production experience and, in fact, the company outsources much of its production to Foxconn, a Taiwanese electronics contract manufacturing company.

What about you and your business?

Are you learning how to break with the past, or focusing on creating more of the same but cheaper?

Experience Curve

The Experience Curve captures the relationship between increasing production experience and declining costs

Experience Curve

(Source: Flickr)

Background

The Learning Curve, the concept which predates the Experience Curve, was first described by German psychologist Hermann Ebbinghaus in 1885 as part of his studies into human memory.

In 1936, T.P. Wright described the effect of learning on production costs in the aircraft industry showing that required labour time dropped by 10 to 15 percent with every doubling of production experience.

In 1966, Bruce Henderson and the Boston Consulting Group conducted research for a major semiconductor manufacturer, in which they introduced the concept of the Experience Curve and revealed that unit production costs fell by 20 to 30 percent every time production experience doubled.

In essence, the Learning Curve and the Experience Curve capture the same big idea: performance improves with experience in a fairly predictable way.

How do the two curves differ?

In his 1968 article, Bruce Henderson distinguished the Experience Curve from the Learning Curve by explaining that the Learning Curve relates only to labour and production inputs, while the Experience Curve focuses on total costs.

On the surface his explanation sounds reasonable, but when you think about it what he was really saying is that the Experience Curve is the same as the Learning Curve, just with a slightly broader focus.

Henderson’s distinction was a clever conceit, and his trick allowed the Boston Consulting Group to take credit for an idea that had been in circulation for more than 80 years.

Legitimate or not, the rebranding exercise was effective and has meant that since 1966 the concept has been widely known in management and business circles as the Experience Curve with due credit going to Bruce and the Boston Consulting Group.

This article is entitled “Experience Curve”. We didn’t want to rock the boat.

Experience Curve Explained

The Experience Curve captures the relationship between a firm’s unit production costs and production experience. Research has shown that a firm’s costs typically fall by a predictable amount for every doubling of production experience.

Experience Curve Example(Source: Wikipedia)

Unit production costs tend to decline at a consistent rate as a firm gains production experience, however the rate will typically vary from firm to firm and from one industry to another.

The interesting thing about the Experience Curve is not that a firm’s performance improves with experience, we would expect as much, but instead that performance tends to improve with experience at a predictable rate.

This is surprising. What could explain such consistency?

Learning from Experience

In his 1968 article, Bruce Henderson noted that:

“… reductions in costs as volume increases are not necessarily automatic. They depend crucially on a competent management that seeks ways to force costs down as volume expands. Production costs are most likely to decline under this internal pressure. Yet in the long-run the average combined cost of all elements should decline under the pressure for the company to remain as profitable as possible. To this extent the [Experience Curve] relationship is [one] of normal potential rather than one of certainty … ”

While falling costs may not be inevitable, the Experience Curve effect is pervasive and so declining costs must result from some kind of innate human and organisational factors rather than from, say, the brilliance of a rock star management team or the well power pointed recommendations of a top consulting firm.

Where do the reduced costs come from?

While by no means an exhaustive list, factors that may contribute to the Experience Curve effect include:

  1. Labour efficiency – As employees at all levels of the organisations gain more production experience they gain skills, learn shortcuts, and find ways to produce more with less.
  2. Standardisation – Over time processes and product parts may become standardised allowing for more streamlined production.
  3. Specialisation – As production volume increases a firm is likely to hire more employees, allowing each of them to specialise in a narrower range of tasks.
  4. Optimised Procurement – As a firm gains production experience it will learn about its suppliers and what they have to offer, which will allow it to optimise its procurement practices.
  5. Product Refinement – A firm may engage in significant R&D and marketing prior to and during its initial product launch, but as it learns more about the product and its customers it will be able to refine the product for the requirements of the market. This may allow a firm to reduce ongoing R&D and marketing costs.
  6. Automation – Increased production volume may lead to the adoption of more automated and advanced production technology and IT systems.
  7. Capacity Utilisation – If a firm has incurred large fixed costs, then increasing production will allow it spread these costs across a larger number of units.
  8. Equipment Upgrades – Higher production volumes may justify investment in more advanced equipment.

Implications for Strategy

The Experience Curve effect shows that a firm’s production costs decline in a fairly predictable way as it gains production experience.

What are the implications for corporate strategy?

In 1968, in light of BCG’s research, Bruce Henderson took the view that a firm should price its products as low as would be necessary to dominate their market segment, or else it should probably stop selling them. The same year BCG also developed its now famous growth share matrix, a framework that recommends allocating resources within a firm towards products that are, or are going to become, market leaders.

The clear and resounding message from Henderson and BCG was “dominate the market or don’t bother”.

The thinking behind this rather clear-cut view was that a company with market share leadership would be able to gain production experience more quickly than its rivals and so would be able to achieve a self-sustaining cost advantage.

As it turns out though, pursuing market share leadership will not always be beneficial. There are four countervailing forces that can neutralise the benefits of this strategy.

Firstly, market share may not confer a cost advantage since firms can learn not just from production experience but also from books, courses, formal training, conferences, reverse engineering, talking to suppliers and consultants, and by poaching staff from the competition.

Secondly, if multiple firms pursue market share leadership at the same time then this can create intense rivalry and destroy industry profitability.

Thirdly, new entrants can often avoid going head to head with the market leader by creating more advanced products or using more efficient production technology. This can allow new players to leap frog the competition and force existing firms to play catch up by investing heavily in R&D, forming strategic alliances or acquiring the upstarts for a princely sum.

Fourthly, even if market share leadership does confer a cost advantage there are other ways to compete effectively. Firms can gain an edge by creating unique products or by focusing on niche segments of the overall market (see Porter’s Generic Strategies).

So, where does this leave us?

Well, a firm that aims to be the cost leader within its industry will probably want to pursue market share leadership since the Experience Curve effect and economies of scale will allow it to reduce costs.

On the other hand, a firm that aims to compete by providing a unique offering or by serving a market niche may find the pursuit of market share leadership detrimental. A firm that provides unique or targeted products will generally be able to charge higher prices and this will limit potential sales volume. If it makes its products more generic in an attempt to appeal to the mass market, then this could destroy the “je ne sais quoi” which made the firm successful in the first place (see “Stuck in the Middle”).

Market share leadership can work, but it will not be the correct strategy in every situation.

Stock and Flow

Advice for The Australian and other failing newspapers

Late last year at the Oxford Union we had the opportunity to talk with Tim Ferris, author of the 4-Hour Workweek, about his tips for successful blogging.

Tim’s key piece of advice, an echo of every good guidebook we’ve read, is that bloggers who are just starting out should focus on producing “evergreen content”. That is to say, publish content that will be just as interesting in 6 months time as it was the day it was written.

Tim Ferris knows what he is talking about, and his advice is sound. But why?

Well, in order to understand what Tim’s talking about, you need to understand the difference between “stock” and “flow”. (Very simple concepts, but incredibly powerful.)

Stock is how much you have of something at a point in time, whether it be money, property, equipment, or interesting articles. Flow, on the other hand, measures the rate of change over a period of time: income, expenditure, production of new articles, or the depreciation in value of old ones.

Not surprisingly, the value of an online publication derives in part from its stock of interesting and insightful content.

The most obvious way to make this number go up is to write more, increase production, and burn the midnight oil. We had coffee with a journalist from The Australian recently, and understand that they are doing just that. They are working harder than ever, but with shrinking expense accounts and diminishing job security.

The problem with merely writing more is that news articles are losing their value more quickly than ever. Breaking news becomes old news within 24 hours, and the fair use exception means that news aggregators can pinch chunks of content without paying for them.

Could it be that Tim’s advice for rookie bloggers is relevant for struggling newspapers too?

Producing content with a more enduring value may help them to stem the flow.

Monopoly Money

If you were playing Monopoly, Quantitative Easing would be the equivalent of helping yourself to a $100 note every time you rolled the dice and never having to pay it back

Monopoly

(Source: Flickr)

CENTRAL banks continue to finance government spending by easing monetary policy in order to help economies get back to “potential output”. (It remains unclear whether Grand High Priest Bernanke slaughters a lamb before proclaiming what the level of “potential output” should be for the US economy. It would be interesting to know.)

Quantitative easing (referred to as “QE”) is an unorthodox monetary policy tool that involves creating new money to buy assets, usually in the form of government bonds. The policy was introduced during the financial crisis to enable central banks to continue stimulating the economy even as interest rates approached zero (see, liquidity trap). During the crisis the policy was viewed by many people as helpful in providing liquidity to the banking system and in preventing long term interest rates from rising.

In America, the Federal Reserve pursues QE by buying US government bonds in the secondary market, which basically gives the government a blank cheque to sell as many bonds as they want to private investors in the primary market (who then turn around and on-sell these bonds to the Fed in the secondary market).

QE makes things easier for a cash strapped government in times of crisis by providing a willing buyer for their bonds.

But by allowing governments to continue running deficits, QE removes the need for fiscal discipline.

Where will it end?

The Fed already owns around $2.3 trillion of Treasury bonds, and the Bank of England owns around £375 billion of gilts. Any attempt to sell these bond could result in an unwanted rise in interest rates. And, The Economist reports that Mark Carney, Governor of the Bank of England, recently signaled that the Bank is not expecting to sell all of its holdings.

What does this mean exactly?

In effect, central banks are providing their governments with interest free loans financed by printed money. If you were playing Monopoly, this would be the equivalent of helping yourself to a $100 note every time you rolled the dice and never having to pay it back.

Or, to speak more plainly, our governments are cheating us.

The Power of Persuasion

How can you get what you ask for? How can you significantly increase the chances that another person will say yes to your request?

ROBERT Cialdini, best-selling author of Influence: The Psychology of Persuasion, gives an insightful talk on how you can persuade people to do what you want.

As a tenured professor, Cialdini jokes that academics are people who are not satisfied by something that works well in practice, until they’ve tried it out in theory.

But after acknowledging the weakness that academics tend to have for pointless theorising, Cialdini goes on to provide 6 practical principles that we can implement immediately in our personal and professional lives to become more persuasive and influential.

The speech above is well worth watching but, if you don’t have a spare hour, just read our dot-point summary below.

Cialdini’s 6 Principles of Persuasion

Influencing the behaviour of others can be difficult and is, in some sense, an art-form which can only be learned through the trial-and-error of life experience.

Despite this, there are some techniques that research has shown can be used to increase the likelihood that people will do what you ask them.

Cialdini provides us with 6 Principles of Persuasion:

  1. Scarcity – Scarcity adds value. By artificially limiting supply, you can make your offering more attractive. This applies equally in the world of business and the world of dating. Cialdini gives an example of a beef wholesaler who was able to increase her sales of beef by telling customers that there would be a shortage of beef in a few months time. And in the world of dating, if your dating experience is as ludicrously hapless as your author’s, you may have noticed that the appealing girls (or guys) tend to be the ones who are already in a relationship. This is no coincidence. We want what we can’t have since scarcity adds value.
  2. Exclusivity – People are attracted to exclusive offerings. Clubs, schools and universities are all more appealing if they are able to develop an aura of exclusivity. Cialdini builds on his “beef wholesaler example” by explaining that when the wholesaler informed customers that her intel about the impending beef shortage was from an exclusive source, people responded more positively and bought more beef. It was the same offer, but its exclusivity made it more persuasive.
  3. Authority – People respond positively to authority figures. Cialdini explains that authority can be established by demonstrating expertise and trustworthiness. This can be done by first bringing to the surface a weakness in your offering, and then presenting your strongest arguments which overwhelm the weakness. By presenting information in this way, it helps to demonstrate your expertise and trustworthiness, and thereby establish you as an authority figure.
  4. Consistency – People are more willing to act consistently with what they have already said or done. Cialdini provides an example of a telephone receptionist whose job was to take restaurant bookings. Faced with the problem of “no shows” (that is, with customers who make a booking and then fail to turn up), the receptionist was able to dramatically reduce the issue by adding two words to her parting remarks. Instead of telling the customer “please call if you want to cancel your reservation” she changed her closing remarks to instead ask them “will you please call if you want to cancel your reservation?” After giving a verbal promise, customers were significantly more likely to fulfill their booking.
  5. Consensus – In deciding what to do, people often take their cue from the behaviour of others. This phenomenon is known as “social proof” – prevalent in ambiguous social situations where people imitate the actions of others in an attempt to adopt appropriate behaviour. Cialdini gives the example of a telly marketing company which exploited this behavioural quirk by getting the presenter to change the closing remarks of her pitch from “Operators are waiting, please call!” to instead say “If operators are busy, please call again!” The second form of words suggests that the operators may be busy, implying that lots of other people are interested in the offer. The number of calls went through the roof.
  6. Affection – People prefer to say “yes!” to people that they know and like. You can help people like you by focusing on the similarities between you, emulating their thinking and behaviour (imitation is the sincerest form of flattery!), and by paying compliments where they are due.

How Much Loss Aversion Will A Person Feel?

“Everything is relative in this world, where change alone endures” (Leon Trotsky)

Loss Aversion 2

IF you were offered the chance to win or lose $100 on the basis of a coin flip, would you take the bet?

If you are like most people, you would probably decline the wager.

Even though the gamble offers an even chance of winning, the stakes are unattractive since the suffering from a loss would be felt much more deeply than the joy from winning.

Economists refer to this as loss aversion, and the emotional impact from a loss is thought to be around twice that of a comparable gain.

While it is convenient to talk about losses as being “twice as powerful”, research suggests that loss aversion will tend to vary from person to person, in different situations, and for the same person at different points in time.

Below we highlight 5 factors that have been shown to influence how much loss aversion a person will feel.

1. Everything is relative

Leon Trotsky is quoted as saying that “everything is relative in this world, where change alone endures”, and Trotsky may well have been talking about loss aversion.

Due to the way that people mentally account for things, gains and losses tend to be evaluated in relative terms. For example, if you lose $100 from a stock portfolio worth $10,000 then you are likely to suffer much less than if the entire portfolio was worth only $100 and you lost the lot.

2. Intention

Nat Novemsky and Danny Kahneman explain that our intentions for a good define whether it is “an object of exchange or … an object of consumption, and therefore … determine whether giving [it] up … is evaluated as a loss or a foregone gain.”

What exactly does this mean?

Well, imagine you have an iPhone. If you are carrying it around with you and someone steals it, then you have suffered a loss. Alternatively, if your intention is to sell the iPhone (because you want to get a Samsung Galaxy) and a good friend offers you $600 for it, but you end up giving it to her for free, then that’s a foregone gain. In each case the result is the same (no iPhone and no money), but the first situation, the one where you suffered the loss, will be more distressing.

3. Duration of Ownership

A person will tend to view a product as more valuable if it has been owned for a longer period of time. For example, if you have a well-worn pair of slippers that you have grown to love, then you will probably be reluctant to throw them away (probably even if they are riddled with holes).

4. Substitutability

A person will find it easier to give up a product if it is exchanged for something that affords similar benefits. For example, you will be much more likely to sell your old car if it is exchanged as a trade-in for a new car which has comparable features.

5. Age

It will probably come as no surprise that older people are more loss averse.

It is easy to imagine a situation where a budding 20-something might be prepared to risk her entire life savings on an entrepreneurial venture, whereas a middle-aged woman might be less enamored by the idea.

Loss Aversion

Loss aversion is a widespread behavioural trait which causes people to experience the suffering from a loss much more deeply than the joy from a commensurate gain

Loss Aversion

Background

Everyone knows that people don’t like to lose things.

People are reluctant to give their old clothes to Vinnies, to leave dysfunctional relationships, or to throw away an old pair of slippers.

While it is common sense that people are averse to loss, the principle of “loss aversion” is a relatively new development in the history of economic thought. It was first introduced by Danny Kahneman and the late Amos Tversky in 1979 to help them explain how people make decisions under conditions of risk.

What is Loss Aversion?

Loss aversion is a widespread behavioural trait which causes people to experience the suffering from a loss much more deeply than the joy from a commensurate gain.

The emotional impact from a loss is thought to be around twice that of a comparable gain. Or, as Dan Ariely puts it, “finding $100 feels pretty good, whereas losing $100 is absolutely miserable.”

While prevalent in humans, loss aversion is by no means unique to homo sapiens. In a study conducted around 2005, capuchin monkeys were shown to exhibit similar behaviour.

Under experimental conditions, the capuchins were offered two alternative gambles: (i) one grape with a coin-flip chance of winning a second grape, or (ii) two grapes with a coin-flip chance of losing the second grape.

As you will appreciate, the two gambles offer the same sweetener (in expectation). The only difference was that the first gamble was framed as a potential win, whereas the second was framed as a potential loss.

Which alternative did the monkeys prefer? Surprisingly, they favoured the first one, the gamble framed as a potential win.

This is not what mainstream economics would predict. But, as it turns out, the capuchin monkeys share a certain behavioural trait with most humans – loss aversion.

World Collapse Explained in 3 Minutes

Bailouts: a band-aid solution for continuing sovereign debt crises

BAILOUTS were the band-aid solution prescribed for the Greek sovereign debt crisis. And every indication suggests that Greece will require another band-aid early next year.

In this context, Clarke and Dawe raise an interesting and often carefully overlooked question. Where does the money come from to bail out basket case economies? Countries whose finances are in such a state of disarray that they were not only unable be repay their original debts but will almost certainly be unable to repay the subsequent bail out money.

In the case of Greece, the money has come from the EU, the European Central Bank and the IMF, which is all well and good. Saving Greece is possible since it is only the 13th largest economy in the European Union.

Compare this with Italy which is the 3rd largest economy in the Eurozone, and has public debts of around 125% of GDP (second only to Greece). Standing at around $2.5 trillion, Italy’s gross external debt is simply too big to bail out. If Italy should default on its debts, as well it might, then this could spell the end of the Eurozone.

Looking slightly further afield, we see the USA (~$17 trillion of public debt) and Japan (~$14 trillion of public debt). These two countries continue to run large fiscal deficits, to rely on foreign creditors (who for the moment seem happy to continue fueling government excess), and are also the largest donors to the IMF. For these two countries, there are no lenders of last resort.

Both countries appear to be aware of their precarious position, and have engaged in a number of rounds of Quantitative Easing (read: printing money). QE is a remedy of last resort which aims to create price inflation and thereby reduce the real value of government debt. Printing money is often associated with hyper-inflation and is the kind of solution you would expect from leaders like Robert Mugabe (hyperinflation in Zimbabwe was estimated at 6.5 sextillion percent in November 2008).

Bailouts are only a band-aid solution for government excess. They don’t work in the long run, and they don’t work if the country is too big to bail out. We can only hope that Greece, the USA, Japan, and other countries decide to get their fiscal houses in order. Failure to do so may result in more loss of blood than can be remedied by a few band-aids.

Kyle Bass: The End is Nigh for Japan

“I would like to live in a world where it’s all rainbows and unicorns, and we could make Krugman the President … And then reality sets in” ~ Kyle Bass

KYLE BASS founded and runs Hayman Capital Management, a Dallas-based hedge fund. He is a successful investor who is well known for predicting and profiting from the sub-prime mortgage crisis in 2008.

In the speech and Q&A above, which is from May this year (worth watching), Bass shares his views on the beginning of the end for Japan. He believes that Japan has about 2 years before its systemic economic problems manifest themselves in full force. Once this happens, he believes that the resulting implosion will require the West to completely redefine its economic orthodoxy.

Japan’s public debt to GDP ratio currently exceeds 200%, which makes the Japanese government more heavily indebted as a percentage of GDP than any other country in the world (including Iceland, Greece, and Italy). In the past, Japan survived due to a high national savings rate which allowed the government to fund fiscal excess by selling bonds to domestic savers.

Bass argues that the Japanese government will not be able to continue as it has in the past. He gives a number of arguments but one of the big ones is changing demographics. Almost a third of the Japanese population is now at least 60 years old. Pension funds, the largest holders of JGBs, are already becoming net sellers of the bonds in order to discharge pension liabilities. And the Bank of Tokyo Mitsubishi has reported that expected personal savings rates in Japan will become negative since there will be more people leaving the workforce than entering the workforce in coming years. With fewer people having babies, the population is also expected to shrink from around 128 million today to below 100 million in 2050.

Is the Japanese “Keynesian end point” fast approaching?

The Tortoise and the Hare

Stable growth is often more important than fast money

SINGAPORE is on the rise as a wealth management hub with funds under management growing by 22% in 2012 compared with around 5% for Western Europe as a whole.

The disparity in growth rates is large, and the FT has attempted to narrate a story that fast growing Singapore will replace Switzerland as the world’s leading wealth management hub.

Swiss assets under management may be growing more slowly, but the Swiss continue to manage significantly more assets (US$2.8 trillion compared with US$1.29 trillion for Singapore).

As we know from Aesop’s fable about the Tortoise and the Hare, running faster does not always secure you first place, and there are three reasons to believe that Swiss wealth managers will remain in the lead:

    1. Firstly, shrewd wealth managers from Switzerland are setting up bricks-and-mortar operations in Singapore. They recognise that regional Asian investors want to deal with real people on the ground, and they’re accommodating the demand. This means that Swiss wealth managers can directly benefit from the rise of the Asian region rather than competing in a zero sum game (a race where the Swiss have to lose for the Singaporeans to win).
    2. Secondly, it is possible for both Singapore-based and Swiss-based wealth managers to thrive. For cultural and geographic reasons, Switzerland is a much better location for serving European clients (as well as many US clients); for the same reason, wealth managers based in Singapore are better placed to serve Asian clients. Both can thrive in their respective niche.
    3. Thirdly, the Swiss have a long tradition of wealth management (dating as far back as the 18th century). Swiss neutrality and national sovereignty, long recognised internationally, have ensured the stability necessary for the banking sector to survive and thrive. Can we expect the same stability from Singapore, an island state located in fast growing yet newly prosperous Asia? If the ongoing financial crisis which commenced in 2008 has taught us anything, surely the lesson was that stable growth is often more important than fast money.