Wednesday, September 30, 2009

How to turn around a corporation

Lessons from Starbucks' renaissance:
  1. Hire the old CEO who originally built up the brand
  2. Close poorly performing outlets
  3. Squeeze $500M efficiencies out of the production process
  4. "Freshen" the brand with social awareness and "fair trade" coffee
  5. Get rid of the cookie-cutter retail outlets, and customize shop designs to fit into local markets
  6. Close for a day to teach the baristas how to make better espresso
These changes have lead to a 100% abnormal return (above what the market did) in the last year.

How to "loot" a corporation

In 1994, George Akerlof and Paul Romer showed us how to loot a corporation by borrowing with other people's money:
firms have an incentive to go broke for profit at society's expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.
Ben Bernanke has apparently read their paper:
On Tuesday morning in Washington, Ben Bernanke, the Federal Reserve chairman, gave a speech that read like a sad coda to the “Looting” paper. Because the government is unwilling to let big, interconnected financial firms fail — and because people at those firms knew it — they engaged in what Mr. Bernanke called “excessive risk-taking.”
I like the NY Time's characterization of the current crisis as an example of looting 
Think about the so-called liars’ loans from recent years: like those Texas real estate loans from the 1980s, they never had a chance of paying off. Sure, they would deliver big profits for a while, so long as the bubble kept inflating. But when they inevitably imploded, the losses would overwhelm the gains. As Gretchen Morgenson has reported, Merrill Lynch’s losses from the last two years wiped out its profits from the previous decade.
What happened? Banks borrowed money from lenders around the world. The bankers then kept a big chunk of that money for themselves, calling it “management fees” or “performance bonuses.” Once the investments were exposed as hopeless, the lenders — ordinary savers, foreign countries, other banks, you name it — were repaid with government bailouts.
There are two ways to address this problem. Get rid of the "too big to fail" guarantees that allow banks to gamble with other people's money (heads I win, tails the government loses) or impose more regulation on the banks to prevent them from taking risk. You can probably guess which path they will take.

The Economist on B-School Reform

After citing some sketchy statistics about MBAs' responsibility for the recent global "catastrophe" (e.g., "Most of the people at the heart of the crisis . . . had MBAs after their name"), the Economist offers some advice for how B-Schools should reform themselves. Ideas include teaching more business history, fostering more scepticism and cynicism in students, and hiring more professors who aren't afraid to "bite the hand that feeds them" (which I believe refers to business in general).

Tuesday, September 29, 2009

Moral Hazard at NSF

Oh my!
For instance, one senior executive spent at least 331 days looking at pornography on his government computer and chatting online with nude or partially clad women without being detected, the records show.
Investigators put the cost to taxpayers of the senior official's porn surfing at between $13,800 and about $58,000.

Evidently, he was not alone
The problems at the National Science Foundation (NSF) were so pervasive they swamped the agency's inspector general and forced the internal watchdog to cut back on its primary mission of investigating grant fraud and recovering misspent tax dollars.

Unfair, but well done

Monday, September 28, 2009

Will this merger succeed?

Wells Fargo's acquisition of Wachovia looks as if it will create synergies:
On the positive side, the merger has doubled the number of Wells branches to more than 6,600, giving it a footprint that only Bank of America comes close to matching. Wells and Wachovia were “mirror images” of each other, says Mr Stumpf, with Wells strong west of the Mississippi and Wachovia powerful to the east.
This gives Wells huge deposit-gathering power, as well as an opportunity to pump more products to Wachovia customers, who typically have four to five products with the bank, compared with almost six for Wells clients. Mr Buffett sees echoes of Wal-Mart in Wells’s retailing ethic. The merger gives Wells a formidable position in areas such as mortgages. In the first half of the year it handled a staggering 23.5% of all new home loans, according to Inside Mortgage Finance, a newsletter.
But by buying an undercapitalized bank, Wells Fargo reduced its own capitalization:
Among big banks, Wells scores poorly on Tier-1 common equity, the core-capital measure favoured by regulators (see chart). It is well below the 6% level that is likely to be the minimum required in future. And at some point it will have to repay the $25 billion of government capital it got last year.

What do longer skirts, shorter hair, lipstick, hair coloring and hot waitresses have in common

All are counter-cyclical indicators (inferior goods). On the last item:
“They slowly let the boys go, then the less attractive girls, and then these hot girls appeared out of nowhere. All in the hope of bringing in more business. The managers even admitted it. These hot girls that once thrived on the generosity of their friends in the scene for hookups—hosting events, marketing brands, modeling—are now hunting for work.” A Soho restaurateur I know recently received applications from “a couple of classic Eastern European fembots. Once upon a time, these ladies must’ve made $1,500 a night lap dancing. At my place, they’re not going to make that in a week.”

"Strategic" Mortgage Defaulters

A new study of mortgage defaults using a sample of 24 million individual credit files has found much higher rates of "strategic" default than previously assumed by the industry. A strategic defaulter is someone who goes directly from a good payment history to no mortgage payments at all (in contrast to many financially troubled customers who continue to try to make payments after they have fallen behind on their mortgage and other accounts). Interestingly, those with high credit scores are 50% more likely to be strategic defaulters compared to those with low credit scores.

Thursday, September 24, 2009

Consumer Reports Goes after Wireless "Exclusivity deals"

Received via email today:
If you own a cell phone, the giant telecom companies are likely holding you hostage right now.

They know they can charge you what they want, give you spotty service, and even prevent you from getting the latest technology, because almost all the most popular wireless handsets on the market today are shackled by "exclusivity deals" — meaning if you buy a particular phone, you can only get service from one company.

Want an iPhone? You're stuck with AT&T. Own a Blackberry Storm? You have to deal with Verizon. These exclusive contracts mean your pricey phone is virtually worthless if you try to change companies. And forget about shopping around for a better deal.

...In Asia, 80 percent of wireless phones are sold outside of a wireless carrier contract. But in the United States, you're either stuck with one company, or your phone is effectively worthless. That's not a free market, that's just un-American.
Apparently, Consumer Reports doesn't think much of the ex-ante competition among manufacturers to design popular products in order to obtain lucrative exclusivity contracts.

Free market environmentalism

Wednesday, September 23, 2009

We get $226K for living in Nashville,

In the text, we use the example of house prices in Nashville vs. San Diego to demonstrate the indifference principle: "If labor is mobile, people will move from Nashville to San Diego. This migration will increase the demand for housing in San Diego, driving up San Diego house prices while simultaneously reducing Nashville house prices. The process will continue until the higher price of housing makes San Diego just as unattractive as Nashville." At this point, people are indifferent between living in the two cities.

Here's some evidence that quantifies the lower house price benefit a Nashvillian receives for putting up with lousy weather. The info compares the prices charged for a 2,200-square-foot, 4 bedroom, 2.5 bath, single-family homes in more than 300 markets around the nation. The price in Nashville is $235,336 while the price in San Diego is $461,432. Obviously, these are city-wide averages, and prices vary quite a bit in particular areas (and surrounding communities; for example, the price in La Jolla, CA is $2,125,000).

Tuesday, September 22, 2009

Would you rather be unemployed, or...

consume more pollution?

The main factor behind this year’s drop in emissions is the slowdown in industrial activity and trade around the world, according to a study due to be released in November by the International Energy Agency.

The article everyone is talking about

How American Health Care Killed My Father
Would our health-care system be so outrageously expensive if each American family directly spent even half of that $1.77 million that it will contribute to health insurance and Medicare over a lifetime, instead of entrusting care to massive government and private intermediaries? Like its predecessors, the Obama administration treats additional government funding as a solution to unaffordable health care, rather than its cause. The current reform will likely expand our government’s already massive role in health-care decision-making—all just to continue the illusion that someone else is paying for our care.

How to innovate innovation

Auction off patents:
A flurry of new companies and investment groups has sprung up to buy, sell, broker, license and auction patents. And venture capital and private equity is starting to pour into the field.The arrival of these new business-minded players, according to patent experts and economists, could lead to a robust marketplace for patents, where value is determined not so much by court judgments but by buyers and sellers, perhaps, someday, like eBay.

Monday, September 21, 2009

The wierd legacy of the Bush administration...

...was to rehabilitate Keynes as a justification for bigger government.   Instead of incentives, Bush used "stimulus" as a justificaiton for his 2008 tax cut.  However, as the below graph illustrates, the tax cut did not have the expected "multiplier" effect on consumption that Keynes' model would predict.

For a more detailed critique, check out
John Cochrane's essay:
Most fiscal stimulus arguments suffer from three basic fallacies.
First, if money is not going to be printed, it has to come from somewhere. ... Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending.

Second, investment is “spending” every bit as much as consumption. Fiscal stimulus advocates want money spent on consumption, not saved. ... But the economy overall does not care if you buy a car, or if you lend money to a company that buys a forklift.

Third, people must ignore the fact that the government will raise future taxes to pay back the debt. If you know your taxes will go up in the future, the right thing to do with a stimulus check is to buy government bonds so you can pay those higher taxes. Now the net effect of fiscal stimulus is exactly zero, except to raise future tax distortions. The classic arguments for fiscal stimulus presume that the government can systematically fool people.

Finally, I am not even sure that Keynes would have been convinced that Keynesian stimulus was a good idea (Via ThinkMarkets):
Organized public works, at home and abroad, may be the right cure for a chronic tendency to a deficiency of effective demand. But they are not capable of sufficiently rapid organisation (and above all cannot be reversed or undone at a later date), to be the most serviceable instrument for the prevention of the trade cycle.

Another Approach to Outsourcing

When Netflix decided that they wanted to invest in improving its software that recommends movies to users, it could have done the work internally or hired an outside software development firm. It decided to do neither, instead opting to offer a $1 million prize in October 2006 to anyone who could submit a solution that improved its current system by at least 10% (if multiple submissions beat the 10% barrier, the winner would be the solution with the greatest increase).

The contest drew over 51,000 contestants from 186 countries. Netflix just awarded the $1 million to a team consisting of two researchers at AT&T Inc., two engineers from Montreal, a research scientist at Yahoo Inc. and two machine-learning researchers from Austria whose solution improved the current system by 10.9%.

Friday, September 18, 2009

Laughter is the best medicine

Study: Most Children Strongly Opposed To Children’s Healthcare

The Economist calls out President Obama

... for pouring silicone into the wealth-creating engine of capitalism:
YOU can be fairly sure that when a government slips an announcement out at nine o’clock on a Friday night, it is not proud of what it is doing. That is one of the only things that makes sense about Barack Obama’s decision to break a commitment he, along with other G20 leaders, reaffirmed last April: to avoid protectionist measures at a time of great economic peril. In every other way the president’s decision to slap a 35% tariff on imported Chinese tyres looks like a colossal blunder, confirming his critics’ worst fears about the president’s inability to stand up to his party’s special interests and stick to the centre ground he promised to occupy in office.
This newspaper endorsed Mr Obama at last year’s election (see article) in part because he had surrounded himself with enough intelligent centrists. We also said that the eventual success of his presidency would be based on two things: resuscitating the world economy; and bringing the new emerging powers into the Western order. He has now hurt both objectives.

Wednesday, September 16, 2009

Detroit - Where Houses are Cheaper than Cars

Economics Professor Mark Perry, from the University of Michigan-Flint, tracks house prices in Detroit. In a recent post, he reports that the average year-to-date price fell to $11,596 in July. The average had peaked in 2003 at $97,850; the current prices represent an 88% decline.

Benefit costs rising more slowly than direct pay

Medical and pension benefits are a victim of the recession:
As the [second] graph shows, though, that decline isn't the result of any serious slowdown in medical inflation. No doubt there's a lot of shifting of costs onto employees going on, either in the form of dropped coverage or higher co-pays.
As we pointed out in our July 13 issue, a substantial portion of the rise in consumption over the last couple of decades has been driven by spending on medical care. With all this apparent cost-shifting from employers to employees going on, pressures on household budgets have been increasing -- another reason to wonder where any sustained consumption revival can come from.

Moving patents to higher-valued uses

Buyers come in all flavors, both strategic and financial:
...Of the financial ones, some hope to profit from the market’s relative youth and illiquidity, seeking out undervalued patents and taking advantage of pricing inefficiencies (and the difficulty of valuing such a complex asset) to sell them at a hefty mark-up.
Others are longer-term holders, pejoratively referred to as “patent trolls”, who are looking for an income stream from collecting royalties. Ugly they may be to those they harass, but lazy they are not. Such investors typically undertake exhaustive analysis of the relevant technologies and the firms that may be using them. Negotiations with those they deem to have breached a patent can be tortuous. Even by the standards of alternative investors, this is esoteric stuff. But the returns can be handsome and, with a broad enough portfolio, fairly predictable.
As the market evolves, its supporting infrastructure grows more sophisticated. New brokers are popping up. Like estate agents, they package together information—on the patent’s validity, infringement by others and so on—and try to maximise proceeds for clients. iPotential has helped some clients get more than ten times the initial asking price. ICAP Ocean Tomo, another broker, began running patent auctions in 2006, and this year an affiliate set up an IP exchange. Its index of patent-rich shares is tracked by several exchange-traded funds. IP is moving out of the lab and into the financial mainstream.

Day trading is back

If you buy a stock, sell it, and earn money on the trade, you might mistakenly infer that you have above-average stock-picking ability. So you try it again.  And as long as the market keeps rising, you will be successful, more often than not.  This is the kind of feedback loop that leads to bubbles:
Trading volume surged 14% or more last month from July at online brokerage firms Charles Schwab Corp., TD Ameritrade Holding Corp. and E*Trade Financial Corp. Electronic trader Knight Capital Group Inc. also posted a 7.7% increase.

Buffett: "there is nothing new under the sun"

Buffett did an interview this week, reflecting on the credit crisis….not the greatest interviewer but not too terribly bad, either…what I really like best is in the last 40 seconds, where the interviewer asks, what did YOU, Warren Buffett, learn from this crisis?  And he talks about how there’s nothing new under the sun, that the behaviors that caused the last bubble have always happened in the past…the dangers of leverage, mass belief in a hot asset class, and joining the crowd b/c the crowd has been making money (rather than b/c the crowd is doing something that is sound fundamentally).

Tuesday, September 15, 2009

Second edition out today


Praise for Managerial Economics:
“I used the first edition of Managerial Economics: A Problem Solving Approach with great success. The more I used it the more I appreciated the focus on the rational actor paradigm… students shared my appreciation… [they] see how decision rights, incentives and information flows affect decisions where they work and [have] examples based on first-hand experiences.
-Professor Edward Millner, Chair Department of Economics, Virginia Commonweatlh University

 “Managerial Economics: A problem solving approach is sophisticated… teaches the students what they need to know, and integrates well with the MBA curriculum. The students love it!”
-Professor Eduardo Zambrano, Department of Economics, Cal Poly.

Is the decline in spending permanent?

John Mauldin draws inference from the growing gap between essential, and non-essential spending:
A gap this wide looks like a real structural shift in spending behavior, as austerity becomes the new normal. Though Americans have shaken off bouts of prudence before, like that of the early 1990s, with consumer credit constricted, household balance sheets ravaged, and labor income weak, it's probably going to take some time before anything resembling extravagance returns. 

Monday, September 14, 2009

"free" as a business model

Top 50 business education blogs

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The one lesson of real estate development

Build houses that people want to live in. If instead you build housing for investment demand, you are going to get burned:
Median household income hasn’t grown over the last decade, but average house size has. The average square footage of a new single-family home in the U.S. has gone from 1,660 square feet in 1973 to 2,215 square feet in 2008.

Sunday, September 13, 2009

Kraft's Proposed Acquisition of Cadbury

Last week, Kraft announced a $16 billion offer to acquire British confectionary company, Cadbury. Potential benefits include providing Kraft access to new distribution channels, especially foreign markets, where Cadbury is particularly strong.

Cadbury rejected the offer saying that the 31% premium to its stock price at the time “fundamentally fails to reflect the current value of Cadbury as a standalone business.” Kraft shareholders appear to be skeptical that the synergies from the potential acquisition will exceed the premium Kraft would eventually have to pay - Kraft's stock fell around 7% following announcement of the offer.

Friday, September 11, 2009

What can we learn from Chile, Sweden, and Hungary?

How to control government spending:
One way to bolster trust would be to put fiscal policy on the same footing as monetary policy, by outsourcing budgetary decisions to independent councils with a mandate to preserve fiscal solvency.
A fiscal council could monitor compliance with a budget-balance target, consistent with a stable or falling debt burden, leaving politicians to make tax and spending decisions within those limits. That sort of set-up has been adopted in Chile and Sweden.
Another convert is Hungary. George Kopits, the head of its fiscal council, says a good fiscal-stability framework has four main features. The first is a numerical policy rule, such as a target for the debt ratio or, as in Chile, a pledge to run a budget surplus of 1% of GDP over the business cycle. The second is a set of “procedural” rules, such as a cap on public-sector pay growth or—as in Hungary now and America until 2002—a “pay-go” rule that says new spending schemes have to be funded by tax increases or cuts in other programmes.

Labor Unions vs. consumers

President Obama has until Sept. 17 to rule on a U.S. International Trade Commission recommendation that the White House put a 55% tariff on low-grade car tires imported from China. The  Steelworkers Union charges that a flood of cheap Chinese tires in recent years had cost more than 5,000 union jobs.
The president's decision -- he is under no obligation to follow the ITC -- is due just days before he hosts Chinese President Hu Jintao and others world leaders at a G-20 summit in Pittsburgh.
Mr. Obama's call is fraught with political risk. If he sides with the steelworkers, he invites accusations of protectionism. Siding with China risks disappointing a key constituency that he is relying on to support his domestic agenda

UPDATE: Consumers lose

Do we want more NASA disasters?

If you have never been late for a plane, then you are not optimizing.  Is NASA making a similar mistake?
...NASA's costly and extreme aversion to it ever since Apollo. Recall the famous words of Gene Kranz ...  from the movie Apollo 13: "Failure is not an option."

The problem with that is, as some have responded, that success gets very expensive. This is the cost of risk aversion.

Wednesday, September 9, 2009

Cash for Clunkers blip

The sharp spike in demand suggests that the Cash for Clunkers car buying subsidy had only a very short lived effect on demand. 

Note the seasonal troughs in December.  Seems to validate my ex-girlfriend's father's practice of buying cars on Christmas eve.  If there is no one else around, the opportunity cost of selling a car to you is almost zero (The alternatives to agreement determine the terms of agreement.)

HT: Calculated Risk

Monday, September 7, 2009

Where were the economists last fall?

Out to lunch, opines Paul Krugman, in this well written intellectual history ranging from Adam Smith to Ben Bernanke.
Until the crisis, efficient-market advocates like Eugene Fama dismissed the evidence produced on behalf of behavioral finance as a collection of “curiosity items” of no real importance. That’s a much harder position to maintain now that the collapse of a vast bubble — a bubble correctly diagnosed by behavioral economists like Robert Shiller of Yale, who related it to past episodes of “irrational exuberance” — has brought the world economy to its knees.

According to Krugman, our focus on "beauty" caused us to miss the "truth" of the credit, real estate, and asset bubbles.  His conclusion reminds me of one of Ronald Reagan's favorite sayings: "an economist is someone who sees something in practice and then wonders if it can exist in theory."

Solving Adverse Selection Mafia Style

Under Japan's revised Anti-Organized Crime Law, higher-ranking gang members can be sued for lower-level members' activities. Potential "new hires" (who will come in as low-level members) know whether they are familiar with the dictates of the law while the "employers" (high-level members) don't know who is more or less likely to get them into trouble. I suspect some high-ranking members of the Yamaguchi-gumi purchased a copy of everyone's favorite managerial economics textbook because they are now using a screen to identify the "good" type neophyte gangsters.

Japan's largest and most notorious organized crime group, the Yamaguchi-gumi, is forcing members to take a "gangster exam" in order to reduce costly damages suits, police have discovered.

Questions included "What kind of activities are banned?" with "dumping industrial waste; bootlegging fuel; theft of construction vehicles and other expensive items; phone fraud scams" etc. listed as the correct answers.

The model answer to the final question, "What are you required to do in all your activities?" was: "report and consult with my bosses."

Sunday, September 6, 2009

Unintended Consequences - Cash for Clunkers Edition

What industry was most adversely effected by "Cash for Clunkers?" Probably demolition derbies. See the story in Time.

Hat tip: Alex Ward

Friday, September 4, 2009

Cutting out the middle man

Pharmaceutical Benefit Managers design and administer pharmaceutical services on behalf of employers and insurance companies.  They negotiate with upstream drug companies and with downstream retail pharmacies (some also use mail) to deliver drugs as efficiently as possible.  Now Caterpillar is managing its own pharmacy benefits program:
Caterpillar will negotiate pricing directly with Wal-Mart and Walgreen instead of paying a PBM to handle that part of the business. Savings will come through lower prescription drug costs for Caterpillar. ...
As part of its arrangement with Caterpillar, Walgreen will offer Caterpillar employees discounts on nonpharmacy goods. Walgreen and Caterpillar are also talking about expanding the program to provide health clinics at or near certain Caterpillar offices, Mr. Bisping said.

Thursday, September 3, 2009

Do financial consumers need protection?

Former colleague Todd Zwyicki says that consumers are substituting credit card debt for other kinds of debt, like revolving credit from, e.g., from an appliance or furniture store. (9 minute video)

Adverse Selection Among Health Care Workers

Potential employers have access to a federal list of physicians disciplined by state licensing boards. The federal government created a similar list of nurses, nurse aides, pharmacists and pharmacy aides, but even after 22 years, employers do not have access to this list. Why not? From NPR's "Morning Edition" we have:
By law, it was supposed to be open to hospitals and nursing homes when they hire staff and want to run a background check. But the Department of Health and Human Services never completed the regulation implementing the law. Turns out, slow-moving bureaucracy is the main culprit.

Some comments:
  • Does the comparison of HHS to the DMV do injustice to the DMV?
  • Employers will typically have access to their state's list. But which health care workers are more likely to move across state lines?
  • Is NPR trying to undermine health care reform?

Performance Contracts in Health Care

This story by NPR's "Morning Edition" is about a novel contracting form between a health insurance company and a health care provider. Traditional "fee for service," encourages more services, many of which may be unnecessary, and an under-provision of preventative care and counseling, because it is difficult to contract over something you cannot effectively measure. Instead, this experiment pays for performance measures, such as actual health outcomes and decreased need for future procedures. The firms have innovated on the contract form in order to create value to the insurance company, the provider, and ultimately the patient.

I do not know if NPR included this near the end as a dig at health care reformers.
It's kind of interesting that Washington is reforming health care, when they're not the ones in the room with the patient, and that's really what this project is about: letting the people in the room with the patient reform health care.

Under this new model, we're accountable ...

Wednesday, September 2, 2009

Taxes create opportunities

Taxes deter wealth creating transactions.  But they also create opportunities for those know how to evade them"
A [Massachusetts]  lawmaker who voted to hike the state sales and alcohol taxes was spotted brazenly piling booze in his car - adorned with his State House license plate - in the parking lot of a tax-free New Hampshire liquor store

eBay Sells Skype

Internet auction site, eBay, announced yesterday that it is selling off a majority interest in Skype, which provides voice and video connections over the Internet. Apparently there were fewer "synergies" between eBay and Skype than originally claimed, although it looks like the acquisition and subsequent sell-off won't end up costing eBay that much in dollar terms.
eBay (EBAY) will sell a controlling share of the Internet-calling service to a group of investors led by private equity firm Silver Lake for $1.9 billion in cash and $125 million in short-term debt. The sale values Skype at $2.75 billion, not far below the price eBay paid for the business in 2005, and higher than the value recently placed on Skype by some Wall Street analysts.