Tuesday, December 30, 2014

Using information to price discriminate more profitably

WSJ spills the beans on retailers strategies:  they try to figure out what motivates each shopper and then give it to them.

A fifth of online shoppers are considered true “discount junkies,” people who make purchases only when plied with discounts, according to new data from AgilOne Inc., which works with 150 retailers to analyze customers’ purchases and predict their behavior. About 15% of shoppers generally pay full price for items and don’t bother searching for sales.
“Smart retailers understand discounting only moves the needle for a portion of their customers,” said Omer Artun, chief executive of AgilOne and a former marketing executive at Best Buy Co.
“You don’t want to offer discounts to full-price shoppers, because over time your profit margins will erode,” he said.
Shoe brand Donald J Pliner, which is sold online, in department stores and through an eponymous six-store chain, divides its customers into three types based on their previous shopping behavior: Discount shoppers who buy clearance items and last season’s styles once they are priced at more than 25% off; full-price shoppers who rarely buy clearance items; and customers who fall somewhere in between.

HT:  Erin

Friday, December 19, 2014

Putin's bubble bursts

Earlier we blogged about the effects of the drop in oil prices on the fall of the ruble.  Paul Krugman has penned a good column on why the rouble has fallen much farther than the oil.  The key to understanding it is the large scale borrowing, with debts denominated in a foreign currency, from abroad.

When the nation’s currency falls, the balance sheets of local businesses — which have assets in rubles (or pesos or rupiah) but debts in dollars or euros — implode. This, in turn, inflicts severe damage on the domestic economy, undermining confidence and depressing the currency even more. 

So what does this have to do with Putin?  The answer is crony capitalism.  Russia has been running trade surpluses (which should make the ruble appreciate), but this current account surplus has been offset with huge foreign borrowing by the private sector.

...walking around Mayfair in London, or (to a lesser extent) Manhattan’s Upper East Side, especially in the evening, and observing the long rows of luxury residences with no lights on — residences owned, as the line goes, by Chinese princelings, Middle Eastern sheikhs, and Russian oligarchs. Basically, Russia’s elite has been accumulating assets outside the country — luxury real estate is only the most visible example — and the flip side of that accumulation has been rising debt at home.

Monday, December 15, 2014

How do oil investors (principals) align the incentives of operators (agents) with their profitability goals?

With the so-called "1/3 for 1/4" contracts:  if an investor pays for 1/3 of the cost of the well, she receives 1/4 of the net revenue from the well (after the landowner receives a royalty payment, e.g., 15%).  If the operator sells three shares, then the costs of drilling are covered, and the operator gets a 1/4 share of the well.

Since the operator gets 1/4 of the upside but the investors bear most of the downside, the operator has a bigger incentive to drill a marginal hole than do the investors.  To mitigate the costs of adverse selection and moral hazard, the operator releases information to the investors:

As soon as the well is spudded, the investor will be entitled to receive daily drilling reports to keep him abreast of the well’s progress. Ordinarily, all sophisticated industry working interest partners are responsible for their proportionate part of the drilling costs, regardless of what the operator’s initial cost estimate was or how much money they have prepaid. If the well goes over budget, those partners may be called upon to contribute additional funds to keep the drilling rig going. A partner who fails to respond in a timely manner may forfeit all or part of his interest in the well.

In general, here are rules to screen out bad investments:


• Beware of overly simple deals in which you are approached by a broker or landman brandishing a small lease map with nothing more than a yellow outline on it. A legitimate prospect will almost always be presented by one or more industry professionals who have taken the time to prepare a comprehensive (and comprehensible) brochure that contains maps, several pages of text describing the geology of the immediate area, nearby (and presumably analogous) production data, cross sections, etc. 

• A slick brochure is no guarantee that the prospect has any geological merit. Your best bet is to hire a consulting geologist for half a day to take a look at the information the operator has furnished you and render an opinion. 

• Beware of “hot” deals that have a short fuse. If you have to put your money up by the end of the week in order to get in on a “can’t miss” prospect that is about to spud any day now, forget it. This is one of the oldest come-ons in the book.

• Don’t be in too big a hurry to spend your oil and gas investment money. Industry insiders ordinarily expect to participate in only about one out of every 10 to 20 unsolicited prospects that are submitted to them. You should be discriminating with your funds as well.

• Don’t put all your eggs in one basket. Take a small piece of several deals in several different areas. 

  1.  Most sophisticated investors within the industry would have to be very impressed with the geological features of the prospect before they would agree to a anything less than 1/4 for 1/3.


Thursday, December 11, 2014

Can the Russian Central Bank stop the rouble's fall?

Apparently not, i.e., the promise of 10.5% rates is not enough to increase demand for roubles:

Russia’s central bank raised interest rates on Thursday, but the move failed to stop the drop of the rouble as the slide in oil prices continues to put pressure on the currency.

Here is the bigger problem:

Economists said the Bank of Russia faced a conundrum: only decisive rate increases had a chance of reining in inflation and stopping the currency devaluation, but further steep rises risk weighing on an already stagnating economy. In a reflection of this dilemma, analysts’ forecasts ahead of Thursday’s rate decision had ranged from no further increase to a three percentage points rise.

Friday, December 5, 2014

Why do US public pension funds carry so much risk?

Under-funded pension funds can "catch up" by either (1) saving more or cutting benefits; or (2) going into more risky investments that have higher expected return, which makes the current liabilities look smaller (because future liabilities are discounted at the higher rate).  They often choose the latter because it is less painful, at least in the short run, than the former.

In November the Society of Actuaries noted that “public sector plans in the U.S. are unique in that they have taken additional risk as the plans have become more mature, compared to private sector plans in the U.S. and private and public sector plans in Canada, UK and the Netherlands, which have taken less risk as plans have matured.” The reason: GASB accounting rules let U.S. public plans credit themselves with the higher returns on risky assets before those returns are earned, creating an artificial incentive to take risk. U.S. corporate pensions and public plans overseas may credit themselves only after investment risks pay off, and thus better balance risk and return.

To see how much they are over-investing, they compare the actual asset allocation (75% in risky investments for California) vs. a conservative "rule of thumb" for individuals:

Many individuals follow a rough “100 minus your age” rule to determine how much risk to take with their retirement savings. A 25-year-old might put 75% of his savings in stocks or other risky assets, the remaining 25% in bonds and other safer investments. A 45-year-old would hold 55% in stocks, and a 65-year-old 35%. Individuals take this risk knowing that the end balance of their IRA or 401(k) account will vary with market returns.

Friday, November 28, 2014

Wednesday, November 26, 2014

Unobstructed

This short U.S. Bank ad shows how voluntary transactions move an asset to a higher valued use.
It also shows a slightly subtler notion called the Coase Theorem.  It shows that there is no need for government intervention, if the property rights are defined well enough for bilateral trade to occur.

Tuesday, November 25, 2014

Is religion good for you?

The question is fairly difficult to answer because nature doesn't randomly assign individuals to carry strong religious beliefs (experimental group) or to agnosticism or atheism (control group).

Jonathan Gruber (yes that guy) uses religious density as an instrument that changes religious beliefs--acting as sort of a natural experiment--that allows him to trace out of the causal effects of religion.  Here is his conclusion:

Religious density significantly increased level of religious participation, and as well to better outcomes according to several key economic indicators: higher levels of education and income, lower levels of welfare receipt and disability, higher levels of marriage, and lower levels of divorce.

Bottom line:  religious beliefs have tangible benefits.

Monday, November 24, 2014

REPOST: The real meaning of Thanksgiving

What they don't tell you about Thanksgiving in school

Peter Klein gives us a more complete story of the first Thanksgiving:

Faced with potential starvation in the spring of 1623, the colony decided to implement a new economic system. Every family was assigned a private parcel of land. They could then keep all they grew for themselves, but now they alone were responsible for feeding themselves. While not a complete private property system, the move away from communal ownership had dramatic results.

This year I am giving thanks for private property.

Wednesday, November 19, 2014

Protesting Against Yourself

Every year, the town of Wunsiedel receives unwanted guests. Neo-Nazis march in commemoration of Rudolf Hess. The townsfolk have tried to get them to stop. In some German towns, there has been a history of violent clashes between extreme left-wing and extreme right-wing groups. This time, rather than confront these marchers, they merely undermined them. As the WSJ reports:
Instead, the group Rights versus Rights (Rechts gegen Rechts) had come up with a new way to protest the annual neo-Nazi march: For every meter the neo-Nazis walked, local businesses and residents would donate $12.50 to a nongovernmental organization devoted to making it easier for neo-Nazis to leave behind their hateful politics.

The group changed the payoffs of the game in order to change the behaviors of the participants. Do see the short video here in which the bewildered marchers are encouraged by banners and notices along the way of how much funds they have generated. :)

Tuesday, November 18, 2014

If only President Obama had read Chapter 5

It looks as if the President failed to anticipate the consequences of his "net neutrality" policy.  After the White House "offered a full-throated endorsement “for the strongest possible rules” in support of “net neutrality,” AT&T CEO Randall Stephenson said that his company was going to step back from investing billions of dollars in building out its own GiGaPower fiber network:

Stephenson clearly fears that the President’s call to the FCC will result in heavy new regulations that will reduce the profit potential of the company. AT&T is holding back to see just how badly the new rules will damage its investment prospects.
Some economists found the President's analysis short-sighted:
The President defends this supposed pillar of the Internet policy by insisting that “an entrepreneur's fledgling company should have the same chance to succeed as established corporations, and that access to a high school student's blog shouldn't be unfairly slowed down to make way for advertisers with more money.” 
But why should this be the case when paid prioritization is the norm in virtually all highly competitive markets? A quick trip to the Federal Express website, for example, reveals a wide range of “fast and full of options” like “FedEx Priority Overnight and FedEx Standard Overnight.” There is also two- or three-day shipping and Saturday service for those who want it. The different tiers of services are offered, not surprisingly, at different rates. These differential services are available to all customers. It is simply wrong for the President to assume that any system of paid prioritization entrenches established companies at the expense of new entrants, or greedy advertisers at the expense of high-school bloggers.
If President Obama had read Chapter 5, he would have known to "look ahead and reason back."  Don't worry though, I sent him a copy of the third edition 

Monday, November 17, 2014

OPEC caught in prisoners' dilemma

Oil prices have fallen by 30%.  If the oil producing nations cooperate, and cut back output, then prices would go back up.  While this would be good for everyone in OPEC (and bad for consumers), it is not individually rational.

Students will recognize this as a pricing dilemma, that makes it very hard for rivals to maintain a cooperative outcome.  See earlier post here:  Never start a land war in Asia (or a price war)

Saturday, November 15, 2014

Pirate Joe's erodes Trader Joe's profit

The forces of competition are at it again:

There is a Trader Joes in Bellingham, WA near the Canadian border. Many Canadians cross the border to stock up on Trader Joes groceries because there is no Trader Joes on their side near Vancouver. One man recognized this demand for Trader Joes groceries so he set up a store on the Canadian side of the border in which he sells Trader Joes products. He calls it Pirate Joes. He buys all of the Trader Joes groceries on the US side, brings them to his store and re-sells the Trader Joes products at a slightly higher price. People are willing to buy the Trader Joes products at a slightly higher price because it saves them the hassle/expense of crossing the border (the border dissuades people from going for the even lower prices at the actual Trader Joes store in Bellingham)

Why doesn't Trader Joe's open a store in Canada?

HT:  JS

Who wants to get married in Mexico?

Leonel Luna, a Mexican legislator has proposed 2 year renewable marriage contracts to combat the high cost of divorce in Mexico:
"Almost 50% of couples in Mexico City end up in divorce," Luna says. "What we're trying to do is acknowledging reality and creating a mechanism that will allow couples to end their marriage without going through the additional pain and suffering of a legal battle."

If you cannot immediately spot two problems with this contract, you are not ready to get married:

  • Problem 1:  Post-investment hold-up (who would make relationship-specific investment with a short term contract?)
  • Problem 2:  Adverse selection (what do you learn about a potential spouse who wants a renewable marriage contract

Thursday, November 13, 2014

How Victoria's Secret discriminates against men

The art of price discrimination is to identify consumers who are less sensitive to price, charge them a higher price, and prevent them from mimicking the behavior of more price sensitive consumers.  Victoria's Secret has discovered that their male customers are less sensitive to price than their female ones:

"The general feeling about men is that they would buy anything in order to get out of the store as quickly as possible," the worker, who wished to remain anonymous, told us. "That means they would spend more money." 
...Women are more value-oriented, and so we were encouraged to show them deals," she said. "Men would buy a couple of $50 bras without questioning us because they felt awkward."
HT:  Andrew

Will this start or end a price war?


From Reuters:  
 Wal-Mart Stores Inc has informed managers of its roughly 5,000 stores across the United States that they can match prices with Amazon.com Inc and other online retailers, the head of the company's U.S. business said on Thursday.
In the past, the FTC has sometimes viewed announcements like this as an "invitation to collude"  because it seems likely that the primary target of this announcement is Amazon.  If Amazon believes the announcement then it changes their profit calculus, i.e., it reduces the benefit of cutting price.

A modest proposal to close the gender pay gap

From Ashe Snowe:

“... working age women earn less than men mostly due to the choices women make in their careers. ... And so I humbly present my own proposal for closing the gender wage gap, which I hope will not only solve the problem but also satisfy voices on all sides of the argument. As a society, we must begin telling women what subjects they can major in, what colleges they can attend, and what jobs they can take.”

Monday, November 10, 2014

REPOST: what is the cost of marriage?

Wednesday, August 22, 2007


What is the cost of marriage?

To an economist, the cost of an activity is what you give up to pursue it.

In the year following a divorce, women's living standards fall by 27 percent while men's living standards rise by 10 percent.Steven Landsburg's classic column on Why Men Pay To Stay Married argues that the difference is a compensating differential, the "price" that men pay to women to compensate them for the relatively unpleasant job of marriage.

If men stay in marriages that cost them a lot of money, that just proves they really like being married. They're getting something they value, and they're paying for it.

When I first read this 8 years ago, I thought it was funny. Now, after 19 years of marriage, I wonder why the price is so low.

For more on marriage, see these posts.

What is causing inequality?

The talking bears describe the "Bernanke Put"

What is missing from Economics?

Colleague Ted Fischer will tell us this thursday:


Saturday, November 8, 2014

Free money

Another Planet Money episode on inter-temporal arbitrage (mobile assets moving over time: from low-value summer to high-value winter) that is making me rethink my longstanding opposition to government subsidies for public radio.

HT:  Sarah

Thursday, November 6, 2014

Some Cops Don't Like Being Monitored


Ford's New Police Interceptor will be able to monitor police driving behavior in real-time. This is an effort to increase driving safety by cops but also to deter the unintended uses of these vehicles. From wired:
Everyone’s seen a cop driving like a jerk: Double parking and blocking traffic. Cruising down the highway way beyond the speed limit, with no suspect to run down. Blatantly texting while driving. Pulling the old turn-on-the-siren-just-long-enough-to-run-the-red-light trick. And for anyone who’s fantasized about making a citizen’s arrest of one of their city’s finest, police departments soon will be able to track how their cops are driving, and when they’re behaving badly.

But at least some of the cops don't like curbs in their ability to engage in moral hazard. From The Free Thought Project:
Police union representatives have already spoken out against this new feature, calling it intrusive.

Tuesday, November 4, 2014

Why is Apple borrowing in euro's?


...because the European interest rates are so low.  Apple will borrow in euros, sell the euros to buy dollars (called the "carry trade"), and return the dollars to shareholders.  This is an increase in the supply of euros in the market for foreign exchange, which depreciates the euro relative to the dollar.  In fact, a lot of speculators are betting on a stronger dollar or a weaker euro.

How has the 2000 Pepsi-Gatorade Merger worked out?

From Business Week at the time of the merger:

Some of the more obvious synergies between Quaker Oats and Pepsi won't happen for a while. To overcome the Federal Trade Commission's fears of monopolization of the sports-drink market, Pepsico agreed not to bundle Pepsi and Gatorade in contracts with merchants for 10 years. It also agreed not to allow its bottlers to distribute Gatorade, which would have been an easy and cost-effective way to ship Gatorade to smaller stores.

Does anyone know of if these synergies ever materialized?

Markets vs. Mother Theresa: who has done more for the world's poor?


Extreme poverty fell 15% in the last 25 years, due in large part to the spread of the institutions of capitalism:  markets, free trade, private property, and de-regulation:
China and India are leading examples. In 1978 China began allowing private agricultural plots, permitted private businesses, and ended the state monopoly on foreign trade. The result has been phenomenal economic growth, higher wages for workers—and a big decline in poverty. For the most part all the government had to do was get out of the way. State-owned enterprises are still a large part of China’s economy, but the much more dynamic and productive private sector has been the driving force for change. 
In 1991 India started dismantling the “license raj”—the need for government approval to start a business, expand capacity or even purchase foreign goods like computers and spare parts. Such policies strangled the Indian economy for decades and kept millions in poverty. When the government stopped suffocating business, the Indian economy began to flourish, with faster growth, higher wages and reduced poverty.

This has got to be one the greatest achievements in history.  Consequentialists rejoice!

HT:  Carpe Diem and WSJ

Thursday, October 30, 2014

Bolivia legalizes child labor for ten-year olds

voluntary transactions?
In December, the Union of Boy, Girl and Adolescent Workers of Bolivia marched to the presidential palace in La Paz to press its case for legal recognition of under-14 workers. Anti-riot police fired tear gas and the TV images of gasping, red-eyed youngsters alarmed President Morales.
After meeting with the child workers, Mr. Morales declared: “The state shouldn’t outlaw child labor. It should protect them.”
The Legislative Assembly followed his advice and rewrote parts of Bolivia’s Code for Children and Adolescents. Now, children starting at age 12 who have parental consent can work under contract and those from age 10 may be self-employed, as long as both stay in school.
Luis Canaza, 15, argued that part-time jobs can improve math skills and provide money to buy school uniforms and books. Luis, who has been working since he was 7, performs weekend clown shows and moonlights as a “voceador,” the barkers who shout the destinations of minibuses to lure passengers.

Nashville's own Merle Hazard on the Federal Reserve's dual mandate

As anyone who has read chapter 21 should realize, motivating an agent to follow two conflicting goals is very difficult for any principal, much less the US government.


Thursday, October 23, 2014

For those of you who missed his Vanderbilt class, ...

Mike Aronstein spoke at Brendant Moynihan's investment class, where he spoke about inequaltity caused by the Fed:
How this works is that people in the investable class who have access to assets can liquidate them for real cash. And if these assets have been rising in value (perhaps in a bubble), the amount of cash available to borrowers can be enormous. “Anybody who has an engagement with the nominal value of investable assets right now is getting wealth at a pace that’s hundreds of times beyond that available to somebody who’s outside of that stream.”
He also thinks inflation will eventually appear.  
Are there any benefits from recent Fed policy? Possibly down the line. “Seepage of this monetary excess into the rest of the local economy, piece by piece, means you’re going to wind up with a generalized inflation later on in this process, that I don’t believe the Federal Reserve will be able to stop it, or have the will.” Could this lead to higher wages? That’s anyone’s guess at this point.

Wednesday, October 22, 2014

BEYOND IRONY: Fed Chairman causes the very inequality she bemoans


Chairman Yellen complains about inequality, yet seems oblivious to her own role in exacerbating it.  Quantititative easing makes money plentiful and cheap; and this has benefitted those who can access the money in extraordinary ways.  Let me count a few of the beneficiaries:

  • The big Wall Street banks, .. which can borrow directly from the Fed, essentially free. Because banks are in the business of making money from money, they use the Fed’s money to make more money by trading with it, investing it in government debt and pocketing the profit or by lending it out at wide spreads. ...No other business on the face of the earth gets its raw material so cheaply. No wonder bank profits have soared.
  • Wall Street’s traders and investment bankers...know – and have known for years, thanks to the Fed’s telegraphing of its quantitative easing program – that the Fed will be a continuing buyer of their risky securities at (ever-rising) market prices. Since the onset of Mr. Bernanke and Ms. Yellen’s policy, the Fed’s balance sheet has grown to $4.5 trillion, from around $800 billion before the crisis. That’s a whole lot of securities bought at high, profitable prices and paid directly to Wall Street traders. The Fed might as well have been paying the traders’ seven-figure bonuses directly.
  • The Fed’s low-interest rate policies have also been a bonanza for Wall Street’s investment bankers – and their bonuses — as companies around the world race to raise debt capital at low rates. 
  • Private equity firms ... borrow money cheaply and leverage the billions of dollars in equity – said to be $3.5 trillion these days — to buy and sell companies. The buyout firms, and of course Wall Street, also get fees from all this deal activity. 

Meanwhile the little guys on fixed income get crushed by low interest rates:
...because they can’t get a return without taking an inordinate amount of risk, by either investing in the stock market, ...,or by “reaching for yield” by investing in risky debt securities that are increasingly overpriced. Either way, Ms. Yellen’s policies are crushing these 62 million American households. 

Monday, October 20, 2014

REPOST: Ãœber succeeds where taxis fail

Saturday, April 14, 2012


Ãœber succeeds where taxis fail

Almost all the everyday complaints about cabs trace back to bad regulation
Drivers won’t take you to the outer reaches of your metropolitan area? The regulated fares won’t let them charge you more to recover the cost of dead-heading back without a return customer. Cabs are poorly maintained? Blame restricted competition, and the inability to charge for better quality. Cabbies drive like maniacs? With high fixed costs for cars and gas, and no way to increase their earnings except by finding another fare, is it any wonder that they try to get from place to place as fast as possible?

Ãœber is a better way to move assets to higher valued uses

Uber makes its money at least in part by alleviating these inefficiencies. In most places, “black car” or livery services are regulated differently, and more lightly, than taxis are. Though Uber has good reason not to say so, it’s basically turning livery services into cabs. The company is one step further removed from regulation, because it doesn’t run cars itself; it funnels passengers to existing services. “We’re sort of like an efficient lead-generation system for limo companies,” says Kalanick, “but with math involved.”

Predictably, the old technology asks the government to regulate the new technology
The commission has also launched a public fight against Uber. In January, Chairman Ron Linton declared that the service was “operating illegally” and personally led a “sting” operation, impounding the car of the unlucky driver who had dropped him off at the Mayflower hotel in front of a waiting reporter. Linton followed up with an op-ed in The Washington Post, insisting that Uber was unlawfully charging for time and distance. Uber’s defenders pointed out that D.C. limo regulations define “sedans” as “for-hire” cars that charge for service “on the basis of time and mileage.” Linton now says that

HT: Brock

Friday, October 17, 2014

What happens when Apple makes it easy to switch between carriers?

Price competition should become fierce.

A preinstalled data-only SIM card has been inserted into the $499 iPad Air 2, and allows users to change carriers at the tap of a finger. It's available in the U.S. on AT&T (NYSE:T), Sprint(NYSE:S) and T Mobile (TMUS), and in the U.K. on EE. Consumers can buy short-term data plans and can switch between the carriers to find the best deal.

Thursday, October 16, 2014

Automatic Pizza Maker Vending Machine

The demand for low skilled workers continues to fall.

Wednesday, October 15, 2014

Should Tennessee fund venture capital?

Not unless they can do it better than the millions of people who already do this for a living.

Equally direct, when asked about TNInvestco 2.0, Vanderbilt University economist Luke Froeb, who is on the faculty of the Owen Graduate School of Management, said venture investment such as that discussed here should be left to the marketplace, without State involvement. He then pointed us, once again, to his earlier comments regarding what he has termed TNInvestco's "perverse incentives" for fund managers.

In fact, if they had to do it, don't you think they should have mimicked the way that investors fund VC?  Here is a REPOST on the peculiar way that they chose to do it last time.

Monday, September 10, 2012


Perverse incentives in TN state funded investment

The state is auditing the its venture capital fund, which awards $20 Million ($25 M in future tax credits are worth about $20 M today), and then asks fund managers to invest  in early stage ventures.  After the investment pays out, the state and the managers split whatever remains.

Proponents of the program say it was an innovative attempt to steer venture capital toward economic development priorities like health care, bioscience, music and other sectors. As the Business Journal reports today, some Republicans are questioning the program’s job creation so far and want to evaluate other aspects of its financial performance.


Any audit should first understand the incentives.  To do this, lets run through some scenarios.  This is what is called a "sensitivity analysis."

 Compare the (very approximate) terms of a typical Venture Capitalist (VC) to those of TNInvestco under the following scenarios:
  • Scenario A:  Good Scenario (Invest $20 million, sell investments for $50 million)
    • TNinvestco gets $25 million, State gets $25 million
    • Typical VC gets $6 million, investor gets $44 million

  • Scenario B:  Break-even Scenario (Invest $20 million, sell investments for $20 million)
    • TNInvestco gets $10 million, State gets $10 million
    • Typical VC gets zilch, investor gets $20 million

  • Scenario C:  Worse-case Scenario (Invest $20 million, sell investments for $10 million)
    •  TNInvestco gets $5 million, State gets $5 million
    • Typical VC gets zilch, investor gets $10 million
The key thing to note is that the typical VC is makes nothing (other than management fees) unless a fund makes money for investors.  This serves to align the fund manager's incentives with the profitability goals of the fund investors.

In contrast, a TNInvestco fund manager makes a substantial amount unless the fund is a total failure.  

Bottom line, TNInvestco creates incentives for the managers to not lose money, as opposed to the high level of risk taking that is typical to venture capital.  One would expect safer investments. 

Stay tuned for what the audit uncovers.


If you pay people who are unemployed, ...

... you get more unemployment.  From the St Louis Fed:

Longer benefits may reduce unemployed workers’ job search efforts, decreasing their likelihood of becoming reemployed.

BOTTOM LINE:  Every recession since 1950 has included an emergency response from Congress to increase unemployment benefits.  The good news is that the perverse incentives of the program seem small, increasing unemployment rate only a small fraction.

Friday, October 10, 2014

How can a country decrease exports?

by strengthening their currency:

Whenever the ruble moves to the weak end of the trading band, the central bank begins selling dollars and euros to cushion the currency’s decline. It automatically moves the band by 5 kopecks, or hundredths of a ruble, once an intervention allotment of $350 million is exhausted.

To combat the falling ruble, the Russia is raising interest rates, but.... 

While higher interest rates would reduce pressure on the ruble by making assets denominated in the currency more appealing, that isn’t expected to be enough to offset the impact of strong domestic demand for hard currencies. Since the West imposed sanctions against Russia, domestic banks and companies have had increasingly limited access to external borrowing, yet they still need to repay more than $47 billion in foreign debt. 
As a result, both lenders and other firms are buying dollars and euros on the Russian market.

How can a country increase exports?

Countries with strong currencies, face reduced demand for their exports:

“I would not want to be in machine tools in Germany at the moment,” said Adam Posen, president of the Peterson Institute for International Economics and a former Bank of England official. “I would not want to be in ship building in South Korea.”




The feeble recovery is tempting countries to weaken their currencies (by printing money):

European Central Bank President Mario Draghi has praised the euro’s decline, an indication to investors that a weaker currency is a key ECB policy objective. Bank of Japan governor Haruhiko Kuroda made similar remarks about the yen’s value. South Korea and China have come under fire for keeping their currencies lower than levels many economists say would reflect fair market values.

But this works only if you are the only country doing it.  If rivals also weaken their currencies, the net effect is zero, a type of prisoners' dilemma.

Top finance officials trying to talk down the value of their exchange rates have resurrected warnings of a global currency war. Such tit-for-tat devaluations tend to create short-term growth at other countries’ expense.

Monday, October 6, 2014

Saving Endangered Species by Hunting Them

While the scimitar-horned oryx was declared extinct in the wild in 2000, they have thrived in captivity in Texas.
By any measure, those gains have been impressive. In 1979, according to the Texas-based Exotic Wildlife Association, there were 32 scimitar-horned oryx in a captive breeding program in Texas; today there are more than 11,000. Only two addax were known to exist in the state in 1971; today there are more than 5,000. And the number of dama gazelle has increased from nine individuals in 1979 to more than 800 today.

This was accomplished because an exemption from the Endangered Species Act allowed reserves to offer hunting packages so that sportsmen could hunt the animals. This gave reserves a profit opportunity related to conserving the animals. But after protracted court battles, this exemption was drastically curtailed in 2012.
Without the unfettered ability to hunt, breed and trade these animals, ranchers say they will lose the economic incentive to maintain the herds, and whatever gains have been made in restoring their numbers will be lost.

The prospect of the implementation of the new rules led ranchers to escalate hunts before the market evaporated. Fortunately, clearer heads have prevailed and the exemption has been reinstated. Poachers have an incentive to kill off an entire herd because they have no claim to the offspring the herd produces next year. In contrast, no rancher kills off a herd precisely because it is even more valuable next year.

Hat tip: Richard Carroll

Does free contraception reduce pregnancy?

A natural experiment suggests that the answer is "yes"


An experiment conducted in St Louis provided 1404 girls aged between 14 and 19 with free contraceptive advice and free long-acting contraceptive devices ... The comparison group was that of similar girls in the rest of the United States who were not included in the experiment. 
The researchers found that, by giving both free advice and free contraceptives, the rates of pregnancy, live birth and induced abortion declined precipitously by comparison with national averages. ... On the face of it, the experiment was a triumphant success.

Until you look a little closer at how the experimental group was "selected":

The young girls were drawn from those who resided in St Louis or sought contraceptive services in selected community clinics, and furthermore had no desire for pregnancy for at least 12 months. These girls, then, were a self-selected group...

BOTTOM LINE:  the observed different between the groups is the sum of the "treatment" effect (the effect of the contraception) and the "selection" effect (that girls less likely to get pregnant were in the experimental group).  This is why randomized experiments are so much easier to interpret.   

Saturday, October 4, 2014

REPOST: bundling architecture and art

Sunday, June 19, 2011


Museum Bundling

Stockholm's Moderna Museet (modern art museum) and the Arkitekturmuseet (architecture museum) share a building and, therefore, share a pricing plan. The first cost 100 krona and the second cost 60 krona, but the combination cost 140 krona.



















I suspect most modern art fans are less enthusiastic about architecture and most architecture aficionados are less interested in modern art. For both groups, the profit-maximizing price for their first choice is greater than the profit-maximizing price for their second choice (adjusting for the apparent preference for modern art). That is, you would like to price discriminate between consumers' first choices and their second choices. But people rarely tell you which one they came for. With bundle pricing, they don't have to. So long as you are willing to take the same discount for both (20 krona in this case), they will self-select into the appropriate ticket purchase.

Mathematically, the increased sales from reducing the price on the second ticket has to more than make up for the lower margin. But this would be true since demand is usually more elastic for the second choice.

We can model pure bundling using a simple demand structure.  Suppose your marketing director surveyed consumers and estimated the following demand structure (values):


                                     Art Museum  Architecture museum
Art afficionados                     100                       40
Architecture afficionados          40                     100


If the cost of serving a customer is zero, the museums make more money by offering only a bundle (what price should they charge) than they do by pricing separately.  Verify this for yourself.

The reason is that you make consumers more homogeneous by bundling so you can extract their consumers surplus with a single price.  

Thursday, October 2, 2014

Why are health costs so high?

Because Medicare pays for drugs like Sipuleucel-T that extend life 4.1 months for patients with advanced cancer at a cost of $100,000

How many people would buy this drug if they had to pay for it themselves?

Wednesday, October 1, 2014

Risk Off: stock market drops 1% as investors dump risky stocks

Investors behaved as if the world had all of a sudden become more risky:

Traders said large fund managers and institutions were selling riskier investments like stocks, and fleeing into the relative safety of government bonds. Many of those investors were initially optimistic about the fourth-quarter outlook for stocks, traders said, but were changing course after weak economic data from the U.S. and Europe. Sectors seen as growth-sensitive posted sharp declines, with materials dropping 2.3% and industrials shedding 1.9%. Utilities stocks, seen as a defensive bet, climbed 0.9%.

See our past post on risk on vs. risk off trading

How does Health Spring make money?

Founder Herb Fritch explains that it is all about aligning the incentives of physicians with the goals of payers using narrow networks (to increase bargaining power), physician incentives (to reduce costs), and a disease management registry (to guide physician behavior):

On narrow networks:
We stuck with the more restrictive HMO models, even though with the higher payments, it was certainly possible to do less restrictive PPO or private fee-for-service kinds of plans. We have always taken the view that at the end of the day, the fee-for-service system costs too much and we need to be able to deliver care where the beneficiary can get an incentive to join a more structured program. But the government needs to share in some of those savings, too, and we have to be prepared ultimately to get paid at FFS Medicare rates and to share savings with the government and the beneficiary.

On physician incentives:
We organize doctors into delivery systems, typically around a hospital. They are doctors that refer to each other routinely anyway. ... We share risk on a targeted budget that is based on a percentage of the premium we collect, so there’s a shared savings based on economics and performance. 

On disease management registry:
 We also have a disease management registry tool that makes the doctor aware of which patients are due for a visit and what they need. You can actually look at the diabetics who haven’t been in for a visit and be proactive in making sure they come in and get the screenings that they should have. ...

We believe that when chronic disease is managed appropriately we can measure reductions in emergency room visits and hospitals admissions at the same time. That’s ultimately the payoff.

Why is Alibaba worth $162B?

Because it moves assets to higher valued uses, from B2B.

Planet Money has another episode that is making me rethink my opposition to subsidies for Public Radio.

One thing I like about the podcast is the description of how business used to be done in China, with drinking and karaoke, as a solution to the problem of adverse selection.

Tuesday, September 30, 2014

Decision Driven Data?

Blum, Goldfarb and Lederman have a nice commentary on the use of data driven decision making. We may hope that the collection and analysis of more data leads to more evidence based decision making. However, in many organizations, decision making is advocacy based in which subordinates petition their manager for permission to go ahead with their pet project. In this case, the subordinates have an incentive to cherry-pick the evidence and managers learn not to trust the evidence. If this is not addressed, the promise of "data analytics" is lost.

Blum, Goldfarb and Lederman suggest that the organizational relationships must change in order to make use of all these new data. Advocacy of previously held positions should be minimized. One way is to push decision making down the chain. The role of the manager may be to determine what to test, with the subordinates having decision rights, and responsibility, over how to respond to the test results.

Monday, September 29, 2014

Strong dollar is unwinding the "carry trade"

Investors make money by borrowing in dollars at low interest rates, selling dollars and buying the foreign currency to invest in high interest foreign debt (mainly government debt). 

But what happens when these investors expect that the gain they make by taking advantage of the interest rate differential falls below the loss they expect when they have to sell the foreign currency to buy dollars to pay back the loans?  

They get out before before the bubble bursts:
Several analysts sense danger. “The carry trade strategies are finally cracking,” said Luis Costa, currency strategist at Citi bank. “The market has been so flooded with liquidity and interest rates have been so low for so long but this is turning now.” 

...The headwinds eviscerating the carry trade are reinforced by a robust outlook for the US dollar that derives from three enduring trends: the US economy is recovering strength, boosting the greenback’s attractiveness; the US Federal Reserve is poised to end its programme of quantitative easing in October, tightening dollar liquidity; finally, the European Central Bank has begun a dovish phase of monetary policy, enhancing the dollar’s outlook relative to the euro.

I put this in the "bubble" category because it is the expectations that drive the changes.  

Thursday, September 25, 2014

How best to sell drugs

It used to be easy to sell drugs:  employ the most attractive sales people you could find--drug companies favored former cheerleaders with no experience in medicine--and take doctors to sports events or cater lunches for their offices.  

But things are changing.
Today, 42% of doctors practice as salaried employees of hospital systems, up from 24% in 2004, according to Cegedim Relationship Management, a marketing consultant.  As a result, the pharmaceutical industry is shifting its sales efforts from doctors to the institutions they work for.
Hospitals get better prices than drug stores because they have the ability to steer patients to drugs on a formulary:
The superior bargaining clout of hospitals and HMOs relative to drugstores is attributable to their use of formularies, which enable them to solicit bids from competing manufacturers for an all-or-nothing contract.  Drugstores, in contrast, typically stock their shelves with all competing brands of a drug, and cannot credibly threaten to withdraw their business from a manufacturer that fails to offer a discount.

Bottom line:  the alternatives to agreement determine the terms of agreement.  In this case, the ability of hospitals and HMO's to "steer" patients to particular drugs means that the alternative to agreement is much worse for the drug manufacturer.  This makes the drug manufacturer more eager to reach agreement, which results in better prices. 

Saturday, September 20, 2014

REPOST: why are so many donated kidneys discarded?

Thursday, September 20, 2012


Why are so many donated kidneys discarded?

In the past, we have blogged about our inefficient kidney matching system:  almost 100,000 people are waiting for kidneys, only about 20,000 receive kidneys.

Now we learn that physicians throw away about 2000 usable kidneys.  One of the reasons is the government's performance evaluation metric:  If the number of failures exceeds expected levels by 50 percent, transplant programs are put on watch list, and then decertified if they dont improve.  This incentive encourages physicians to reject all but the best organs for transplant:
“When you’re looking at organs on the margins, if you’ve had a couple of bad outcomes recently you say, ‘Well, why should I do this?’ ” said Dr. Lloyd E. Ratner, direct of renal and pancreatic transplantation at NewYork-Presbyterian/Columbia hospital. “You can always find a reason to turn organs down. It’s this whole cascade that winds up with people being denied care or with reduced access to care.” 
After the University of Toledo was cited, a transplant surgeon cut back to about 60 transplants a year from 100, becoming far choosier about the organs and recipients he accepted. 
The one-year transplant survival rate rose to 96 percent from 88 percent, but Dr. Rees still bristles at the trade-off. “Which serves America better?” he asked. “A program doing 100 kidneys and 88 percent of them are working, or a program that does 60 kidneys and 59 of them are working? It’s rationing health care under the guise of quality, and it’s a tragedy that we are throwing away perfectly good organs.”
Someone, please, let these people use a market.