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. 

REPOST: Dating Game

Friday, November 15, 2013

Dating Game

QUESTION: A man and a woman are trying to decide where to go on a date.  The woman prefers ballet, but the man prefers going to a football game.  There is some gain to going together, but each would rather go to their preferred activity alone, than together to their less preferred activity.  Diagram this game, and show how best to play.


                                              Football             Ballet
                              Football   (1,4)                  (0,0)
                                  Ballet   (2,2)                  (4,1)

The man does better by going to the football game, regardless what the woman does, and the woman does better by going to the ballet, regardless what the man does.  These are called "dominant strategies."  The equilibrium of the game is for each to go to their preferred activity.

Notice, however, that the two players could make themselves better off by cooperating.  Self interest is taking them to a place (2,2) with a lower group payoff than the cells on the main diagonal. 

There are two ways to change the game to increase group payouts.

1. Alternate.  If the couples take turns, their group payout goes up.

2. Have the player that receives the higher payoff, compensate the other player for going to their less preferred activity.

In this case, the man could give 1.5 units to the woman if they go to the football game, which would change the payoff in the upper left to (2.5, 2.5).  This would change the equilibrium of the game.

Alternatively, the woman could give 1.5 units to the man if they go to the ballet.  This is the premise of an off-color South Park episode.

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. 

Thursday, September 18, 2014

Why are wages decreasing and employment increasing in Great Britain?

The simplest explanation is tat supply is increasing:  as supply increases output increases real prices fall and output increases.

The Financial Times shows the data and puts forward several explanations:  (1) welfare reforms are pushing people off the dole and into the labor force; (2) older workers are choosing to retire at a later age.  Both explanations would imply an increase in supply.

Tuesday, September 16, 2014

Should you travel to India for your Hepatitis C cure?

Gilead, the company who invented Solvadi, a pill that cures hepatitis C, has just announced its global price discrimination scheme.

In the US, a twelve week regimen of the $1000 pills costs $84,000, while in India a the same treatment costs only $1800.

The price difference could pay for a pretty nice 3 month vacation to India.

What is the number one business book on iTunes today?

Vanderbilt and Owen's own Brendan Moynihan's "What I learned losing a million dollars."

Listen to his podcast on the Tim Ferris show.
“One of the rare noncharlatanic books in finance.”
– Nassim Nicholas Taleb, author of The Black Swan and Antifragile
“There is more to be learned from Jim Paul’s true story of failure than from a stack of books promising to reveal the secret formula for success…this compact volume is filled with a wealth of trading wisdom and insights.”
– Jack Schwager, author of Hedge Fund Market Wizards
The newest book in The Tim Ferriss Book Club (all five books here) is a fast read entitled What I Learned Losing a Million Dollars. It packs a wallop.

Is RG III a sunk cost?

No, but the draft picks the Redskins paid for him are.  The  NY Times has more:

The moment the owner Daniel Snyder signed off on trading those draft picks to the St. Louis Rams to get Griffin, those picks were gone forever. Poof! Never coming back. 
From that point, the strictly logical approach would have been for coaches and management to treat Griffin like any other rookie who had great potential but a lot of work to do to live up to it. That doesn’t mean that they should have plopped him on the bench every time he made an errant throw. Of course he needed (and, apparently, still needs) to learn the pro-level game, and it’s worth sacrificing wins today if you are getting a more skilled player for the longer run. No one argues that the 1998 Indianapolis Colts should have parked Peyton Manning on the bench amid his 3-13 rookie season. 
But there are plenty of indications that rather than treat Griffin like another promising but unfinished player, both fans and, at times, the team’s coaches seem to view him through the prism of what was paid to get him.

Strategy is simple...become a monopolist

WSJ has an essay from the head of PayPal who reminds us that capturing value is more important than creating value:

...U.S. airline companies serve millions of passengers and create hundreds of billions of dollars of value each year. But in 2012, when the average airfare each way was $178, the airlines made only 37 cents per passenger trip. Compare them to Google,GOOGL -0.56% which creates less value but captures far more. Google brought in $50 billion in 2012 (versus $160 billion for the airlines), but it kept 21% of those revenues as profits—more than 100 times the airline industry's profit margin that year. Google makes so much money that it is now worth three times more than every U.S. airline combined.

Airline competition is so intense that firms capture only 1% of the value that they create.  Google has far less competition and is able to capture 20% of the value that they create.  20% of their smaller pie is worth way more than 1% of the airlines' larger pie.

MAXIM:  Creating value is only the first step.  You also have to figure out how to capture it.  

Tuesday, September 9, 2014

Is "artharitis" a good excuse for price fixing?

I first heard that expression from a defendant in a price-fixing trial brought by the Justice Department against a gas station owner in Iowa.  The defendant called the gas station across the highway every morning to ask what price he was charging.  Since she had to match his price (otherwise she would sell no gasoline), she argued that a simple phone call would save her one more painful trip up the ladder to change the price on the sign. 

At first I thought it was just rural slang, but when I saw the jury foreman walk in with a pair of jeans so loose that you could see the top of his inter-gluteal crevice (one of my students who is also a surgeon gave me that expression when he saw me struggling to avoid saying “butt crack” in class), I suspected it was part of the trial strategy.   The defendant's attorney wore a rumpled white linen suit and spoke with a thick accent, which contrasted with the attorneys and economists from “the Federal Government in Washington, DC.” All of us were wearing dark suits and speaking with no accent.  Her attorney used the expression again in his closing argument to chastise us for wire-tapping an old widow who was coping with her “artharitis” as best she could.

Needless to say, we lost the trial--we got “home fried.”  But years later, when I ran this case past two second-grade classes, I got a unanimous conviction.  Of course, I first had to explain that antitrust cops (my daughter was surprised that I had been a cop) enforce laws that make it a crime to discuss prices with your competitors.  One of her classmates who almost cried when I explained to her that the Sherman Act covered conversations with her friends.  The idea that there are some things that you cannot share with your best friend was extremely upsetting to her.  

Monday, September 8, 2014

REPOST: The force that Porter forgot

The force that Porter forgot

Preston McAfee was the first to realize that Michael Porter's famous industry analysis leaves out one crucial force: cooperation from complements. A new article, How Companies Become Platform Leaders, offers a framework for thinking about strategy in industries like telecommunications where success requires creating an "ecosystem" of complementary products.

A company must first decide whether to pursue a "product" or a "platform" strategy:
Put simply, a product is largely proprietary and under one company’s control, whereas an industry platform ... requires complementary innovations to be useful, and vice versa. An industry platform, therefore, is no longer under the full control of the originator, even though it may contain certain proprietary elements.
One of the biggest mistakes a company can make is to pursue a product strategy and fail to recognize the platform value of their product. The best example of this is perhaps Macintosh computer which, due to its early technological lead, could have become the dominant platform for personal computing. Instead they priced high, failed to encourage complementary innovotion, and let Microsoft become the dominant platform.

If you decide on a platform strategy, then the authors recommend one of two strategies, coring or tipping.
"Coring" is using a set of techniques to create a platform by making a technology "core" to a particular technological system and market. ... Examples of successful coring include Google Inc. in Internet search and Qualcomm Inc. in wireless technology.

"Tipping" is the set of activities that helps a company "tip" a market toward its platform rather than some other potential one. Examples of tipping include Linux's growth in the market for Web server operating systems

Friday, September 5, 2014

How to tell if your resources give you a sustainable competitive advantage

According to the RBV view of strategy a resource can give you a sustainable competitive advantage only if the above conditions are met.

Some examples from HBS:

Valuable resources can take a variety of forms, including some overlooked by the narrower conceptions of core competence and capabilities. They can be physical, like the wire into your house. Potentially, both the telephone and cable companies are in a very strong position to succeed in the brave new world of interactive multimedia because they own the on-ramp to the information superhighway. Or valuable resources may be intangible, such as brand names or technological know-how. The Walt Disney Company, for example, holds a unique consumer franchise that makes Disney a success in a slew of businesses, from soft toys to theme parks to videos. Similarly, Sharp’s knowledge of flat-panel display technology has enabled it to dominate the $7 billion worldwide liquid crystal display (LCD) business. Or the valuable resource may be an organizational capabilityembedded in a company’s routines, processes, and culture. Take, for example, the skills of the Japanese automobile companies—first in low-cost, lean manufacturing; next in high-quality production; and then in fast product development. These capabilities, built up over time, transform otherwise pedestrian or commodity inputs into superior products and make the companies that have developed them successful in the global market.

Thursday, September 4, 2014

REPOST: should we raise the minimum wage?

Should we raise the minimum wage?

Mark Perry has a nice piece on proposals to raise the minimum wage from $7.50 to $10, a 38% increase.  He begins with research that finds an elasticity of demand between  -0.1 and -0.15 or a 2-3 percent reduction in employment from a 20 percent increase in the minimum wage.
Accordingly, a 38 percent increase in the minimum wage to $10 per hour would reduce teenage employment by between 3.8 and 5.7 percent.  And what would that mean for the number of jobs eliminated and the increase in the jobless rate?  
If the 38 percent increase in the minimum wage to $10 per hour had the minimum effect of reducing teenage employment by “only” 3.8 percent, that would put 171,000 currently-employed teenagers out of work and increase the teen jobless rate almost three full percentage points to 26.6 percent.  At the high end, a 5.7 percent reduction in teen employment would put almost one-quarter million teenagers out of work and drive the teenage jobless rate up to 28.1 percent, the highest rate in history. 

REPOST: Why are Turkey prices 9% lower at Thanksgiving?

The NY Times explains the debate among economists who worry about such things:

The most intuitive and popular explanation for a high-demand price dip is that retailers are selling “loss leaders.” Stores advertise very low prices — sometimes even lower than they paid their wholesalers — for big-ticket, attention-grabbing products in order to get people in the door, in the hope that they buy lots of other stuff. You might get your turkey for a song, but then you also buy potatoes, cranberries and pies at the same supermarket — all at regular (or higher) markups. Likewise, Macy’s offers a big discount on select TVs on Friday, which will ideally entice shoppers to come in and buy clothes, gifts and other Christmas knickknacks on that frenzy-fueled trip.

When you price complementary products (chapter 12) it makes sense to reduce the price.  An alternate explanation is from the demand side:

Consumers might get more price-sensitive during periods of peak demand and do more comparison-shopping, so stores have to drop their prices if they want to capture sales. Perhaps, during the holidays, the composition of consumers changes; maybe only rich people or people who really love turkey buy it in July, but just about everybody — including lower-income, price sensitive shoppers — buys it in November. Or maybe everyone becomes more price-sensitive in November because they’re cooking for a lot of other people, not just their nuclear families. 
“People are a little less picky about what they’re buying for other people,” explains Judith Chevalier, an economics professor at the Yale School of Management. “Let’s say I prefer Coke over Pepsi. If I’m buying for myself, I’ll probably buy Coke even if it’s more expensive. But if I’m buying soda for a party, I have no reason to think everyone else also prefers Coke, so I’ll go with whichever brand is cheaper.”

If turkey demand becomes more price elastic around Thanksgiving then we know that it makes sense to reduce price (Chapter 6).  A related explanation is that prices dont change, but rather the more price sensitive consumers substitute toward the cheaper brands. 
 One paper looking at canned-tuna prices argued that this kind of brand substitution was the primary case for an overall decline in price during Lent. It turns out that the cheapest tuna brands aren’t significantly discounted during Lent, but because the cheap brands temporarily accounted for a much higher share of overall sales, they dragged down the average price of a can of tuna.

HT:  Sam

REPOST: Simple Pricing, the "stay-even" quantity

The marginal analysis of simple pricing, i.e., price at the point where MR=MC, is sometimes implemented by using a version of break-even analysis.  Instead of asking which price maximizes profit, you instead ask "will a given price increase, e.g., 5%, be profitable?"  To answer the question, we

1. Compute the stay-even quantity, the quantity you can afford to lose and still break even

2. Predict (or guess) whether the actual quantity lost will be greater or less than the stay-even quantity.

3.  If the actual quantity lost is less than the stay-even quantity, then the price increase will be profitable.   

Here is the derivation of the stay-even quantity:

The benefit of a price increase is the extra revenue you earn at the new (and lower) quantity, Benefit=dP*(Q+dQ)

The cost of a price increase is the margin on the lost sales, Cost=dQ(P-MC)

where dP=P1-P0, dQ=Q1-Q0, P0=initial price, P1=final price, Q0=initial quantity, and Q1=final quantity.

You compute the Quantity at which you are indifferent between raising price or not, and you get the formula:


where m=(P-MC)/P, dQ/Q=% change in Q, and dP/P=% change in P.


The stay even quantity for a 5% price increase for a firm with a 40% contribution margin is 11.1%=(5%)/[(5%)+(40%)].  If you expect to lose less than 11%, then a 5% price increase will be profitable.

REFERENCE:  Page 9 of
A Critical Analysis of Critical Loss Analysis,
Daniel P. O’Brien and Abraham L. Wickelgren, January 2003 (Published in Antitrust Law Journal) [PDF 236K]

Why is the NFL so valuable?

CBS just bid $300 million, and won an auction to broadcast eight thursday night games.  Broadcast networks like CBS use the NFL to attract viewers from different media for one reason,

TV channels see sports as vital to their lineups because 97% of all sports programming is watched live, .... CBS, 21st Century Fox Inc.'s Fox, NBC and Walt Disney Co. DIS +0.19% 's ESPN have committed to pay $5 billion a year to air NFL games through the 2021 season.

Euro weakens as ECB reduces interest rates

The Financial Times has an article on the recent moves by the European Central Bank to stimulate the domestic economy, 

“The ECB is the first central bank to announce large-scale asset purchases and negative deposit rates. The euro could weaken further if European banks use the cash to purchase assets abroad via euro-funded carry trades.”

As a result, the euro fell below  $1.3 and is down almost 5 per cent against the dollar since the beginning of July.

The WSJ chimed in with the graphic above that better illustrates the ECB strategy:  they are buying bonds issued by Eurozone banks, and then charging them 0.2% interest unless the banks lend the euros out.  

If as the Financial Times article suggests, the Eurozone banks make loans to foreign investors, the Euros will weaken by the "carry trade."  Here's how:  A US investor, for example, would borrow from Eurozone banks, sell the borrowed euro's to buy dollars, and then invest the dollars in the US.  This represents an increase in the supply of euros (or a decrease in the demand for dollars) in the market for foreign exchange.  

Tuesday, September 2, 2014

Dollar strengthens on expectations of US interest rate rise

Two reasons for this:

1. Investors sell euros to buy dollars to invest in the US to take advantage of the higher US rates. 
2. US borrowers borrower in foreign currency to take advantage of the lower foreign rates, and then sell the foreign currency to buy dollars to invest in the US.  This is called the "carry trade."

Both factors increase the demand for dollars in the market for foreign exchange which raises the "price" of a dollar, the exchange rate.