Will AI get rid of billable hours?

• WSJ: Say Goodbye to the Billable Hour, Thanks to AI

Ironically, what began as an effort to promote transparency and efficiency for legal work has since become a tyrannical arrangement with both senior people and junior associates motivated to rack up hours to maximize profits. It spread from law firms to accounting firms, consultants and most other professional services firms as the dominant mechanism for value exchange. ...

...as AI handles routine cognitive work, the remaining human contribution shifts toward judgment, creativity and relationship management—the value of which bears little relationship to time expended.

• Value-based pricing represents the most obvious alternative, where fees are tied directly to outcomes achieved or value delivered rather than time spent. 
• Subscription and retainer models offer another path forward, providing clients with ongoing access to expertise and capabilities for a fixed periodic fee. 

 The end of the billable hour also could bring change to the organizational structure of professional-services firms. Instead of maintaining a pyramid structure in which authority flows down from a small group of leaders at the top to a large group of employees at the bottom, these firms might become flatter and more flexible, consisting of a small core of senior experts who assemble teams and technology on an as-needed basis, depending on the client or project.

Gamification of Hiring

A primary role of HR is to screen job applicants to address adverse selection in hiring. Now they can automate much of this with apps like HireVue. This platform performs virtual video interviews that include various tasks to assess skills. Candidates perform 'gamified' tasks that are linked to various applicant traits. Not surprisingly, influencers have developed content helping applicants prepare for these games.

 

Trust and Scale

I am enjoying the History of the Germans Podcast by Dirk Hoffnan-Becking. Along with endless "Game of Thrones" style dynastic struggles among countless counts, dukes, princes, and emperors, there is a fair amount of business economics. A recent episode described the emergence of an early joint stock corporation to solve a thorny asymmetric information problem. The episode compared trade within the Baltic based Hanseatic League, which came to prominence in the 13th-14th century, with Great Ravensburg Trading Society dominant in Southern Germany in the 15th century. Long distance trade requires trust since your trading partner has many ways of cheating you. As Dirk notes:

In the Hanse system, this problem was solved through an elaborate surveillance operation. Each merchant would have several correspondent agents in each city that he or she would trade with. These correspondent agents would not only keep an eye on the market, but also on the behaviour of the other correspondents. That way a merchant would know fairly quickly if say the creditworthiness or honesty of one of his agents was placed in doubt. And the higher a merchant rose within their city, the more access he would gain to information. As a member of the city council, he would hear about the state of negotiations with kings and princes, where pirate activity was most intense and what would be done about it etc. And finally, long standing relationships, intermarriage and the fact that Hanse traders all spoke Low German created trust between the participants in that network.

The Hanse system limited the size of each trader's operations since its hallmark was engaging multiple traders in each location keeping an eye on each other. In contrast, the Great Ravensburg Trading Society, employed agents throughout its network, each with a stake in the company's fortunes.

The main constraints to this model were the number of family members and trustworthy business partners one could recruit. That is likely one of the reasons the three firms of Humpis, Mötteli and Muntprat joined forces in Ravensburg in the early 15^th century. They all had been extremely successful merchants, but growth has hit a wall as they had run out of individuals they could send out as their representatives. By pooling their resources, they could establish a much larger network of agents than they could set up individually. Another key benefit was that the combination reduced competition, increased pricing power with suppliers and customers and reduced risk.

Every three years a full account of the books was made to determine the dividend payments and bonuses. The company expanded to as many as 90 smaller partners and grew into a truly pan-European network. The founders' wealth eventually became many multiples even of nearby Kings. 

Managing Remote Workers

As we all know, Work From Home (WFH) arrangements became important with the COVID-19 pandemic. However, five years on, about a quarter of the US workforce still works from home. WFH appears to be here to stay, but it represents an employee management challenge. Since monitoring offsite effort is more difficult, the professions that tended to take advantage of WFH, at least initially, have been those in which constant monitoring has been less important.

Increasingly, firms are taking advantage of newly developed monitoring tools for remote workers. VPN Express reports that three types of remote monitoring have become common.: Online tracking tools (74%), Physical surveillance (75%), and AI-driven metrics (61%). These tools can mitigate moral hazard problems and make WFH available to larger classes of workers, but they may also undermine trust and, therefore, incentive pay schemes. 

“𝗜 𝘄𝗮𝗻𝘁 𝘆𝗼𝘂 𝘁𝗼 𝗰𝗹𝗼𝘀𝗲 𝘆𝗼𝘂𝗿 𝗰𝗼𝗺𝗽𝘂𝘁𝗲𝗿, 𝗰𝗼𝗺𝗲 𝘀𝗶𝘁 𝗯𝘆 𝗺𝗲, 𝗮𝗻𝗱 𝘁𝗲𝗹𝗹 𝗺𝗲 𝘄𝗵𝘆 𝗜 𝘀𝗵𝗼𝘂𝗹𝗱 𝗶𝗻𝘃𝗲𝘀𝘁 𝗶𝗻 𝘆𝗼𝘂.”

It was the most terrifying moment of my entrepreneurial journey. 

I was 31 - a farm kid from Mississippi, sweating through my suit jacket at Rockefeller Center in New York. I’d already been rejected by Nashville investors: “Too young, too risky, too small to compete.” This felt like my last shot.

Ten minutes into my polished pitch, Ted McCourtney, Senior Partner at Venrock, asked his team to leave. Then he told me, “I'm already an investor in your biggest competitor. Why should I bet on you?”

I knew the deck wouldn’t save me. So I just told the truth.

I shared how I grew up on a rural farm. Joined the Army to pay for college. And then I said:

“Mr. McCourtney, I’ve mortgaged my home and my family farm to start this. If I fail, I lose everything. If I fail, you lose a fraction of a percent of your holdings. I’m all in. This cannot fail.”

He listened quietly. Then he brought his assistant back in and said, “We’re going to back Michael.”

Years later, after we’d successfully sold the company, I asked him why.

He said “Michael, I rarely see such naive honesty in New York. Given your story and what you had on the line, I knew you were a good bet.”

LESSON: Venture Capital investing is inherently uncertain. Investors like Ted McCourtney have to guard against moral hazard (will the entrepreneur act in the best interests of the investor) and adverse selection (if other investors turned him down, am I missing something). But the entrepreneur's revelation that if he failed, he would lose everything, assured the investor that his goals were aligned with those of the investor.

CREDIT: Professor Michael Burcham

Weaker incentives in unionized plants make them more likely to close

Unionized plants have worse incentive alignment:

• 26% less likely to offer performance-based bonuses. 
• 11% less likely to promote based on performance 
• 13% less likely to dismiss workers for poor performance. 

Consequently, unionized plants have: 

•  Higher rates of business closures, 
•  lower investment 
•  slower employment growth 

BOTTOM LINE:  right-to-work states (no unions) have higher employment and better outcomes. 

CITE:Maksimovic, Vojislav and Yang, Liu A., What do Unions do? Incentives and Investments (June 16, 2023). Available at SSRN:  https://ssrn.com/abstract=4565288 or http://dx.doi.org/10.2139/ssrn.4565288

HT: MarginalRevolution.com

WSJ: Why EU lags US in tech.

Someone at the WSJ read Why the U.S. Produces More Unicorns than the EU

• Limited Presence of Major Tech Firms: 
• Apple's market cap > entire German stock market, 
• Structural Barriers to Innovation: 
• risk-averse business culture, 
• stringent labor laws, 
• heavy regulation
• smaller venture capital pool
• Talent and Incentive Challenges: 
• lack of stock options makes it harder to align incentives--and retain--innovators.  
• Underinvestment in Emerging Technologies: no quantum computing and artificial intelligence. 
• Dominance of Legacy Industries/lack of dynamism:  EU firms founded in 1911, US in 1985

Would Thomas Jefferson approve of DOGE?

From ChatGPT:

Thomas Jefferson would likely have mixed feelings about a Department of Government Efficiency, depending on its scope and function.

• Why He Might Approve: 
•  Limited Government & Fiscal Responsibility – Jefferson was a strong advocate for minimizing government waste and ensuring efficient use of public funds. If such a department worked to reduce bureaucracy and streamline operations, he might have supported it. 
•  Republican Virtues – He believed in a government that served the people effectively without unnecessary complexity, so an effort to improve government efficiency could align with his ideals. 
• Why He Might Disapprove: 
• Bureaucratic Expansion – Jefferson was skeptical of centralized power and large government institutions. The very creation of a new department could be seen as adding more layers to the bureaucracy he often opposed. 
•  State vs. Federal Power – He strongly favored states’ rights and decentralized governance. If the department operated at the federal level, he might argue that efficiency efforts should be handled at the state or local level instead. 
• Final Thought: If structured as a temporary commission to identify inefficiencies and reduce waste, Jefferson might have supported it. But if it became a permanent federal agency with expanding influence, he would likely have opposed it as a contradiction to his vision of a small, decentralized government.

NFL Teams as Franchisees

The NFL had been the only large US sports league to prohibit private equity firms from owning teams. Beaton and Gottfried at the WSJ report that this prohibition is slowly being removed.

The National Football League, the most lucrative league around, has long barred firms from owning a piece of its teams. Its policy was simple: team owners should be actual people, not corporate entities. That meant eschewing the free-flowing cash infusions from institutions that now line the pockets of owners in the National Basketball Association, the English Premier League and Major League Baseball, among others.

Now, after years of discussions, that’s finally changing.

At a meeting Tuesday afternoon, NFL owners passed a new policy that will allow them to sell up to 10% of their teams to a select group of preapproved firms. It removes the last major hurdle to the flood of private capital sweeping through the sports landscape, which now has firms circling the college game and others amassing portfolios of pro franchises.  

Why such severe restrictions on private equity ownership? Possibly, this is a way to keep franchisees interested in maximizing league profitability and not just club profitability. It has long been suspected that club owners are willing to sacrifice some of their profits to generate more wins and, perhaps, a championship. (An exception that still chaffs me is the McCaskey's dismantling of the 1985 Bears immediately following their Superbowl victory, but I digress.) This seeming "over-investment" in team quality improves quality of play throughout the league enhancing fan engagement across the board and so makes all the teams more profitable. It is feared that private equity firms would be too interested in the club's bottom line to keep up these investments.

 

Incentivizing Data Analytic Teams

The effectiveness of incentivizing routine or manual tasks has often been been studied. The effectiveness of incentives for non-routine, analytical tasks, such as data analytics, is much more difficult to determine. As well as the usual free-riding in teams, performance metrics are noisier and these tasks tend to have higher levels of intrinsic motivation. Englmaier et al (2024) find a clever setting to test the efficacy of external incentives - escape rooms. A 10 euro incentive to escape with 45 minutes, doubles the likelihood of meeting the target. The usual time allotted is 60 minutes. This provides some evidence that bonus incentives can be a viable instrument to increase performance in these tasks.

Why Hilton Doesn't Franchise Luxury Hotels

The WSJ has posted a nice eight minute video about the hotel business as part of their "Economics of" series. One trends has been a decades long shift toward franchising properties to the owner / operators. However, Hilton, as well as other chains, own and operate their luxury hotels themselves. In this segment, their are just too many non-quantifiable dimensions of amenities on which a hotel can falter. It is too difficult to set metrics for a franchisee.

Book Review: The Venture Mindset

Summary by author in HBS:

"In the late 1970s, the firms on the S&P 500 had been on that list for 35 years, on average; by 2019, the average tenure was closer to 20 years. And rapid advances in technology mean that even the most stable industries risk being upended by start-ups that can reach scale on ever-faster timelines."

• Consensus decision making doesn't work because "contrarian ideas because those are the ones that deliver outsize returns....At successful VC firms, individuals are not trumped by the group." For example Reid Hoffman backed Airbnb even though his fellow investors were opposed to the idea. 
• Keep teams small: "Think of Amazon, where meetings with more than 10 participants are quite rare. Communication in smaller teams is faster and clearer, and there is greater accountability. The setup not only streamlines decision-making but also ensures that diverse perspectives—crucial for innovative outcomes—are heard and considered."
• Assign a devil’s advocate.: To ensure that opposing views are heard, many VC partnerships make it a standard practice to assign the role of contrarian to one person or to a small team. For example, a16z often designates a “red team” of people who argue against a deal. 

What interested me most was:

• discussion of "the jockey [the team] vs. the horse [the idea]."  A bad team with a good idea is doomed to failure but a good team with an OK idea can pivot to a new idea as they learn more.  
• the books hostility to "team building," "consensus," and "bureaucracy."   [professors learn this from faculty meetings]

Tractor Supply Ditches DEI, ESG After Online Attacks

• We will review and consider revising our current DEI goals while still ensuring a respectful environment. [Diversity, Equity, Inclusion]

• Withdraw our data on emissions and focus on our land and water conservation efforts. [ESG=Environmental, Social, Governance]

Stories: Bloomberg, Zerohedge

See also:

• The paradox of ESG investing
• What happens if we cannot measure ESG?
• How Saudi Aramco, world's largest oil company, became "green."

What's wrong with the Episcopal Church?

As a result of declining attendance and giving, driven partly its emphasis on politics instead of ministry, administration costs have risen to 60% of revenue, way above the recommended 40%.

Throughout the church, parishes and dioceses are being asked to do more with less, except at the top levels, where [the Episcopal Church] now spends more on church chancellors than evangelism.

And when the General Convention directed that Church HQ relocate from New York City to a cheaper location, the NY-based administrators simply ignored the directive.

Lets run this through our problem-solving algorithm:

1. Who made the bad decision?  Church administrators decided to stay in NYC.  
2. Did they have enough information to make a good decision?  Yes.
3. Did they have the incentive to do so?  No.  They put their own lifestyle preferences ahead of the Epicopal Church's.  We can infer that church administrators have decision rights over the costs they incur, but not the incentives to make good decisions for the church.  

OK, now that we have identified the problem, lets try two obvious solutions:

1. Give decision rights to someone else;  One suggestion from Rev. Everett Lees, almost as if he had read Managerial Economics: A Problem Solving Approach, is to decentralize decision making to individual parishes and reduce the 15% Episcopal franchise fee down to 10%.  When you decentralize decision making, strengthen incentives, i.e., by letting parishes keep more of what they make.  
2. Better align Church Administrator incentives with those of the individual parishes.  However, because church administrators are so far removed from the concerns of individual parishes, it is hard to imagine a good performance metric.

"Institutional Neutrality" to organize polarized people

NPR's interveiw with Chancellor Diermeier: Vanderbilt University, "...will not take policy positions unless they directly affect the operating of the university." 

Also WSJ editorial by the Chancellor.

Meritocracy and Productivity

A new paper by Bandiera et al. focuses on how matching worker skills to job characteristics affects productivity. They use detailed data for 120,000 workers across 28 countries in an attempt to identify the productivity effects of i) worker skill endowments, ii) technology, and iii) job markets frictions. They formalize meritocracy as as the degree to which worker skills match with the skill requirements of jobs. Miss-allocation, due to, say, inflexible labor laws or nepotism, would imply a reduced the role for meritocracy.

Not surprisingly, they find that most of the difference in income between developed and developing countries is from differences in skills and technology.  However:

... a large share (36 percent) of the gains from adopting frontier endowments and technology are realized through enhanced sorting. Improvements in worker-job matching thus constitute an important amplification channel for economic development ...

Without the ability to hire he right person, technology is less productive. Without the likelihood of using advanced skills on the job, workers forgo acquiring these skills. More generally, meritocracy improves incomes because it increases the return to investing in the technology and skills. This is further documentation of the importance of getting the incentives right.

Diverse MBA teams perform worse

From "Diversity and Performance in Entrepreneurial Teams" (SSRN): 

• Among the randomly-assigned teams [of MBA students], greater diversity along the intersection of gender and race/ethnicity significantly reduced performance. 
• However, the negative effect of this diversity is alleviated ... [when teams can choose their teammates]
• ...teams with more female members perform substantially better when their faculty section leader was also female. 

Incentive alignment in Benefits Corporations

Begun in Maryland in 2012, thirty states now have Public Benefits Corporations (B-corp's) (wikipedia, seeking alpha, quora) 

• For-profit companies that can be publicly traded, but which follow other goals, like ESG. 
• B-corp managers get legal protection from shareholder suits based on low profitability, as they can claim they are pursuing ESG goals.

Chapter one identifies their fatal flaw: not only is ESG hard to measure, but it also conflicts with the pursuit of profit.  This is similar to the problems created by balanced scorecards.

Without good performance metrics,  it is hard for shareholders to tell if B-corp managers are doing a good job, so managers will pursue their own goals at shareholder expense.

Related:  ESG blog posts

Potential Workers Use ESG as an Employer Screen

A new multiple author study looks at how workers sort into, or out of "good" firms, that is, firms with environmental, social, and governance (ESG) practices. From their abstract:

We conduct a field experiment in partnership with the largest job plat-form in Brazil to study how environmental, social, and governance (ESG) practices of firms affect talent allocation. We find both an average job-seeker’s preference for ESG and a large degree of heterogeneity across socioeconomic groups, with the strongest preference displayed by highly educated, white, and politically liberal individuals. We combine our experimental estimates with administrative matched employer-employee microdata and estimate an equilibrium model of the labor market. Counterfactual analyses suggest ESG practices increase total economic output and worker welfare, while increasing the wage gap between skilled and unskilled workers.

Limiting your investment portfolio to only ESG projects should lower returns. However, this could easily be overcome if better workers have a preference for ESG employers.

Car Wash Industry Dynamics

"The Economics of Everyday Things" a recent episode on Car Washes. Lots has happened to transform this industry.

•  Growth - The industry is growing fast thanks, in part, to less "home production."

  When we started in— back in 1996, more than half of people with cars in the U.S. reported that they most frequently wash their car themselves in the driveway. Our most recent survey, we’re approaching 80 percent now use a professional car wash.

• Bundling - New technology has allowed new pricing schemes more like subscription services or gym memberships that are likely to increase consumer surplus capture.

We fix a little RFID sticker in the bottom corner of your window. And it knows exactly what wash to get, how often you’ve washed and what vehicle you’re in, any contact information. It’s kind of like a barcode, if you will, for your vehicle. And when you pull up to the pay station the gate goes up immediately.

• Input Substitution - Increasing use of technology has reduced labor costs.

A modern car wash today can be run with three or fewer employees versus having, you know, 12 to 25 at some stores back in the day. In those days, car wash owners were almost like farmers. I mean, you’re always watching the weather. You’re always trying to anticipate what demand is going to be so you can manage that labor expense.

All these changes have manager implications. Growth often allows firms to exploit sale economies. Bundling is easier with multiple establishments run under the same brand. Fewer workers could mean more decision rights to each one suggesting more incentive compensation.