Gaming Target's Incentive Compensation Scheme

Canadian Business has a long and thorough article about Target's failed entry into Canada. Highly recommended. Buried inside is this little vignette.

A small group of employees also made an alarming discovery that helped explain why certain items appeared to be in stock at headquarters but were actually missing from stores. Within the chain’s replenishment system was a feature that notified the distribution centres to ship more product when a store runs out. Some of the business analysts responsible for this function, however, were turning it off—purposely. Business analysts (who were young and fresh out of school, remember) were judged based on the percentage of their products that were in stock at any given time, and a low percentage would result in a phone call from a vice-president demanding an explanation. But by flipping the auto-replenishment switch off, the system wouldn’t report an item as out of stock, so the analyst’s numbers would look good on paper. “They figured out how to game the system,” says a former employee. “They didn’t want to get in trouble and they didn’t really understand the implications.” Two people involved in the discovery allow that human error may have been a component, too. Like SAP, the replenishment software was brand new to Target, and the company didn’t fully understand how to use it. When Schindele was told of the problem, he ordered the function to be fully activated, which revealed for the first time the company’s pitifully low in-stock percentages. From there, a team built a tool that reported when the system was turned on or off, and determined whether there was a legitimate reason for it to be turned off, such as if the item was seasonal. Access to the controls was taken away from the analysts, depending on the product.

Sometimes, it is difficult to get the metrics right.

Precise Bids

New research from Keloharju and Hukkanen has one clear piece of advice: "When Negotiating a Price, Never Bid with a Round Number." The argument is that a round number signals that you have no clue what the true value is. A more precises bid indicates that you have done your homework and have a more precise estimate of the underlying value of the object. As a consequence, your counter-party is more likely to accept your bid. The graph reports the returns as a based on round number bids or not.

Another study by Jerez-Fernandez, Angulo, and Oppenheimer based on the TV show The Price Is Right examined the guesses contestants made for the market price of consumer products. Audience suggestions for bids ending in zero were least likely to be chosen.

what makes us rich?

Its the incentives, stupid.

Why You Might Want to Hire an Econmist

Jed Kolko has an interesting blog entry titled "Should Your Tech Firm Have an Economist?" It is short and full of insights but a lot of our advantage comes from reducing uncertainty through careful analysis of the data. Specifically, he claims our comparative advantage comes from:

• Knowledge of economics frameworks 
• Data detective and mash-up skills 
• Hypothesis-driven statistical modeling
• Cleverness about experimentation 
• Culture of internalized data scrutiny

Not a bad set of skills.

Why did Henry Ford raise wages to $5/day?

In 1913, Henry Ford doubled wages because he had to:

"Turnover at the Ford plant had soared to 370 percent by 1913. The company had to hire 50,448 men just to maintain the average labor force of 13,623. Company sur­veys at Ford revealed that more than 7,300 workers left in March 1913 alone. Of these, 18 percent were discharged; 11 percent formally quit; and 71 percent were let go because they missed five days in row without excuse and so were deemed to have quit. On each day, it was necessary to make use of 1,300 or 1,400 replacement work­ers without any experience. One observer remarked, 'the Ford Motor Co. had reached the point of owning a great factory without having enough workers to keep it humming.'

But since turnnover among women was small, he didn't raise their wages:

In addition, Ford disqualified all women. According to one source, 'Women did not work on the assembly line, and were not likely to drink and fail to show up for work. They did not jump from job to job. So there was no reason to include them.'

HT:  WJ

A cauliflower bubble?

Probably not:  prices of up to $8/head seem to reflect fundamentals of increased demand from carb counters and reduced supply from cold weather in California.

Should we eliminate the middlemen?

Forbes answers with a resounding "no!" --because they move assets to higher-valued uses.

Uber and Airbnb do not own cars and hotels. Rather, they are profiting from what they know about consumers and dead capital. Before the rise of Uber there were many people who needed rides but were unable to efficiently contact nearby strangers who would be willing to give them a ride in exchange for a fee. In a similar fashion, Airbnb connects travelers in strange cities to the hundreds of nearby homeowners who have spare bedrooms. Before companies like Airbnb travelers faced significant costs if they wanted to spend their holiday living in a native’s spare room. In almost every circumstance, booking a hotel or hostel room was more cost-effective and reliable. Now, finding people who want to give you a place to sleep is just a few clicks away.

Renting vs. Buying

Our friends at Marginal Revolution have a nice post about renting vs. buying.  Most of it is about the benefits and costs of the enormous tax subsidies that bias the decision towards buying.  Economists think the subsidy destroys wealth because it prevents people from moving closer to better jobs, and needlessly subsidizes the rich.

But some of the advice is aimed at would be homeowners

Housing is overrated as a financial investment. First, it’s not good to have a significant share of your wealth locked into a single asset. Diversification is better and it’s easier to diversify with stocks. Second, unless you are renting the basement, houses don’t pay dividends. Stocks do. You can hope that your house will accumulate in value but don’t count on it. Indeed, you should expect that as an investment your house will appreciate less than does the stock market. You didn’t expect to get a great investment and a place to live in the meantime did you?

Finally, they recommend buying a smaller house close to where you work because commuting is really inefficient and the compensating differentials reduce the value of small houses (so buy one).

is the stock market over-valued?

In the long run, stock price should equal the expected discounted flow of future earnings.  However, it is difficult to measure these earnings.  Robert Shiller uses a ten year lag of inflation adjusted earnings to determine whether a stock's price is too high or low, called CAPE (wikipedia link).    According to this measure the stock market is still over valued relative to its earnings.

HOWEVER, there are other ways of measuring long term value.  The equity premia of stocks--the extra return you get for investing in stocks over bonds--is high right now (4-5%) which implies that the stock prices have to rise to bring it back to historical levels.  In other words, using the long run releationship between stocks and bonds, rather than stocks and earnings, says that stocks are under-valued.

Why would a firm sign this long term contract?

Interesting story from China where lower raw milk prices are actually hurting a Mengniu Dairy (a processing firm that should ordinarily benefit from lower input prices).  Instead, it has to support its upstream suppliers with continued purchases in the face of very low demand.

In the West, this kind of long term contract would be signed to encourage the upstream dairy to make relationship-specific investments necessary for trade.  But it is difficult to see the value of such investments with a good like raw milk.

I am curious, does any one know why dairies would sign contracts like this?  Is it custom, or some kind of mandate in a country where the state has a very big interest in full employment.

HT: WJ