This is illuminating to say the least. The Washington Post is reporting on spending under Bush vs Obama. Keep in mind that the Post has been called “Pravda on the Potomac”, so it comes with a healthy pinch of liberal bias. My view is that the budget culture in Washington is broken because a new budget item becomes permanent by default, so spending can never decrease.
Presh Talwalkar has an elegant explanation on why competing entities in an environment where demand is linearly distributed (like two burger stands on a beach) tend to cluster in the center of demand.
The intuitive explanation is this: Imagine two burger stands on a straight beach a mile long with the beach crowd evenly distributed along its length. Customers will gravitate towards the closest stand. If one stand was a quarter mile from the left and the other was a quarter mile from the right, they would have an equal number of customers.
But if one of the stands moved slightly towards the center, it would gain more customers and the other stand would lose those same customers (a zero sum game). So the optimal position for both stands is dead center i.e. on top of each other. That gives them both 50/50 market share and prevents the other stand from gaining more market share.
…even though it causes people on the beach to have to walk further to get a burger.
Check out Presh’s blog entry for a full explanation and accompanying graphics. He relates this to why politicians tend to position themselves in the political center and why news channels all carry the same stories.
Bringing this back to the real world, I wonder about things like goodwill, brand loyalty, pricing power, brand cachet and so on. Positioning yourself in the center of the beach, in the center of the political spectrum or, if you’re a news channel, carrying the stories everyone else carries does not engender much love in your target market.
If a competitor were to come along and position themselves off-center, they may sacrifice a portion of the market, but develop fierce loyalty among their customers for being better and being different.
This brings to mind many famous brands who started with a cult following:
Keith Hennessey does a spectacular job of explaining the complicated process of arriving at the federal budget and where it is currently stuck in this week’s Econtalk.
He also breaks down who has the power to move things forward right now. It’s so good I was tempted to transcribe selected bits here, but I just don’t have the darn time.
Got another call from the Obama campaign today who I spent a lot of time and energy supporting last election. I don’t support either party currently because I’ve evolved into an economic conservative but still socially liberal which leaves me stuck with no party to support.
So just for the hell of it I tried to convert the volunteer into a Hayekian liberal. After 5 minutes he still wouldn’t bite.
He did mention he’s had a rough day. Surprised, I am not.
Yesterday FT.com’s Alphaville posted a graph showing that the US treasuries CDS graph had inverted for the first time ever.
What that means is that the cost to insure against default on 1 year US Treasury Notes costs more than it does to insure a 5 year note. This goes contrary to economic liquidity preference theory – meaning that investors generally see bonds with a longer maturity as being riskier so to insure them usually costs more.
So why does it cost more to insure a 1 year treasury bond? Investors see the risk for the US government as significantly higher in the short term and that psychology creates this weird effect.
Footnote: I’ll make this clearer in another blog entry but for now I’d like to add that I see the risk of an actual default by the US government is extremely close to zero. If we don’t get our act together by August second, we don’t automatically default. We just have to gradually make harder and more irresponsible decisions about who to pay and what to defer. Those decisions have a forcing effect on our political system as pressure will rapidly mount beyond calls from disgruntled constituents to calls from creditor’s lawyers.
Here’s a little reminder that sovereign debt is unsecured. Greece just defaulted. And for some reason only Reuters are calling it like it is. Expect fireworks tomorrow. Here’s the story:
http://blogs.reuters.com/felix-salmon/2011/07/21/greece-defaults/
My new favorite economist Tim Harford did a great TED talk recently chatting about our assumption that an expert approach is needed to problem solving. He argues that instead we should rely more on trial and error, a method that has proven very effective both in nature and business.
If the loading animation won’t disappear then try viewing the video on this page.
David Skeel of UPenn’s law school talks with Russ Roberts on econtalk about the mechanics of bankruptcy law and whether the government should have bailed out the auto industry. Bear in mind you’re getting the Hayekian view on Russ’s show (to which I subscribe). For the Keynsian argument, check out NPR’s Planet Money blog and podcast.
Skeel discusses the bankruptcy process including voting rights, creditor seniority and the role of a judge in an ordinary bankruptcy which is required knowledge for any entrepreneur. Even though this is the last thing anyone aspires to, you should know the worst case scenario, the process and your options and rights.
I’ve had this blog entry saved as draft for a month, and Tom Buck’s post earlier today titled “Failure: Building a $50/month web app” inspired me to post this. He remarks in his post “My mistake quickly became obvious: I had built a tool for an audience that didn’t like to spend money.”. Here’s my take (and my verbatim draft from a month ago):
“The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.” — Friedrich von Hayek
Hayek’s wonderful quote captures both the wisdom and arrogance of economists and their field, so consider it my caveat for the observations below.
The canonical example of adverse selection comes from the industry that invented the term: In the insurance industry, customers who are more likely to die tend to buy more life insurance. Because the insurer doesn’t have all information on the health of buyers, life insurance as a product tends to select the wrong customer i.e. customers who are less profitable because they die sooner.
In the online world, “Free” is a popular model for gaining “Traction”, meaning access to many customers. The assumption is that a reasonable percentage of those free customers will at some point become buyers. Therefore success is gauged by growth in the population of a company’s free customers because at any time a company can pull the “revenue lever”.
The problem and a realization I had during the last year, is that “Free” can adversely select against paying customers.
Customers who use many free products online are less likely to pay for a paid service. Conversely, customers who have recently paid for an online service are far more likely to pay for other online services. And what you may view as incentives to upgrading may be further selecting against customers who will pay in future.
One might argue that this is simply the old sales adage that customers who are most likely to buy something from you are those that just bought something from you. But I’d argue that this works across company boundaries e.g. if a business refers customers who recently bought their service to another business, those customers are far more valuable than referrals from a free service – because they’re the kind of customer that pays.
Adding disincentives to using your free product (or incentives to upgrading if you flip it around) strengthens the adverse selection problem because those who adopt your free product, presumably prior to upgrading to paid, have a strong desire to never pay. Their desire is so strong that they will tolerate whatever irritant you’ve introduced in the free product which makes the likelihood of them upgrading to your paid product even less.
So is Free useless? No it’s not and it can be a method of establishing a relationship and trust provided you target free customers where other criteria qualifies them as likely to pay in future and the free product doesn’t disqualify them.
For example, you could choose to only provide your free service to customers who have recently paid for an online service somewhere else. In addition, the free product must not adversely select against those customers once you’ve recruited them e.g. Your free product must be something that a paying customer is more likely to use and like, rather than a gatekeeper that irritates until the customer either leaves in frustration or upgrades.
Free works, provided it targets the correct customer and continues to incentivize them on their journey to becoming a future paying customer.
Money talks. Or, in this case it doesn’t.
Have you noticed that the vast majority of published ideas will not increase your business or personal revenue? If someone has a truly great idea for increasing earnings or creating new revenue out of thin air, they will implement or trade it themselves and will never share.
At the point a great (tech sector) business concept is shared, it enters the highly efficient ideas market that is the Tech Echo Chamber (HN, Reddit, Slashdot, TC, etc..) – which efficiently propagates it out to the rest of the world’s population of innovators. At this point the idea is undifferentiated, rapidly being implemented by all, and you’re in a price or other kind of efficiency war.
This, combined with the truism that it’s not a bad idea to completely ignore your competitors and focus on your customers, makes it a pretty darn good idea to avoid spending too much time on tech publications and social media outlets. You will learn nothing new and what you will learn loses much of its value the moment it’s published. The temptation to imitate will probably harm your business as you’re bounced along in the current of swarming incompetents.
The main (possibly only) thing I use blogs and social media reporting on tech news for is to keep track of landscape changes. Changes in the economics of a sector or changes in technology. Either of these almost always signal the start of a firestorm of innovation.
Focus on your customers, find the truly brilliant ideas that solve customer problems and beware of sharing them too early.
Footnote: The concept I’m describing relates to Efficient Market Hypothesis and Information Asymmetry if you’d like to read more.