SOPHISTICATED FINANCE

Competition

Competition, like profitability, is one of those issues where every aspiring entrepreneur has already learned all the folk wisdom before they start their company. And, of course, because it is folk wisdom we do not lose any time stoppping to validate the correctness.

Lately I have been thinking about competition and how to properly understand it. Fortunately, whenever a subject starts to bother me along come 3-4 good articles to stimulate my thinking.

The first article I saw was "The Achilles Heel of Every Great Idea" which does a beautiful job of discussing the restaurant industry to describe competition, differentiation and target customer/market. There are 1 million restaurants in the U.S. with combined annual revenue of $650 billion. This would clearly be a competitive market with 300 million customers as restaurant patrons. Yet this large number of companies succeed by differentiating their offering to match their taregt market. So perhaps the conclusion is focus on the customer and not the competition.

In an article on ROBGO.ORG entitled "Competition", the author says:

"Sometimes you can be too paranoid and get way too focused on competitors, to the point that they cause you to take your eye off the ball."

The author recommends focus on the customer and do not obsess over competition

In another good article, "Why I Don’t Stress Over Competition Anymore", the author makes two good points:

1. Competition validates the market and reduces the investment to educate customers about a new need.
2. "Don’t get caught focusing on your competitors at the cost of making wise decisions about your own business." Point 2 above again.

My own thoughts on competition go back to this post on strategy. Effective battles are fought where you can set the stage and bring the most resources to bear. Focusing on competition allows them to determine the battlefield. Better to pick a market segment, differentiate a product to meet those target customer needs and let the competition react.

Second, competitors help to pay to educate customers about a new product. I actually know of a company that kept their competition in business for that reason after the competitor plant was rendered inoperable by the Fukushima nuclear power plant. Like everything, there are good things about competitors.

The last thought comes from Clayton Christensen's concept of disruptive innovation. Christensen says that there is an 80% chance of failure if you compete directly with the market incumbent. One should serve a set of customers who cannot afford the incumbent product. Christensen is advocating for a focus on new market segments.

More to follow.

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Seeing to Learn

Fast Company has an interesting post on Flannery O'Connor's cartoons. Ms O'Connor was also a very accomplished author, which provides additional data for the thesis that creative people frequently master a second art.

This quote from O'connor I found particularly interesting.

“For the writer of fiction,” she said, “everything has its testing point in the eye, and the eye is an organ that eventually involves the whole personality, and as much of the world as can be got into it.”

"This way of seeing she described as part of the “habit of art,”. She used the expression [habit of art] to explain the way of seeing that the artist must cultivate, one that does not separate meaning from experience. And like any other habit, it has to be developed over time and through practice."

The notion of seeing is a central theme in creativity, both literally and figuratively. Many geniuses say that they saw their solutions in their mind before they tried to articulate them. This suggests that creativity involves a more basic process such as seeing rather than language or writing.

The notion of not separating meaning from experience is also a powerful tool. If one takes pictures of dolphin swimming in the ocean, the experience is the photography. If one merely observes the dolphins there are opportunities to derive many "meanings". I think this is part of the reason I do not like videos. In the video the experience of the story is choreographed to make the writer's point. If I am just observing life real time I create the meaning.

 

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World Pay Corporate Social Responsibility Program (CSR)

World Pay is one of the largest credit card and fixed payment processors in the world. A new promotion allows the company using World Pay to nominate a charity to receive 10 percent of the World Pay processing fee. Nice simple social benefit from using World Pay.

I would be happy to connect any interested business with World Pay. I receive no compensation for this activity.

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Good Question: What Good is Wall Street

The New Yorker has an excellent new article, "What Good is Wall Street". This article inspired today's post on the theme of morality in capitalism, which includes several previous articles such as "Is Capitalism Moral" and "A Refresher on the Fundamentals of Capitalism".

The New Yorker article makes several good points:

1. Banks are a type of utility to allocate capital to worthwhile third party investments. In return for this privilege, they are regulated the same as water and power companies.
2. Banks went astray when they diverted so much capital to support trading schemes in the new derivatives they developed, which was not part of their original mandate as utilities.
3. In bringing so much innovation to the development of derivatives, the banks failed to consider a fundamental requirement of innovation, that it create economic value.

Effectively, the large banks have trading operations that dwarf their original purpose to allocate capital productively, such trading amplifies market risk and such trading does nothing to contribute to transparent efficient markets. In summary, the benefits of the financial innovation in derivatives is not sufficient to warrant the scale or the increased risk

Interestingly, The New Yorker does not raise the issue that the capital used by the banks to support derivatives trading could have been deployed for more productive investment in third party borrowers.

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Economics: Understanding or Knowledge

Economics probably first emerged as a formal discipline with the writings of Adam Smith in the late eighteenth century. Drawing inspiration and guidance from philosophy, political science, psychology and other fields, economics became a full fledged part of the humanities perhaps culminating with the Austrian School of Economics in the early 20th century. Then after a distinguished history marked by such great thinkers as Smith, Keynes, Van Mises and Hayek, economics followed academic pressure and morphed into a science. The effect of this change from the humanities to science was the emergence of modeling, econometrics and almost a requirement that any economic thinking be expressed quantatively. Many other disciplines followed this trend to convert to a science and produce papers filled with higher math, which may explain the disappearance of thoughtful writers such as Van Mises in many areas of academic writing. 

In a very thoughtful piece, "Must we give up understanding to secure knowledge in economics?", Alex Rosenberg and Tyler Curtain argue that economists have achieved understanding without knowledge. The crux of the argument is that if you can explain one has understanding, if one can predict accurately (mathematically) one has knowledge. By this formulation, physics has knowledge but not yet understanding, which sounds about right given the state of quantum mechanics and related theories.

So economics is left in the unenviable position of trying to mathematically model human behavior, which the writers argue cannot be done. Physicists have only nature to explain, which Mandelbrot, Einstein and many others have shown lends itself increasingly to mathematical explanation and accurate prediction.

Now if the current state of economics should concern you, you merely have to accept a determinist view of the world, which makes humans just collections of matter and wait long enough for the physicists to explain mathematically human behavior and consequently economics. Alternatively, one could ponder the definition of knowledge, which has been a subject of discussion for more than 4000 years.

 

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NYT Wrong on Military Pay

In an opinion piece Sunday written by the Editorial Board of the New York Times, "Putting Military Pay on the Table", the newspaper advocates for a reduction in military pay and benefits. The article basically infuriated me for three reasons.

The NYT writes:

"After a decade of war, the very idea of cutting benefits to soldiers, sailors and Marines who put their lives on the line seems ungrateful. But America’s involvement in Iraq and Afghanistan is over or winding down, and the Pentagon is obliged to find nearly $1 trillion in savings over 10 years. "

Essentially we should only appreciate the military when they are actively engaged in a war. Everybody on watch in Afghanistan and other places should not take offense that you are forgotten by the NYT.

The NYT writes:

"Reducing the size of the armed forces would have the quickest effect. The budget office suggests giving smaller pay raises; replacing the current retirement system..."

The Defense Department expenditures of $608 billion represent only 18% of FY 2013 federal government expenditures. Rather than defaulting to reduced military compensation to address budget issues, perhaps we should question first the other 82% of the budget. 

In closing, the NYT writes:

"Soldiers must be adequately compensated. But when programs across the government are being slashed, including those affecting the most vulnerable Americans, no budget account can be immune from reductions and reforms. It is a difficult balance to get right.

I would have thought that the "most vulnerable Americans" are the military personnel we ask to go to war, their families and the returning veterans. For people who write for a living, the NYT Times Editorial Board could have been much more considerate in what they wrote.

New Model to Address Healthcare and Poverty

The Physics arXiv Blog had an interesting story, "Poverty Escape Plan Revealed by Computer Model of Economic Vicious Cycles". Georg Goerg a PhD student at Carnegie Mellon University has developed a model that shows how disease spreads through a country and the resultant effect on that economy. The basic assumptions is that disease debilitates people to the point where they cannot work or they work less days, resulting in less economic output for the country and poorer individuals. As the economy shrinks there are less healthcare resources available, which leads to more sick, poor workers in a vicious downward spiral of less healthcare, less economic output and more poverty.

Goerg's model tested two curative scenarios:

1. A large injection of outside capital
2. "the country increases the proportion of GDP it spends on healthcare, to bootstrap its own way out of the cycle"

Goerg's "conclusion is that increasing the proportion of GDP spent on healthcare cannot release a country from this kind of poverty trap. Indeed, it can do the opposite and trigger a vicious cycle of decline." Effectively, a poor country cannot deal effectively with a health emergency, such as an epidemic, using its own resources. The likely outcome will be a marked decline over a long period in GDP which will reduce healthcare for a long period.

The preferred approach to address healthcare in poor countries, as shown by the model, is to seek out a large amount of foreign capital. Alternatives might include:

1. Development aid
2. Sale of minerals (Saudi Arabia)
3. Sale of future mineral deliveries (Venezuela)
4. Organizing large pools of private capital for "public good" (Israel, Chile)

Regardless of how the pool of capital is put together, it is not necessarily the case that a healthcare program has to be administered by a national government (even if they raised the capital).

 

 

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