Episode #62 - Free-Rider Friday - Septemeber 2015

Ed's Topics

The song "Happy Birthday" is now in the public domain, and you get to hear Ed sing happy birthday to Ron royalty free!

Price Gouging for Drugs

Turing Pharmaceuticals and its CEO Martin Shkreli clearly made a serious mistake in pricing, but chalking it up to gouging and greed missed a large part of the story. 

The Freedom Report, Fraser Institute

The index published in Economic Freedom of the World measures the degree to which the policies and institutions of countries are supportive of economic freedom. The cornerstones of economic freedom are personal choice, voluntary exchange, free- dom to enter markets and compete, and security of the person and privately owned proper

Ron's Topics

Airplane Space is a Human Right?

The Washington Post, September 17, 2015: "Airplanes' space wars are shifting to the human rights front, by Christopher Elliott.

KPMG Australia: Disruptive Innovation?

Hat tip to our good friend Brent Uken at EY for passing this along.

"KPMG Australia disrupts itself with online marketplace for idle staff hours KPMG has launched a new online marketplace to offer the down-time of staff to clients for short term jobs at a discount. Like Airtasker.com or Freelancer.com – but for KPMG clients and staff only. 

Martin Sheppard, KPMG Australia's lead brand and innovation partner, likens KPMG Marketplace to an airline maximising "yield" by selling last-minute seats cheap. The idea grew from a response to an in-house ideas competition. "Relationship partners" don't get to sign off on KPMG Marketplace assignments bought by "their" clients. A start-up built the platform, not a big IT house. 

Some partners bristled at the idea of discounting charge-out rates. But the marketplace meets more business needs than optimising revenue from highly paid workers. Traditional professional services firms like KPMG don't turn a dollar of revenue online. That leaves them ill-equipped to exploit the boom in use of contingent labour by pared-to-the-bone clients struggling with peak workloads. 

KPMG Marketplace can also be used to sell other services. KPMG generated ideas from its staff via an internal competition, dubbed iTiger (i is for innovation). The idea that became KPMG Marketplace started as an idea for overworked KPMG staff to farm out batches of work internally. Others gave it a client focus, and KPMG Marketplace was born. Gestation was 18 months from "lightbulb moment" to launch. 

KPMG Marketplace works like this: Clients struggling with short-term peak seasons or workloads submit assignments online – for example, in foreign exchange reconciliation, financial modelling, data or business process analysis or project administration. They might get three CVs back – and choose one, who comes to work for them for up to 10 days. Longer secondments – say for a stand-in chief financial officer – will continue to be dealt with by the traditional process of speaking with a partner and signing an engagement letter setting out terms and conditions. Engagement online via KPMG Marketplace is more efficient, which explains part of the discount."

We discuss why we believe this is a flawed strategy for a so-called professional knowledge firm (and my Alma Mater).

Question & Shout Outs

Tim Rodman (@TimRodman) asks: If using timesheets means you are "a practicing Marxist", how bad would a Bernie Sanders win be for the @VeraSage mission?

To BJ Lee (@bj_lee_), a vocal coach, who asked us about pricing. We suggested he offer options, which he did, and the customer selected the highest priced option. Congratulations, BJ!

Thanks for Justin Royer (@justin_royer) for letting Ron know he will have to get his check book out to purchase the Apple car, scheduled to be released in 2019. Read about it here.

Episode #61 - Pricing on Purpose: Price Sensitivity Factors

The following is excerpted from Chapter 14 of Ron’s book, Pricing on Purpose: Creating and Capturing Value.

Price Elasticity vs. Price Sensitivity

Certainly mathematics has its place in pricing, allowing us to test, predict, and determine elasticity. Yet, since pricing is an art more than a science, judgments are also vitally important and cannot be substituted with mathematical precision.

Even if a company possesses a precise elasticity calculation it knows is accurate, it would only be part of the puzzle of pricing. Since elasticity normally lumps “consumers” together, it does not help us in segmenting customers into different value propositions, thereby offering individuals different bundles in order to maximize profit.

Ten Factors of Price Sensitivity

In order to assist those who are in charge of Pricing On Purpose in ascertaining and judging price sensitivity, the following ten factors should be examined to see which apply to your particular customer circumstances.

Thomas Nagle identifies ten factors affecting price sensitivity in his book, The Strategy and Tactics of Pricing.

1. Perceived Substitutes Effect

This effect states that buyers are more price sensitive the higher the product’s price relative to its perceived substitutes. New customers to a market may be unaware of substitutes, and thus pay higher prices than more experienced buyers. Restaurants in resort areas face less pressure to compete based on price (which locals may describe as “tourist traps”).

Branding can also overcome, to a certain extent, the substitute effect. Woolite, for example, has maintained a relatively expensive price because it positions itself as an alternative to dry cleaning, not a substitute to regular laundry detergent.

Customers have a reference price when there are many substitutes, and as long as the offering is within that range—sometimes referred to as a zone of indifference—it will be considered acceptable, the point being your marketing can influence which products customers will compare yours with, possibly pushing up the price they are willing to pay.

2. Unique Value Effect

Buyers are less price sensitive the more they value the unique attributes of the offering from competing products. This is precisely why marketers expend so much energy and creativity trying to differentiate their offering from that of their competitors.

Heinz ketchup, for example, developed a secret formula for making its product thicker and was able to increase its market share from 27 to 48 percent while maintaining a 15 percent wholesale price premium.

Auction houses rely on the unique value effect in order to command the prices they do among their bidders. Rare artifacts from the John F. Kennedy estate are known as “positional” or “expressive” goods, since the people who purchase them are trying to position themselves in society, or express who or what they are (art collectors, for example).

3. Switching Cost Effect

Buyers will be less price sensitive the higher the costs (monetary and nonmonetary) of switching vendors. Airlines that have a fleet of Boeing airplanes may be reluctant to switch to Airbus because of the enormous investment they have in their pilots, flight crews, parts inventory, and the mechanics of operating a certain plane.

Many people are unwilling to give up certain software products due to the learning and familiarity they have with their existing product. Personal relationships are most susceptible to this type of perceived cost, due to the emotional investment the customer has made in the relationship. Childcare providers, doctors, lawyers, veterinarians, and accountants all can benefit from this effect.

4. Difficult Comparison Effect

Customers are less price sensitive with a known or reputable supplier when they have difficulty in comparing alternatives. People eat at McDonald’s, continue to use AT&T, lodge at Marriott and shop at JC Penny because they are familiar with these offerings and perceive them to be less risky than unknown alternatives.

Stockbrokers price based on different criteria (shares of stock traded, or value of shares traded), making it difficult for the customer to compare one with the other. Cellular phone companies employ this strategy by offering different features among their myriad calling plans, making it very difficult to compare one company’s offering to another.

5. Price Quality Effect

Buyers are less sensitive to a product’s price to the extent a higher price signals better quality. These products can include image products, exclusive products, and products without any other cues as to their relative quality.

It is said that only 15% of Rolls Royce customers ask about price before purchasing. These types of prestige products are an important form of marketing. Witness designer clothing and accessories, along with American Express’ Gold, Platinum, and Black credit cards, which command enormous premiums over alternative cards.

Many customers still have a common visceral reaction that high price equates to high value (and quality). Marketers have discovered that utilizing a high price for new products is quite effective for signaling quality to the marketplace. Other marketing research has shown that while discounting familiar brands can increase sales, the same strategy for unknown brands can actually reduce sales.

6. Expenditure Effect

Buyers are more price sensitive when the expenditure is larger, either in dollar terms or as a percentage of household income. A one-office accounting firm may not pay much attention to the price of paper clips, but an international firm that buys in large quantities will.

Business purchasers look at the total amount of the purchase, while households will compare the expenditure to total income. Many people will not expend much energy shopping for the lowest price of soft drinks, but they will put more effort into searching for an automobile or a home. Higher-income customers often will pay higher prices because they do not have the time to shop as thoroughly as low-income individuals.

7. End-benefit Effect

This effect is especially important when selling to other businesses. What is the end-benefit they are seeking? Is it cost minimization, maximum output, quality improvement? The fulfillment of the end-benefit is often gauged by its share of the total cost.

For instance, steel suppliers selling to auto manufacturers know that the price of the steel comprises a large component of the cost of the car; on the other hand, when steel is sold to a luggage manufacturer, the steel cost is relatively minimal compared to the other material used.

The end-benefit effect is also psychological. Think of going out for a romantic anniversary dinner and paying with a two-for-one coupon. Most people view price shopping as tacky when the purchase involves something emotional. Wedding florists, caterers, and bands certainly understand this principle.

The larger the end-benefit, the less price sensitive the buyer. Think of the Michelin tire ads showing a picture of a baby in diapers next to its radial tire proclaiming, “Michelin. Because so much is riding on your tires.”

8. Shared-cost Effect

When you spend someone else’s money on yourself, you are not prone to be price conscious. This is one reason airlines, hotels, and rental car companies can all price discriminate against business travelers, because most of them are not paying their own way.

This also explains some of the success of the frequent flyer and other reward programs. Many business travelers value these rewards and will not accept alternative offerings, especially since they are reimbursed anyway. Also, publications, educational seminars, and other business expenses are tax deductible, and this also reduces the buyer’s price sensitivity relating to various business expenses.

9. Fairness Effect

Notions of fairness can certainly affect customers, even when they are not economically (or mathematically) rational. If a gas station sells gas for $2.30 per gallon and gives a $0.10 discount if the buyer pays with cash, and another gas station offers the same gallon at $2.20 but charges a $0.10 surcharge if the customer pays with a credit card, which station will sell more gas to credit card users?

The economic cost is exactly the same, but most people will psychologically prefer to deal with the first station and not the second because there appears to be something inherently unfair about being assessed a surcharge.

10. Inventory Effect

The ability of buyers to carry an inventory also affects their price sensitivity. Amateur cooks with large pantries will stock up on a good deal, but a single person living in a small apartment will not. The perishability of the item in question is another factor to consider.

Centralized vs. Decentralized Pricing

We discussed the debate between having pricing centralized versus giving pricing authority to the field. We are advocates of a centralized pricing function, since someone needs to own this function, study it, and turn it into a core compentency.

See our show from February 13, 2015, Who’s In Charge of Value?, for our discussion of the role of the Chief Value Officer.

Episode #60 - Interview with George Gilder

Includes our conversation during commercial breaks which are not heard in the audio above.

From George Gilder's appearance on Uncommon Knowledge (click for interview)

George Gilder is the author of 18 books: Bitcoin & Gold: Information Theory of Money (forthcoming); Knowledge & Power: The Information Theory of Capitalism; Men & Marriage; Wealth & Poverty (new edition 2012); The Spirit of Enterprise; Life After Television, Microcosm, Telecosm, The Silicon Eye, and The Israel Test.

Microcosm and Telecosm both listed among the era's top 10 technology books by VentureBeat in 2012 and Microcosm ranked among the era's top two technology books by Wired. Knowledge & Power was libertarian "book of the year" at FreedomFest 2013. George is a contributor to Forbes, National Review, and the Wall Street Journal.

He is also a venture capitalist (angel) specializing in U.S. technology companies. He wrote and edited the Gilder Technology Report, is number 27 Management Guru in Clayton Christensen's Top 50, and is founder and fellow of the Discovery Institute, and was the most quoted living author by President Ronald Reagan.

His specialties: Long distance running, chiefly trail and hill races, and Nordic skiing.

Why Gilder is Ron’s Mentor

Ron’s Dad read the Playboy interview with George Gilder in August 1981, and insisted he read Wealth & Poverty.

The rest is history. You can read more about this here.

I wrote Mind Over Matter: Why Intellectual Capital is the Chief Source of Wealth, inspired by Gilder, which he included in the bibliography to The Israel Test, and quoted from it in Knowledge & Power (page 145).

We discussed with George some of his books, and his profound speech before the Vatican in 1997, The Soul of Silicon.

Below are some excerpts from these works, most of which were not covered on the show.

Ed and Ron recommend you read anything by Gilder.

Wealth & Poverty, 1981 [updated 2012]

This book grew out of Gilder’s Visible Man book, which was ahead of its time on welfare reform.

Gilder makes the moral case for capitalism, as well as supply-side economics. Ronald Reagan was so impressed with Wealth & Poverty, he gave a copy to each of his Cabinet members.

Gilder went on to become Reagan’s most quoted living author.

Joshua Gilder, George’s cousin, was the main speechwriter on Ronald Reagan’s Moscow State University speech, which we use a clip from to open The Soul of Enterprise show, and discussed in our book, The Soul of Enterprise: Dialogues on Business in the Knowledge Economy. 

One of the key insights in Wealth & Poverty: Greed leads, as by an invisible hand, to an ever-expanding welfare state.

Ayn Rand attacked Gilder, in her last speech in 1982, “The Age of Mediocrity.”

George’s response: “Her atheism blinded her to the spiritual dimensions of capitalism.” Indeed.

The Spirit of Enterprise, 1984 [updated 1992]

Entrepreneurs accelerate creative destruction. Economists measure the destruction and doubt the creativity.

“It is the spirit of enterprise—the mysterious workings of creativity and faith—that can surmount all the material scarcities of human life.”

“Entrepreneurship can no more be reduced to a model of money and markets than poetry can be explained by the rules of grammar and vocabulary.”

“Capitalism offers nothing but frustrations and rebuffs to those who wish—because of IQ, birth, credentials—to get without giving, to take without risking, to profit without sacrifice, to be exalted without humbling themselves to understand others and meet their needs.”

The Israel Test, 2009

The Israel test is a moral challenge, and can be summarized by a few questions:

1. What is your attitude toward people who excel you in the creation of wealth or in other accomplishment?

2. Do you aspire to their excellence, or do you seethe at it?

3. Do you admire and celebrate exceptional achievement, or do you impugn it and seek to tear it down?

Israel’s per-capita innovation dwarfs all nations, so much so that American technology could display the emblem: Israel Inside.

Golden Rule of Capitalism: That the good fortune of others is also one’s own. No one can be rich alone.

Envy of excellence leads to perdition, the love of it leads to the light.

What matters in human accomplishment not average performance, but exceptional performance. Charles Murray’s book, Human Accomplishment, documents extraordinary accomplishments have been made by 4,002 people from 800 B.C. to 1950.

The Jewish world population is approximately .3%, yet they comprise 25% of notable accomplishments. Inequality is the answer, not the problem.

Knowledge and Power: The Information Theory of Capitalism and How it is Revolutionizing Our World, 2013 

The key issue in economics is not aligning incentives with some public good but aligning knowledge with power.

The key force of economic advance is the entrepreneur, who creates new goods, services, business plans and projects.

Proposition: Capitalism is not chiefly an incentive system but an information system.

It lacks a science of disorder and randomness. Until now.

Gilder uses Claude Shannon’s information theory to explain innovation and creativity. Essentially all information is surprise, according to Shannon.

Creativity always takes us by surprise, otherwise we wouldn’t need it, and socialism would work

This is a new way to think about human creativity, not simply invisible hands responding to incentives, but visible hands creating entire new markets.

Information wants a low-entropy carrier to provide demand and predictability for high-entropy signals of supply and surprise.

Gilder’s examples of Low-entropy carriers: rule law, maintenance of order, property rights, reliable regulation, light taxation, transparency, monetary stability, and family life.

Excessive Government regulation creates noise in the channel, distorting the signals of markets, inhibiting learning, growth, discovery, surprise, and thus wealth.

Expansion of wealth happens through learning and discovery through falsifiable experiments.

Knowledge is about the past, entrepreneurship is about the future.

One of the books key insights:

•          Wealth = Knowledge

•          Growth = Learning  

Capitalism is more about ideas than incentives. It’s a “noosphere” (mind-based system) and can revive as quickly as minds and policies can change.

Adam Smith was to assume that the entrepreneur was the tool of the market rather than its creator. This is the original sin of demand-side economics.

“The grander vision of economics fails because it subordinates a higher and more complex level of activity—the creation of value—to a lower level, its measurement and exchange.” 

The Soul of Silicon, May 1, 1997

We believe this is the most profound moral defense of capitalism ever written.

The 21st Century Case for Gold: A New Information Theory of Money, 2015

Click for access to the book

Economist Richard Thaler: “Why tie to gold? Why not 1982 Bordeaux?”

In this monograph, Gilder argues Milton Friedman was wrong on monetary policy. Floating currencies have been an utter. Failure.

Steve Forbes says that floating the currency is as senseless as floating the clock. A measuring stick cannot be part of what it measures, which is what makes time a perfect external measurement unit.

Gilder’s main argument is that while time is not money, money is time. The source of the value of money is time:

• As economy grows, only time remains scarce

• Money succeeds not because it measures value but because it obviates the need to perform impossible calculations Value > Price (consumer surplus)

• Money facilitates exchange, making it an information system

• Austrian subjective theory of value functions within objective time

• Money isn’t the content, it’s the carrier of transactions

Gilder replaces the quantitiy theory of money with an information theory of money.

The old monetary equation: Money supply x Velocity = GDP, always held Velocity constant (this made it a theory, otherwise it would be just an identity equation, like accounting).

But velocity is not a constant 1.7, as Friedman assumed—it has varied from 3.1 to 12. Gilder defines velocity as freedom.

He further argues that if Government guarantees investments, mortgages, banks and auto companies to big to fail, then no learning will take place and you’ll destroy wealth.

Bitcoin not a competitor to gold, but a gold inspired standard for the Internet

Outsider trading scandal—the government doesn’t want you to buy anything you know—buy the lottery where no one knows more than you!

When a company goes public, its information goes private:

• Berkshire/GE, private equity, and venture capitalists are all really inside traders

• Venture capitalists have the most valuable money—less than .2%, yet they have seeded companies that comprise some 21% of GDP, 65% of market          capitalization, and 17% of jobs created

Speaking of George Gilder, by Frank Gregorsky, 1988

This is an excellent compendium of Gilder’s thinking on a wide-range of topics. Well worth reading.

Thank you, George, for appearing on The Soul of Enterprise, it was an honor and privilege!

Episode #59 - Best Business Books

Ron's Books

The Future of Management, Gary Hamel (2007) 

Your company is being managed by a small coterie of long-departed theorists who invented the rules and conventions of ‘modern’ management back in the early days of the 20th century. Management is out of date. Like the combustion engine, it’s a technology that has largely stopped evolving, and that’s not good.

Your company has 21st-century, Internet-enabled business processes, mid-20th century management processes, all built atop 19th-century management principles.

Types of innovation:

• Management Innovation

• Strategic Innovation

• Product/Service Innovation

• Operational Innovation 

Management Ideas 1900—2000 (most born after Civil War!)

• Scientific management

• Cost accounting and variance analysis

• The commercial research laboratory

• ROI analysis and capital budgeting

• Brand management

• Large-scale project management

• Divisionalization

• Leadership development

• Industry consortia

• Radical decentralization (self-organization)

• Formalized strategic analysis

• Employee-driven problem solving

Made organizations more efficient, not more ethical

Our organizations are less human than the people in them—people are amazingly adaptable and creative, our organizations are not.

Put efficiency ahead of every goal, since most management was invented to solve the problem of inefficiency.

1917 Henri Fayol, early management theorist, described the work of management as, "Planning, organizing, commanding, coordinating, and controlling." Sounds familiar, no?

From Hamel again, “Today the most valuable human capabilities are precisely those that are the least manageable. While the tools of management can compel people to be obedient and diligent, they can’t make them creative and committed.”

Management Innovation is defined as anything that substantially alters the way in which the work of management is carried out, or significantly modifies organizational forms, and, by so doing, advances organizational goals.

Management Innovation yields a competitive advantage if:

1. Is a novel management principal, challenges long-standing orthodoxy

2. Is systemic, encompassing a range of processes and methods

3. Is part of an ongoing program of rapid-fire invention where progress compounds over time

Most managers find it easier to acknowledge the merits of a disruptive business model than to abandon the core tenets of their bedrock management beliefs. "What management practice or behavior does most to drive really great people out of our company? Or, which of our management practices does the most to destroy employee initiative?"

Examples of Management Innovations

• Results Only Work Environment

• Prediction markets

• Internet, all periphery and no center

• Knowledge Worker

• Strategic Pricing (C-Suite)

• Our Firm of the Future (not just a business model change!!) It’s an End, not just a means. It’s a Management Innovation as well:

  • Intellectual Capital leverage, not time leverage

  • Effectiveness over efficiency, efficaciousness

  • Value Pricing, not hourly billing

  • No timesheets

  • After Action Reviews

Positive deviants (management mutants), examples of companies that innovate management itself

• Toyota (USA automakers thought it was  their paternalistic culture; then Toyota opened plants in USA and got same results)

• Whole Foods

• GoreTex

• Google

• Semco

• Morningstar

• Linux

The real reason it takes a crisis to provoke big change:  too much authority has been vested in too few people.

A Class with Drucker: The Lost Lessons of the World’s Greatest Management Teacher, William A. Cohen, PhD, 2008

William Cohen was Drucker’s first Graduate PhD Student (1975-1979), Claremont Graduate University.

Drucker called himself a social ecologist in that he believed the human condition could be advanced by more effective management and more ethical leadership.

Some of Drucker’s Lessons

What everybody knows is frequently wrong. For example, the demise of Tylenol (Johnson & Johnson) was predicted, but failed to occur.

If you keep doing what worked in the past you’re going to fail. Organizations  should make revolutionary change itself, even though it means obsolescing products of its current and past success

GE’s Jack Welch, CEO 1981 $12B value. 25x that when he left

            Drucker’s two questions:

1.    If you weren’t already in the business, would you enter it today?

2.    What are you going to do about it?

Approach problems with your ignorance—not your experience.

Ignorance is the most important component for helping others to solve any problem in any industry.

Henry Kaiser’s Liberty Ships, built 1500 in 2/3 the time and ¼ cost! He knew nothing about ship building.

Develop expertise outside your field to be an effective manager.

Outstanding performance is inconsistent with fear of failure.

The objective of marketing is to make selling unnecessary. Selling and marketing are neither synonymous nor complementary. One could consider them adversarial in some cases. There is no doubt that if marketing were done perfectly, selling, in the actual sense of the word, would be unnecessary. Marketing is not a business function, like manufacturing, because it permeated every aspect of the business. 

You can’t predict the future, but you can create it.

A Model organization that Drucker Greatly admired. The Army trains and develops more leaders, with a lower casualty rate. George Patton: “A pint of sweat in training is worth a gallon of blood in combat." Training is Army’s most important investments, not an expense.

How to motivate the knowledge worker

• Theory X/Y not the answer

• There is a responsible manager in authority

• Workers are led, not managed

• Workplace is participatory, but not “free-wheeling”

• Workers are not motivated by money alone

• Each worker is motivated differently, according to the   individual and the situation

• Workers can leave = volunteers, treated with respect

• Volunteers don’t need contracts, they need covenants

Drucker’s principles of self-development

Not up to others after we leave home/school—up to ourselves!

• Reading

• Writing

• Listening

• Teaching

Ed’s Books

A Failure of Nerve, Edward H. Friedman

Ed opened by quoting from the Preface of Friedman's book, here is blog post about the quote. TCMOOTITATIWWWPWAUTC

In short, Friedman's belief is that leaders do not need to be empathetic, but self differentiated and compassionate. They need to be step down transformers who seek to lower the level of anxiety around them, by simply self regulating their own anxiety. 

As an example of this, Ed cited the work of Captain Chesley Sullenberger of the ill fated, but not deadly, Flight 1549. When asked by Katie Couric if as any point he prayed, he replied, “I would imagine somebody in back was taking care of that for me while I was flying the airplane.”

Friedman also points out that data in business is like alcohol or other additive drug. It can be used in moderation, but many leaders are ensnared in its addictive properties and become dependent on it.

Wealth and Poverty, George Gilder (1981 Edition)

In addition to changing the lives of both Ron and Ed, this book influenced Ronald Reagan to implement supply-side economics during his first administration. 

Ed made two basic points about the book. First, that Keynesians, according to Gilder, have "hopelessly and irrevocably" confused cause and effect. Their mantra on demand causing supply is akin to saying demand or need and it will be given unto you.

Second, supply side economics is not about "trickle down." This notion was used to spurn the ideas of the book by its opponents, but in truth, Gilder makes a completely different point. He is saying that in order to receive one must first give, create or give and it will be given unto you. 

In other words if you want a meal/car/house, you don't go about demanding a house, you first give, in most cases to your employer who in turn trades money for your talent. You then can use that money to buy a meal/car/house. 

Note: there has been an update to this book, in 2012, but Ed was discussing the 1981 edition.