Archive for the ‘General Business’ Category.

The Fatal Allure of the Sexy Business

The tech site Engadget directed me to this article on Visual FX and CGI as a "must-read".  What I found was one of the odder economics and business hypotheses I have encountered lately.

The article begins by relating that VFX and digital effects specialty houses all lose money, even when they are providing effects for wildly profitable movies (e.g. Avengers) and purports to explain why this should be.  The author believes that this is a result of Hollywood purposely criticizing the artistry of VFX movies as a way to keep returns in the VFX companies down (and thus increase the returns of film producers).

As the debate surrounding what visual effects are worth rages on, it is clear that the studios themselves have an interest in perpetuating the myth that VFX are the product of clinical assembly lines and the results are equally lifeless and mechanical. Blaming computers for the dumbing down of movies has become a journalistic trope that is bandied about to squeeze the one part of the Hollywood machine that has no union or organizational skill to push back. The right hand asserts they are something not worth paying top dollar for, while the left lines up an interminable roster of VFX-based box office juggernauts for the foreseeable future.

The author goes so far as to say that Avatar was denied the best picture Oscar specifically to support the anti-VFX sentiment and keep returns of VFX companies down (emphasis added).

In 2010, James Cameron’s Avatar became the highest grossing film of all time just 41 days after its release, raking in an incredible $2.7 billion by the end of its run. Weta Digital, the VFX studio that created the majority of the visual effects, along with Lightstorm Entertainment, invested years in developing the tools and talent necessary to create Cameron’s almost entirely computer generated vision, with the cost of making the film rumored to be upwards of $500 million. Cameron had promised to show the world what visual effects could do and he succeeded. The results were universally lauded as visually stunning and unparalleled.

Yet, rather famously, the film and Cameron were snubbed that year at the Academy Awards, both for Best Picture and Best Director. The blame was laid at the feet of the critical success of The Hurt Locker. However, awarding Avatar the Academy’s highest honor would have been acknowledging visual effects as not only lucrative, but high art as well, worthy of its astronomical price tag. And that was a bargaining chip Hollywood was unwilling to concede to an industry it continues to hold hostage with threats of outsourcing to unskilled laborers around the globe.

This hypothesis seems outlandish, and in fact the author never really provides any evidence whatsoever for her hypothesis.   At least equally likely is that Hollywood insiders are snobbish and conservative and reject new approaches to film-making in a way that the public does not.  Or it could be that Avatar wasn't a very good movie (go try to watch it again today, you will be surprised what a yawner it is).  So why are VFX companies really losing money on profitable films?   Let's take a step back, because there is a useful business lesson buried in here somewhere.  I think.

This discussion is a sub-set of an age-old business problem -- how do rents in a supply chain get divided up?   Think of the billion plus dollars the new Avengers movie will make.  Everyone in the supply chain for making that movie, from the actors to the caterers to the VFX houses to the distribution companies believe their contribution has immense value, and that they should be getting a solid cut of the profits.  But profits in a supply chain are not divided up based on some third party assessing value, they are divided up by negotiation.  And the results of that negotiation depend on a lot of factors -- the number of competitors, the uniqueness of the service, regulatory rules, etc.  The most visible example of this sort of negotiation we see frequently in the news is in sports, where players and team owners are explicitly negotiating the division of the end revenue pie between themselves.

If we return to the article, the author actually gives us a hint of the true dynamic that is likely bringing down VFX profits.

The international subsidies-driven business model under which VFX companies operate has been well documented. In pursuit of tax rebates offered by various governments to produce films in their jurisdiction, studios insist that VFX companies open branches in these locations or reduce their bids by the amount of the subsidy in question. Even as studios, directors, and audiences demand the latest in cutting edge technology, VFX houses must underbid one another to get the work and many have been shuttered due to operational losses in the wake of explosive blockbuster budgets. The cost of research and development, shrinking schedules, and the unlimited changes that are the building blocks of every tentpole film, are shouldered entirely by VFX houses.

This is the best clue we get to the real problem.  Here is what I infer from this paragraph:

  1. This is a high fixed cost industry.  There are enormous up-front investments in research into new techniques and large investments in the latest technology, which presumably must be constantly refreshed because it has a short half-life before it is out of date.  The situation is worsened by government policy, which provides incentives for VFX companies to build extra capacity in multiple countries, losing economy of scale benefits from large concentrated production facilities.    One would presume from this that these companies' marginal cost of output, say 15 seconds of finished effects, is way way below their total costs.
  2. There is rivalry among VFX companies that seem to have excess capacity, such that bidding for work is very aggressive.  In such situations (think American railroads in the late 19th century) competitors lower prices down to marginal cost to keep their capacity and their trained people working.  Over time, of course, this leads to numerous bankruptices

I will add a third point which the author fails to cover.  To do so I will return to one of my favorite things I learned at Harvard Business School (HBS).  At HBS, in the first two days of strategy class, we studied two very different business cases.  The first was of a water meter manufacturer, a dead boring predictable unsexy business.  The second was a semiconductor company, which was hip and cool and really sexy.  It turned out that the water meter company coined money.  The semiconductor business was in and out of bankruptcy.

Why?  Well the water meter company had limited investment (made the same meters the same way for decades) and made most of its money off the replacement market, where it had no competitors since users pretty much had to replace with the same meter.  The semiconductor business had numerous shifting competitors and was constantly trying to scrape up enough investment money to keep up with shifting technology.  But there was one more difference.  By being sexy, tons of people wanted to be in the semiconductor business. They got non-monetary benefits from being in it (ie it was cool and interesting).  When there is an industry where lots of people are getting into the business for reasons other than making money, look out!  The profits are probably going to be terrible.   This is why most restaurants fail.  The business-for-sale listings are awash in brew pubs.   The aviation industry was like this for years, and I would argue this also suppresses rents in farming.

I don't know this for a fact, but I would bet that the VFX industry attracts a lot of people because it is sexy.  Yes, like a lot of programming, the actual work is detailed and dull.  But if the coding is detailed and dull, would you rather be doing it for Exxon's new back-office system or to put Ironman on the big screen (and have your name deep into the film credits, seen by the dozen or so people who hang around waiting for the Marvel Easter egg at the end)?

This is why I think a conspiracy theory to believe Hollywood is dissing the artistry of VFX movies as a way to keep VFX company rents down is silly.  It is totally unnecessary to explain the bad rents.  Had you told me it was a high investment business with huge fixed costs and much lower marginal costs and alot of rivalry driven by participants who piled into the business because it was sexy, I would have told you to stop right there and I could have immediately predicted poor returns and bankruptcies.

So what can VFX companies do?  I have no idea.  The first idea I would offer them is branding.  If you are buried deep in the supply chain and want to increase your bargaining power, one way to do it is to develop a brand with the end consumer.   If consumers suddenly latch on to, say, the CoyoteFX brand as being innovative or better in some way, such that they might be more likely to go to a movie with CoyoteFX sequences, then CoyoteFX now has a LOT more power in negotiations with producers.  Dolby Sound is a great example -- you probably don't even know what it is but movies used to advertise they had it.  Certain camera technologies like Panavision are another, where movies actually sold themselves in part on the features of one member of their supply chain.  As a digital house, Pixar effectively did this -- so well in fact its brand actually was bigger than Disney's (its distributor) for a while, and Disney was forced to buy them.  This does not happen just in movies.  I just bought a car that advertised it had a premium Bose sound system.  The car maker doesn't advertise who made, say, the fuel tanks, so my guess is that Bose, via branding, gets a better cut of the supply chain than does the fuel tank maker.

Q: What's The Difference Between GE and Enron? A: GE Got Bailed Out

I am going to oversimplify, but the essence of bank risk is that they borrow short-term and invest/lend long-term.   This is a money-making strategy in that one can often borrow short-term much cheaper than one can borrow long term.  This spread between long and short term rates is due to people valuing liquidity.  You probably have experienced it yourself when buying a certificate of deposit (CD).  The rates for 5 or 10 year CD's are higher, but do you really want to tie your money up for so long?  What if rates improve and you find yourself locked into a CD with lower rates?  What if you need the money for an emergency?  Your concern for having your money locked up is what a preference for liquidity means.

So banks live off this spread.   But there are risks, just like you understood there are risks to locking your money in a long-term CD.  Imagine the bank is lending for mortgages and AAA corporate customers at 6%.  To fund that, they have some shareholder money, which is a long-term investment.  But they make the rest up with things like deposits and commercial paper (essentially 90-day or shorter notes).  We will leave the Fed out for this.  There are two main risks

  1. Short term interest rates rise, such that the spread between their short term borrowing and long-term investments narrows, or even reverses to negative
  2. Worse, the short term money can just disappear.  In panics, as we saw in the last financial crisis, the commercial paper market essentially dries up and depositors withdraw their money at the first sign of trouble (this is mitigated for small depositors by deposit insurance but not for large depositors who are not 100% covered).

These risks are made worse when banks or bank-like institutions try to improve the spread they are earning by making riskier investments, thus increasing the spread between their borrowing and investing, but also increasing risk.  This is particularly so because these risky investments tend to go south at the same time that short-term credit markets dry up.  In fact, the two are closely related.

This is exactly what happened to GE.  Via MarketWatch:

GE’s news release announcing its latest and greatest reduction of GE Capital summed up the move beautifully, saying “the business model for large wholesale-funded financial companies has changed, making it increasingly difficult to generate acceptable returns going forward.”

“Wholesale-funded” refers to GE Capital’s traditional reliance on the commercial paper market for liquidity. The problem with this short-term funding model for a balance sheet with long-term assets is that during a financial crisis, overnight liquidity tends to dry up as it did for GE late in 2008. When the company had difficulty finding buyers for its paper, the Federal Deposit Insurance Corp. stepped in and through its Temporary Liquidity Guarantee Program (TLGP) was covering $21.8 billion of GE commercial paper. GE Capital registered for up to $126 billion in commercial-paper guarantees under the TLGP.

If you have a AAA credit rating, you can always, always make money in the good times borrowing short and investing long.  You can make even more money borrowing short and investing long and risky.  GE made their money in the good times, and then when the model absolutely inevitably fell on its face in the bad times, we taxpayers bailed them out.

Which leads me to think back to Enron.  Enron is associated in most people's minds with fraud, and Enron played a lot of funky accounting games to disguise its true financial position from its owners.  But at the end of the day, that fraud was not why it failed.  Enron failed because it was essentially a bank that was borrowing short and investing long.  When the liquidity crisis arrived and they couldn't borrow short any more, they went bankrupt.   Jeff Skilling didn't actually go to jail for accounting fraud, he went to jail for making potentially inaccurate positive statements to shareholders to try to head off the crisis of confidence (and the resulting liquidity crisis).  Something every CEO in history has done in a liquidity crisis (back in 2008 I wrote an article comparing Bear Stearns crash and the actions of its CEO to Enron's; two days later the Economist went into great depth on the same topic).

So the difference between GE and Enron?  The government bailed out GE by guaranteeing its commercial paper (thus solving its problem of access to short term funding) and did nothing for Enron.  Obviously the time and place and government officials involved differed, but I would also offer up two differences:

  • Few really understood what mad genius Jeff Skilling was doing at Enron (I can call him that because I actually worked with him briefly at McKinsey, which you can also take as a disclosure).  With Enron so opaque to outsiders, for which a lot of the blame has to be put on Enron managers for making it that way, it was far easier to ascribe its problems to fraud rather than the liquidity crisis that was well-understood at Bear or Lehman or GE.
  • Enron failed to convince the world it posed systematic risk, which in hindsight it did not.  GE and other big banks survived 2008 and got bailed out because they convinced the government they would take everyone down with them.  They followed the strategy of the Joker in The Dark Knight, who revealed to a hostile room a coat full of grenades with this finger ready to pull the pins if they didn't let him out alive.




Artist's rendering of 2008 business strategy of GE Capital, Citicorp, Bank of America, Goldman Sachs, GMAC, etc.









Postscript:  For those not clicking through, I though this bit from the 2008 Economist article was pretty thought-provoking:

For many people, the mere fact of Enron's collapse is evidence that Mr Skilling and his old mentor and boss, Ken Lay, who died between hisconviction and sentencing, presided over a fraudulent house of cards. Yet Mr Skilling has always argued that Enron's collapse largely resulted from a loss of trust in the firm by its financial-market counterparties, who engaged in the equivalent of a bank run. Certainly, the amounts of money involved in the specific frauds identified at Enron were small compared to the amount of shareholder value that was ultimately destroyed when it plunged into bankruptcy.

Yet recent events in the financial markets add some weight to Mr Skilling's story"”though nobody is (yet) alleging the sort of fraudulentbehaviour on Wall Street that apparently took place at Enron. The hastily arranged purchase of Bear Stearns by JP Morgan Chase is the result of exactly such a bank run on the bank, as Bear's counterparties lost faith in it. This has seen the destruction of most of its roughly $20-billion market capitalisation since January 2007. By comparison, $65 billion was wiped out at Enron, and $190 billion at Citigroup since May 2007, as the credit crunch turned into a crisis in capitalism.

Mr Skilling's defence team unearthed another apparent inconsistency in Mr Fastow's testimony that resonates with today's events. As Enronentered its death spiral, Mr Lay held a meeting to reassure employees that the firm was still in good shape, and that its "liquidity was strong". The composite suggested that Mr Fastow "felt [Mr Lay's comment] was an overstatement" stemming from Mr Lay's need to "increase public confidence" in the firm.

The original FBI notes say that Mr Fastow thought the comment "fair". The jury found Mr Lay guilty of fraud at least partly because it believed the government's allegations that Mr Lay knew such bullish statements were false when he made them.

As recently as March 12th, Alan Schwartz, the chief executive of Bear Stearns, issued a statement responding to rumours that it was introuble, saying that "we don't see any pressure on our liquidity, let alone a liquidity crisis." Two days later, only an emergency credit line arranged by the Federal Reserve was keeping the investment bank alive. (Meanwhile, as its share price tumbled on rumours of trouble onMarch 17th, Lehman Brothers issued a statement confirming that its "liquidity is very strong.")

Although it can do nothing for Mr Lay, the fate of Bear Stearns illustrates how fast quickly a firm's prospects can go from promising to non-existent when counterparties lose confidence in it. The rapid loss of market value so soon after a bullish comment from a chief executive may, judging by one reading of Enron's experience, get prosecutorial juices going, should the financial crisis get so bad that the public demands locking up some prominent Wall Streeters.

Our securities laws are written to protect shareholders and rightly take a dim view of CEO's make false statements about the condition of a company.  But if you owned stock in a company facing such a crisis, what would you want your CEO saying?  "Everything is fine, nothing to see here" or "We're toast, call Blackstone to pick up the carcass"?

When Corporations Use Social Causes as Cover for Cutting Costs

My absolute favorite example of corporations using social causes as cover for cost-cutting is in hotels.  You have probably seen it -- the little cards in the bathroom that say that you can help save the world by reusing your towels.  This is freaking brilliant marketing.  It looks all environmental and stuff, but in fact they are just asking your permission to save money by not doing laundry.

However, we may have a new contender for my favorite example of this.  Via Instapundit, Reddit CEO Ellen Pao is banning salary negotiations to help women, or something:

Men negotiate harder than women do and sometimes women get penalized when they do negotiate,’ she said. ‘So as part of our recruiting process we don’t negotiate with candidates. We come up with an offer that we think is fair. If you want more equity, we’ll let you swap a little bit of your cash salary for equity, but we aren’t going to reward people who are better negotiators with more compensation.’

Like the towels in hotels are not washed to save the world, this is marketed as fairness to women, but note in fact that women don't actually get anything.  What the company gets is an excuse to make their salaries take-it-or-leave-it offers and helps the company draw the line against expensive negotiation that might increase their payroll costs.

Postscript:  Yes, I understand the theory of negotiation and price discrimination, as used by auto dealers.  One can make an argument that setting prices high (or wages low) and then allowing negotiation by the most wage or price sensitive is the best way to optimize profits, and that Pao's plan in the long-term may actually raise their total compensation costs for the same quality people.  I don't think she is thinking that far ahead.

Beware Applied Underwriters Workers Compensation Insurance

Update 2/1/2016:  I will not comment further at the moment on Applied Underwriters as they are currently suing me to have this article below removed.  So you will need to look elsewhere for news on AU, of which there appears to be plenty.  For example, here and here.  The State of California Insurance Commission, via an Administrative Law Judge's decision, has ruled on the legality of the AU product discussed below.  That ruling (pdf) can be downloaded here.  I would love to comment on it but I will have to leave the evaluation to you.  If you can't read the whole thing pages 33 and 34 are worth your time, as well as the conclusions that begin on page 59.

After you read this, there are more updates on 4/18

Well, I have managed to get myself into a scam.  It is not your normal scam, like the ones that are run by some mafia boiler room with guys working under aliases.  This scam comes via a major insurance company called Applied Underwriters (working under the names California Insurance Company and Continental Indemnity Company) which is owned by Berkshire Hathaway and none other than Warren Buffett.  If you feel sorry for Warren Buffett and want to give him a large interest-free loan for an indeterminate number of years, this is your program.

Update 4/16:  Let me insert here that Applied Underwriters has sent me a letter threatening a libel suit if I do not take down this post and a parallel review at Yelp.  AU Takedown demand here (pdf).   The gist of the matter seems to be the word "scam".  By the text of their letter, they seem to believe that "scam" is libelous because their company is well-rated financially and that they provide reasonable claims service.  I concede both these facts.  However, I called it a "scam" because there is a big undisclosed cost to their product that was never mentioned in the sales process, and that could only be recognized by its omission in the contract I signed -- that there is nothing in the contract committing them to any time-frame under which to return deposits and excess premiums I have paid, which may well amount to hundreds of thousands of dollars.  This fact about the contract is confirmed by their customer service staff, who have said further that the typical time-frame to return such over-collections and deposits is 3-7 years after the contract ends, or at least 6-10 years after the first of the deposits was made.

So is this a "scam"?  I believe that this issue is costly enough, and hard enough to detect, and far enough outside of expected business practices to be called such.  You may have your own opinion, but ask yourself -- When you enter into, say, a lease and have to put down a security deposit, is it your reasonable expectation that the landlord has the right in your lease to keep your deposit for 3-7 years (or more) after you move out?  /Update

Anyway, let's take a step back and look at this in detail.

First, I need to give a bit of background on how workers comp works.  When you are a new company, they assign you an experience rating -- that is a multiplier of your premium based on past loss experience.  There is some default starting number that if I remember right, in most states, is a bit over 1.0x.  Each year, the workers comp world looks back at your past history and computes a new loss rating -- higher if you have had more payouts, lower if not.  Generally it is based on three years experience not counting the last year (so 2-4 years in the past).  Your future premiums get multiplied by this loss rating.

Several years ago we had a couple bad injuries that drove our loss number into the 1.7-1.9x area.   Neither were really due to a bad safety issue, but both involved workers in their seventies where a minor initial injury led to all sorts of complications.  Anyway, my agent at the time calls me one day a couple of weeks before renewal and says that none of the major companies will renew me.  This seemed odd to me -- I understood that my recent claims history was not good, but isn't that what the premium multiplier was for?  In fact, if my loss history returned to normal, they would make a fortune as I paid high rates based on old losses but had fewer new ones.

Apparently, though, insurance companies have fixed rules that keep them from underwriting higher loss ratings.  Probably for the same reason Vegas won't take action on Ivy League football games any more -- just too much variability.  I found out later with my new broker we could probably have overcome this, but I learned that too late.

My broker at the time put me into a 3-year program from Applied Underwriters, in part because they were taking everybody.  This program was set up differently from most workers comp programs.  You had a basic policy, but there was a second (almost indecipherable to laymen) reinsurance agreement that adjusted the rates of the basic policy based on you actual claims.   Here is the agreement (pdf)  In other words, based on your claims, they would figure up at the end how much you owed and what your premium multiplier would be.

I saw two red flags that I ignored in signing up.  1)  The reinsurance agreement was impossible to understand, violating one of my foundational rules that I shouldn't sign things I don't understand.  And 2) The rate structure was very suspicious.  They touted a rate structure that could go as low as, say, $100,000 a year and was capped around $400,000 a year.  But when you pulled out a calculator, the $100,000 was virtually unobtainable.  It would require about zero claims.  If there were any claims at all, even for a few bandaids, the price would march up to $400,000 really fast.  It was the equivalent of a credit card teaser rate, and it should have made me suspicious.

Anyway, I was desperate.  For a business like mine, being told I had no workers comp insurance just a few weeks before the old policy ran out was a death sentence.  No one would write me or even quote me a policy that fast.  So I took the Applied Underwriters offer.  Shame on me, I should have worked on this much harder.

I won't bore you further with my voyage of discovery in trying to figure out how this thing works.  I will just tell you the results that I have found.  There are apparently other companies with similar issues, one of which is documented here: Applied Underwriter Suit (pdf)Newsletter publisher objected to scan of article, so I have taken it down at their request.  Here is a link to roughly the same article.

I spent hours and hours trying to figure out AU's statements.  There is a whole set of terminology to learn that is actually not used in most of the rest of the workers comp world.  The key page of the statement is page 7, which I will show below because it highlights several of the issues with Applied.  Page 7 is the page where the monthly premium is "calculated".  I have added the red numbers and arrows for the discussion below.


Here are some of the Applied Underwriter problems:

  1. Large deposits that must be made each year and may never be returned.    You can see that I am making deposits over $40,000 a year.  And that is each year.  The first year deposit is not returned.  The second year and third year are just added to it.  And I have found out since I joined this program that they are not contractually obligated to return them in any time frame.  Maybe some guy who was hurt in his thirties has a relapse and claims more money when he is 75.  Gotta keep your deposit just in case, don't we?  The timing of the return of your deposits (and overpaid premiums below) is entirely at their discretion, and that has been confirmed by their customer service staff.  In fact, their standard answer is that on average, such monies are not returned to customers for 3-7 years after the contract ends, or at least 6-10 years after the first deposits were made.
  2. Premiums based on the worst of your experience and their estimate of your losses, and they keep the difference for years and years.   For those in the same trap as me, I will try to explain the numbers above.  The estimated loss pick containment at the top is basically their estimate of your losses.  Note that it drives every number on the page and is basically their arbitrary number -- they could have set it anywhere.  The loss pick containment to date is just pro rated for the amount of the year that has gone by.  The 65% is an arbitrary number.    The $25,278 is my actual losses to date.  You can see where I point with #2 above, though, that my losses are irrelevant to my premiums.  They take the higher of my losses and what is essentially their estimate of my losses and I pay based on that.   Note that their higher number is not based on the reserved amounts on actual claims -- the $25,278 includes their reserves.  It is just the number they established at the beginning of my policy they think my claims are going to be and gosh darnit they are going to stick to that (and my claims even in my worst year in history were never even half of their estimate).  Yes, at the end of the policy if my losses stay low, they owe me money back for all the premium they overcharged me based on their arbitrarily high estimates.  But see #1 above -- there is no time horizon under which they have to return the money.  They can keep it for years and years.
  3. The final premium is, after all these calculations, entirely arbitrary.  So after this loss calculation (which essentially just defaults to their arbitrarily high estimate and not my actual loss history) they do some premium calculations.  These actually sort of make sense if you stare at the agreements for a really long time.  But then we get to the line I point to in red labelled 3.  It is the actual amount I owe.  But it does not foot to any other number on the page.  How do they come up with this?  They won't say.  To anyone.  It might as well be arbitrary.  I actually had some dead time and took all my reports and tried to regress to a formula they use for this, but I couldn't figure it out.   So all the calculation on this page is just a sham, it's the mechanical wizard in the Wizard of Oz.  It looks good, but does not actually directly lead to what you are billed.

So I thought I understood my problems.  I put in large deposits and overpaid premiums based on arbitrarily high loss estimates they make -- all of which will take me years and years of effort to maybe get back.  It turns out that I likely will have a third problem.  In the lawsuit linked above, the plaintiff complains that when they left the program after three years, Applied arbitrarily wrote up all their estimated losses on open claims to stratospheric levels and then demanded a large final premium payment at the end.  Folks on Yelp complain of the same thing.  You should know how this works by now -- the plaintiff will theoretically get all this back someday, maybe, when the claims prove to be less costly, but in the mean time Warren Buffet gets to invest the money for years and years (cost of capital = 0) until it is returned.

This is why I think Applied Underwriters actually likes companies with high lost histories.  Rather than costs, losses for them are excuses to over-collect on deposits and premiums -- money that can then be invested and held for years free of charge.

As an aside, I want to thank my new agents at Interwest Insurance for helping decipher all of this.  They actually flew a guy in to help me understand this policy.  They didn't get me into it, but they are helping me pick up the pieces as best we can.

What Musicians and ExxonMobil Have in Common: Both Get "Ripped Off" By Consumers

We have all heard that artists make very little money from their songs, and get "ripped off"by record labels and other folks in the chain.  I have always had mixed reactions to this.  I have no doubt that, with zero power and a burning desire to "make it big", young acts sign uneven deals with record labels.  However, I find it hard to believe that Beyonce is getting hosed in that negotiation.

I saw this chart in TechDirt about where the money consumers spend on music goes (I think this is for a CD sale):


So the performers themselves get about 9% of the retail price after everyone in the chain is paid.  That certainly seems paltry -- after all, they are the owners and creators of the music.  Everyone else is just in the service chain to make sure the music reaches the customers, all the accounting is done, the legal documents are correct, etc.

But it turns out that they may not be doing that badly.  I am a shareholder of ExxonMobil (XOM).  I own a piece of all the oil that XOM owns and controls, along with all the other shareholders.  Think of us as the band, though a really big band with lots of players.   That oil we own, like the band's music, has a ton of value.  When sold as raw crude, it goes for $40-$60 a barrel nowadays.  When sold in pieces (such as gasoline, or asphalt, or lubrication oil) it can sell for hundreds of dollars a barrel.

But out of those proceeds, we have to pay people to help us.  We have to pay managers, and lawyers.  We have to pay oilfield services companies and equipment companies and transportation companies.  We have to pay retailers.  When all those payments are made, before taxes, in 2014 we were left with just under 8% of every dollar we sell.  We own all this oil and we are not even getting as much as a musician!

And XOM shareholders do pretty well.  Owners of Wal-Mart only get about 3% of every dollar they sell.   In my company, I get about 5% of every dollar I sell.   And those evil health insurers?  Their shareholders get just over 2% of every dollar sold (all based on 2014 full-year financials).

Does that mean that Exxon shareholders are getting "ripped off" by Haliburton and Burlington Northern?  Is Wal-Mart getting ripped off by Proctor and Gamble?  Is Humana getting ripped off by GE imaging?  No?

I will reveal the ugly secret:  There is one person who is "ripping off" all of these folks, from Exxon to Rihanna to me.  That person is.... the consumer.  Yep, there are certainly many examples of people signing bad contracts in all these businesses, but the only entity systematically and consistently ripping all these folks off is us.  Because in a capitalist economy, we have the ultimate power.  We drive down the street to get the gas that is 10 cents cheaper, we now shop for our books and TVs at Wal-Mart and Amazon rather than at Borders and Best Buy, and we buy 99-cent individual songs on iTunes instead of buying a whole CD of songs we don't want for $14.99.

Why Opposition to Workplace Discrimination Laws Doesn't Necessarily Make You a Racist

A while back I (for a short time) chaired an effort to get a ballot initiative in Arizona to change to Constitution to allow gay marriage.  In the process, gay rights advocates approached me for support of another law to add LGBT persons to the list of protected classes that are covered by workplace discrimination laws.

I refused to help, and these folks immediately labeled me a hypocrite.  To be fair to them, they honestly thought that workplace discrimination laws did exactly what they intended to do - ban workplace discrimination of an overt sort (e.g., "what, you're gay?  Well, you can't work around here any more").  But anti-discrimination law has a lot of other unintended consequences that are all bad for even the most fair-minded business owner.

Because most of the actual stories I have been through are (and should be) confidential, I will illustrate the problem from a story out of the national news.

Debbie Wasserman Schultz is Chair of the Democratic Party.  Several years ago various party members became dissatisfied with her leadership, a pretty normal occurrence for such a position, particularly after Congressional losses in several elections.  I compare the job to that of an NFL coach, who has job security only as long as he is winning (see: Jim Harbaugh in San Francisco).

Wasserman Schultz’s position as the head of the DNC has long been a source of contention among Democrats, and Politico has previously documented the issue. In September 2014, Wasserman Schultz’s gaffes caught up to her when a string of Democrats voiced their distaste for the way the Florida congresswoman had led the party.

That report found tension between Wasserman Schultz and Obama dating back to 2011 .... At the time, Wasserman Schultz had allegedly complained to Obama about not being able to hire a donor’s daughter to work for her at the DNC.

“Obama summed up his reaction to staff afterward: ‘Really?’ ” according to a source that was present.

So maybe Obama didn’t like Wasserman Schultz’s brashness or her propensity to spout gaffe after gaffe.

So, faced with threats of losing her position based on poor job performance, her response was this:

Democratic National Committee Chairwoman Debbie Wasserman Schultz was prepared to go full force against President Obama if he tried to replace her in 2013.

Wasserman Schultz, according to Politico, was going to accuse Obama of being anti-woman and anti-Semitic — apparently to cover all the bases — if he dared consider replacing her as chairwoman.

There is absolutely no rational reason to believe President Obama wanted to fire her because she was a woman.  Seriously, Valerie Jarrett practically runs the country but Obama doesn't like Shultz because she is a woman?  I would bet that in fact she was hired for the position in large part because she was a woman.  But she was perfectly willing to use the fact that she happened to be in some protected employment classes to try to head off a merit-based firing.

For businesses, this means two things

  1. It typically takes much longer to terminate someone in a protected class, because businesses want to make sure they have an absolutely iron-clad case if the termination is later challenged.  For a service business like ours, this sometimes means tolerating dangerous behavior or really bad customer service longer (with all the risks that entails) from someone in a protected group rather than from, say, a white male.
  2. A large number of employees in protected groups will file grievances to the state, or even sue, over even the most well-documented and justified termination.  Even when employers win such cases, each one take tens of thousands of dollars in legal fees to win.  As interpreted by courts and state civil rights agencies, anti-discrimination law seems to create burden of proof on the part of employers to prove they did nothing wrong, rather than the other way around.

Sort of Sad, But Inevitable I Guess

CBE is closing its open outcry pits (e.g. the type of trading portrayed in the movie Trading Places).  Time to short the manufacturers of brightly covered jackets (from my very very limited experience observing the pit in Chicago, one unreality of Trading Places is that the traders are all wearing fairly normal business attire).

What, No Bailout?

I wish we saw this attitude more often, particularly among large corporations (from an article discussing aftermarket ticket prices for the Super Bowl).

"This is really something we never anticipated," said Will Flaherty, director of growth at SeatGeek. "The cheapest seat on SeatGeek right now is $8,000, but no site seems to have any inventory." Flaherty believes speculative buying is behind the spike. Ticket brokers frequently sell "air" to their customers, taking orders before they have tickets in hand. "We've noticed significantly more speculative selling activity than in recent years," Flaherty said. "Over the last few days, those sellers have been scrambling to buy up tickets to fill their orders, resulting in the Super Bowl ticket version of a short squeeze. Brokers with tickets in hand have been taking advantage of their leverage, raising prices dramatically and arbitrarily withholding some of their inventory."

Ety Rybak, co-founder of the high-end brokerage Inside Sports & Entertainment Group, has spent more than anticipated this time around to fulfill orders before the game. "I can tell you some ugly horror stories about what I have had to pay. But that’s part of the business," he said. "If I sold you tickets for $2,500, and I have to pay $7,500 to do it, unfortunately that’s the world that I chose to live in." The flip side to the high costs is a brisk business in late orders.

Maybe the US sugar cartel, among many other groups, could discover this approach to individual responsibility.

Quantitative Easing and the Left's Relationship to the Rich and to Large Corporations

The Left spends a lot of time railing against the rich and large corporations.  But in practice, they seem hell-bent on lining the pockets of exactly these groups.  Today the ECB announces a one trillion plus euro government buyback of public and private securities.

Between Japan, the US, and now Europe, the world's central banks are printing money like crazy to inflate securities values around the world -- debt securities directly by buying them but indirectly a lot of the money spills over into stocks as well.  This has been a huge windfall for people whose income mostly comes from capital gains (i.e. rich people) and institutions that have access to bond and equity markets (i.e. large corporations).  You can see the effects in the skyrocketing income inequality numbers over the last 6 years.  On the other end, as a small business person, you sure can't see any difference in my access or cost of capital.  It is still just as impossible to get a cash flow loan as it always was.

I Believe the Trend Was Caused by All the Things I Believed Before I Investigated the Trend

This is so common that there ought to be a name for it (perhaps there is and I just don't know it):  Writer does a story or study on some trend, in this case the downfall of the enclosed shopping mall.  In each case, the writer discovers that such malls died because of ... all the things the writer already holds dear.  If the writer hates American consumerism, then the fall of such malls is a backlash against American consumerism.

It is interesting to note that all of the ideas quoted are demand-side explanations, e.g. why might consumers stop going to large enclosed malls.  And certainly I find the newer outdoor malls more congenial personally, but this can't be the only explanation.  Here in north Phoenix, I can see the dying enclosed Paradise Valley Mall out my window, but just a few miles away is the Scottsdale Fashion Square, a traditional mall that appears to be going great guns.  Ditto the Galleria in Houston.  Perhaps part of the answer is that enclosed malls were simply overbuilt and that people are willing to drive a bit to get to the best enclosed mall in town rather than a smaller version closer to their home (certainly Mall of America made a big bet on that effect).

But it also strikes me there are supply side considerations.  The mall out my window is a huge waste of space, surrounded by parking lots the size of a small county.  And it's just retail.  Modern outdoor malls allow developers to mix shopping, living, and office space in what looks to my eye to be a much denser development.  All these malls have stores on the ground floor with condos and offices up above.  To my not-real-estate-trained eye, this would seem to increase the potential rents in a given piece of land and provide some synergies among the local businesses (e.g. office workers and residents eat and shop in the mall shops).  In some sense it is a re-imagining of the downtown urban space in a suburban context.  This is ironic because it is something urban planners have been trying to force for decades and here comes the free market to do it on its own.

People also like going to newer facilities.  Just ask hotel owners.  If owners do not totally refresh a hotel every 20 years or so, people stop visiting and rates fall.  The same is true of gas stations and convenience stores.  When I worked at Exxon briefly, they said they budgeted to totally rebuild a gas station every 20 years.  So it is not impossible there is a big supply-side explanation here -- if people are reluctant to go to establishments over 20 years old, then visitation of enclosed malls should be collapsing right about now, 20 years after they stopped being built.  A shift in developer preferences could be a large element driving this behavior.  I don't insist that the supply side and real estate incentives are the only explanation, but I think they are a part of it.

Letter to Nitin Nohria, Dean of the Harvard Business School

I wrote Dean Nohria in response to this story

Ben Edelman is an associate professor at Harvard Business School, where he teaches in the Negotiation, Organizations & Markets unit.

Ran Duan manages The Baldwin Bar, located inside the Woburn location of Sichuan Garden, a Chinese restaurant founded by his parents.

Last week, Edelman ordered what he thought was $53.35 worth of Chinese food from Sichuan Garden’s Brookline Village location.

Edelman soon came to the horrifying realization that he had been overcharged. By a total of $4.

If you’ve ever wondered what happens when a Harvard Business School professor thinks a family-run Chinese restaurant screwed him out of $4, you’re about to find out.

(Hint: It involves invocation of the Massachusetts Consumer Protection Statute and multiple threats of legal action.)

Here was the letter I sent, which was significantly more mature in tone for having waited 24 hours before writing it

My wife and I are both HBS '89 grads.  We own and actively manage a small to medium size service business.  I was encouraged at our last reunion to hear a lot of the effort HBS seems to be placing on small business and entrepreneurship.

However, I was horrified to see an HBS professor (prof Edelman) in the news harassing a small business over a small mistake on its web site.  I don't typically get worked up about Harvard grads acting out, but in this particular case his actions are absolutely at the core of what is making the operation of a small business increasingly impossible in this country.

Small businesses face huge and growing compliance risks from almost every direction -- labor law, safety rules, environmental rules, consumer protection laws, bounty programs like California prop 65, etc.  What all these have in common is that they impose huge penalties for tiny mistakes, mistakes that can be avoided only by the application of enormous numbers of labor hours in compliance activities.   These compliance costs are relatively easy for large companies to bear, but back-breaking for small companies.

So it is infuriating to see an HBS professor attempting to impose yet another large cost on a small business for a tiny mistake, particularly when the proprietor's response was handled so well.  Seriously, as an aside, I took service management from Ben Shapiro back in the day and I could easily see the restaurateur involved being featured positively in a case study.  He does all the same things I learned at HBS --  reading every customer comment personally, responding personally to complaints, bending over backwards to offer more than needed in order to save the relationship with the customer.

As for the restaurateur's web site mistake -- even in a larger, multi-site company, I as owner do all my own web work.  Just as I do a million other things to keep things running.  And it is hard, in fact virtually impossible, to keep all of our web sites up to date.  Which is why Professor Edelman's response just demonstrates to me that for all HBS talks about entrepreneurship, the faculty at HBS is still more attuned to large corporations and how they operate with their enormous staff resources rather than to small businesses.

Large corporations are crushing smaller ones in industry after industry because of the economy of scale they have in managing such compliance issues.  If the HBS faculty were truly committed to entrepreneurship, it should be thinking about how technology and process can be harnessed by smaller businesses to reduce the relative costs of these activities. How, for example, can I keep up with 150+ locations that each need a web presence when my sales per site are so much less than that of a larger corporation?  This is not impossible -- I have learned some tools and techniques over time -- and we should be teaching and expanding these, rather than spending time raising the cost of compliance for small business.

An Unexpected Roadblock to Some of Our HR Automation

We are trying to use some of the available tools out there to better automate our application and onboarding process for employees.  Though we are not a huge employer (about 350 part-time people) we hire and fire them all every year, so there is a lot of burden for our size on the HR system.

We are running into a frustrating issue.  Most of our employees are older and often have limited computer skills, but we are getting past that.  But we tend to hire couples, and it turns out in the over-50 set that couples often share the same email address.  I can't even imagine having the same email address as my wife and having to filter through all of her business, but there it is.  Unfortunately, in the world of web accounts, must vendors use the email address as the one reliable unique identifier for a person and thus use it for the user name or expect it to be unique.

This is throwing us for a loop.  It is less of a problem in the application system because most of our couples just want to submit a single joint application anyway.  But for onboarding, they  each need their own W-4, I-9, etc.  So they need separate user accounts.

The question then comes down to this for us:  I can require them to get a second email address, but that is likely going to flummox some folks and require my manual intervention to help them.  Do I thus cause more tech support issues for myself than I save from the automation itself?

No point here, just venting on a problem I have not figured out how to fix.  And no fair saying stuff like "gmail is free and easy to sign up for, just make them get another gmail account."  I have managers who do a fabulous job for me that it took me days to teach how to log into and use Gmail.  A better and fairer comment would be "you have 20,000 applicants, make the application process require separate emails and even make it a little technically challenging so you limit your hiring pool to people who are better suited to using modern computer tools."  And yes, that may in fact be our solution.

I Understand the Concern, But....

I think folks are rightly concerned that "disparate impact" logic run amok is leading to a lot of questionable practices, like this one in Minnesota:

The good: Minneapolis Public Schools want to decrease total suspensions for non-violent infractions of school rules.

The bad: The district has pledged to do this by implementing a special review system for cases where a black or Latino student is disciplined. Only minority students will enjoy this special privilege.

That seems purposefully unconstitutional—and is likely illegal, according to certain legal minds.

The new policy is the result of negotiations between MPS and the Department of Education's Office for Civil Rights. Minority students are disciplined at much higher rates than white students, and for two years the federal government has investigated whether that statistic was the result of institutional racism.

I understand the concern here, and I don't think it is unreasonable to demand that a public institution make this review process applicable to all suspensions, not just to those of black and Hispanic kids.

But good God, if I found out, say, that Hispanics were getting laid off at ten times the rate as Anglo workers in my company, I would definitely do something different in the process.  I would not immediately assume it was due to discrimination but I would sure as hell insert myself into the process to make sure things were fair.  I could easily see myself at least temporarily demanding in such a case that all terminations of people of color be reviewed with me first.  Hell, I wouldn't have waited for two years to do it either.   Even if the terminations turned out to be righteous, I would  hopefully learn something along the way about why the disparity exists and what I could do about it in the future.

By the way, in today's legal environment, any private employer who says they don't put extra scrutiny on terminations of folks in protected classes, or don't increase the warnings and documentation required internally before firing someone in a protected class, is probably a liar.

This is Why Running a Service Business is Hard

This Starbucks story illustrates the hardest part about running a service business

"Pregnant woman denied Starbucks bathroom useage"

Of course, Starbucks did not deny this woman access to the bathroom.  Had the board of directors, CEO, and most of the management been at the store, they would have happily helped the woman use the Starbucks bathroom.  This woman was actually denied access to the bathroom by some knucklehead employee of Starbucks, one of the tens of thousands they hire, who likely thought they were doing the right thing.

I am sure Starbucks has a policy that the bathrooms are for customers only, and honestly in a lot of urban areas that is an essential policy or else one finds themselves spending a lot of money cleaning the bathroom and providing the public facilities that the city or shopping center developer chose not to fund.

However, in a service business, one of the keys to providing good customer service and maintaining a good reputation is, ironically, having your employees know when the rules need to be bent.  This is the number 1 thing in every training session we have in our company -- when the rules have to be enforced (safety, fires, quiet time at night) and when to back off and not act like the campground nazi ruining everyone's visit.

I have thought about why this should be for quite a while.  If rules exist, shouldn't they be enforced for everyone?  And if not, shouldn't they just be eliminated?

First, there simply are exceptions.  This is the same reason that mandatory sentencing guidelines in criminal law and no tolerance rules in schools always run to grief.

Second, even if there are not exceptions, there are people who really, really, really, strongly, aggressively believe that they are indeed an exception.  Call this modern entitlement, but we get this all the time.  Dog owners are a great example.  Every single one of them understands perfectly why everyone else's dogs have to be on leash but no one believes their little darling is a problem.  Dogs are in fact the hardest issue we often have to manage.  Ask someone to put a dog on leash and we get vitriolic complaints sent to our government partners, newspapers, etc.  Let them run around and we get vitriolic complaints sent other visitors who are bothered by dogs sent to our government partners, newspapers, etc.

Finally, the marginal cost of serving one or two exceptions is really low, practically measurable, while the cost of allowing everyone to break the rule is high.  Take the case of bathrooms.  Letting one non-customer use the bathroom costs zero.  But once word gets out that you allow public use of your bathrooms, everyone in a half-mile radius is lined up at the door every day.


It May Be Hard to Go Back To Full-Time Work

Back in April of 2013 I wrote about how Obamacare was increasing incentives for offering part-time rather than full-time work.   I warned at the time that once employers got used to scheduling based on part-time shifts, they might never want to go back because it could actually be cheaper and easier than using full-time workers

The service industry generally does not operate 8 hours a day, 5 days a week, so its labor needs do not match traditional full-time shifts.  Those of us who run service companies already have to piece together multiple employees and shifts to cover our operating hours.  In this environment, there is no reason one can’t stitch together employees making 29 hours a week (that don’t have to be given expensive health care policies) nearly as easily as one can stitch together 40 hours a week employees.   In fact, it can be easier — a store that needs to cover 10AM to 9PM can cover with two 5.5 hour a day employees.   If they work 5 days a week, that is 27.5 hours a week, safely part-time.  Three people working such hours with staggered days off can cover the store’s hours for 7 days.

Based on the numbers above, a store might actually prefer to only have sub-30 hour shifts, but may have, until recently, provided full-time 40 hours work because good employees expect it and other employers were offering it.  In other words, they had to offer full-time work because competition in the labor market demanded it.  But if everyone in the service business stops offering full-time work, the competitive pressure to offer anything but part-time jobs will be gone.  The service business may never go back.

The future American service worker will likely be faced with stitching together multiple part-time shifts.  Companies may partner to coordinate shifts so that workers split time between the companies, and third-party clearing houses may emerge in a new value-added role of helping employers and employees stitch together part-time shifts.

Today Virginia Postrel sees this effect in action

The worst thing about being on jury duty isn’t actually serving on a jury. It’s having to check in every day -- possibly several times a day, depending on your local system -- to see whether you’ll be needed. You can’t plan either your work or your personal life. Your schedule is unpredictable and completely out of your control.

For many part-time workers in the post-crash economy, life has become like endless jury duty. Scheduling software now lets employers constantly optimize who’s working, better balancing labor costs and likely demand. The process demands enormous flexibilityfrom part-time workers, sometimes requiring them to be on call all the time without knowing when they’ll work or how much they’ll earn. That puts the kibosh on the age-old strategy of working two or more part-time jobs to make ends meet. As my colleague Megan McArdle writes, “No matter how hard you are willing to work, stringing together anything approaching a minimum income becomes impossible.”

Beware of Scam Calls From (816) 420-4632 or (866) 680-8628

I post this not because the odds are high any of you readers have had this issue but I want these numbers to be found on an internet search.

Both numbers were leaving a message saying they were from "Citi" or "Citicard" calling about my account (and that it was not a sales call).  Since I have no Citicorp credit cards or accounts of any type, and since they were calling a Google Voice number that I would never have put on an account (in fact don't even really use), I was totally suspicious.  When I called them they asked for my account number.  I said I did not have one but was calling to see what kind of scam they were running.  They said they were from Citicard and don't do scams, but could I give them my phone number.  I said I had to look it up, because they were calling a Google voice number I never use.  The moment I said that, they hung up on me, the universal indicator of a scamster giving up.

Update:  There is a legitimate Citi group with the same name.  It sounds to me that these folks at the numbers above are recording the legitimate Citi greeting replaying it on their lines.  But then their physical operator answers the phone completely differently than does the legitimate Citi operator.  The Citi group being spoofed is this one.

Hiring Conundrum -- The Obama Employees

For some reason I do not fully understand, the people who pester me the hardest for jobs tend to work out the worst as employees.  I cannot think of a reason this should be true, so perhaps this is just an artifact of having only a few data points.   But yet again we recently had another person we had to terminate who pursued me literally for years for a job, only to be unproductive and ineffective in the job from day one.  For some reason energy and enthusiasm in the job hunt do not translate to energy and enthusiasm in the job.

I have come to think of these as Obama employees -- people who are brilliant and energetic in seeking a job, but ineffective and oddly unmotivated once they have the job.

Postscript:  Last year, we had about 300 seasonal employees.  Of these, perhaps 50-75 will choose not to return or will not be asked to return the following year, opening up that many positions for new hires.  For these 50-75 spots, we had over 22,000 applications last year.  And since many of these applications are for a couple, we really had well over 30,000 applications.  This makes us more selective than Harvard, lol.

Wherein I Have Another Great Product Idea Too Late

We increasingly use VRBO to find rental houses when we go on vacation.  The key transfer process seems to be the most awkward.  Either the owner or their representative has to meet you (a hassle for them) or they have an old style mechanical lockbox where a fixed combination opens the box and gives you the key.

All of this strikes me as both a hassle and tremendously insecure.  Most folks do not change their lockbox combinations very often, so I could probably go back to most of them today and get back in the house.  Also, since the owners tend to leave only one key, and my wife and I prefer to have two or three for us and the kids, we tend to go immediately to the local hardware store to make copies.

It would make a lot more sense to have an electronic combination lock whose combination changes automatically, over the Internet, with each rental.  I figured developing such a thing would be pretty easy and the first step I would take would be to try to cut a co-branding deal with VRBO, AirBNB, etc.  You can imagine something like "VRBO Secure" where a home owner would buy the lock via VRBO and would then get a little icon on their listing.

Unfortunately, as is usual with my product brainstorms, someone is already there.  But no one yet seems to have cut a co-branding deal with VRBO or airBNB.  Seems like that would be a win-win for both the lock company and the rental agency.go.

Small Homage to Ayn Rand -- Exiting A California Business on September 2

Today I gave notice that I was exiting another park operations contract in California.  This location has always been marginal, but we kept holding out hope of improving it.  But with rising CA minimum wage, the PPACA, and onerous CA labor and liability laws, operating in CA is so hard that I have to make good money or get out.

I had to pick a termination date at the end of the summer.  I was going to choose Labor Day but looking at the calendar, it gave me a smile to slip the date to September 2, a date that should be familiar to anyone who is a real Atlas Shrugged geek.  It is an inside joke guaranteed not to be recognized by any of the government agency managers we work with there.

Two Business Realities I Underestimated in My Youth

1.  Its all about having the right people.  When I was in b-school, I honestly laughed at statements like this.  I thought it was new age bullsh*t.  I was totally enamored of quantitative analysis and business strategy.  After running a business for 10 years, I now know that people are everything.  Everything - our ability to grow, to handle difficult compliance issues, to work safely, to reduce costs - relies entirely on my finding the right people in the right spots.  Everything else is a rounding error.

2.  There is only a very limited number of things you can deploy to the field at any one time.  It took me a really long time to realize that my mind - in fact, any manager's mind - likely works way faster than the bandwidth that exists to actually deploy new things to the field.  Putting customer initiative X on hold because compliance issue Y needs to be deployed first is really frustrating, but trying to do too much means nothing gets done.

I would observe relative to #2 above that over the last few years the combination of the Feds + legislatures like in CA are generating new compliance issues faster than we can deploy solutions and train for them.   In California, we have put most all new customer initiatives on hold because we are simply overwhelmed with management and employee training relative to various local government mandates.

Yet Another Reason I am Short Facebook

via Maggies Farm

In addition, some smart people are saying the WhatsApp acquisition for a bazillion dollars makes sense, but I can't help feeling like it is the late 90's all over again.

update:  Apparently unlike most all other major online advertisers, Facebook terms and conditions do not allow 3rd party click audits.

Administrative Bloat

Benjamin Ginsberg is discussing administrative bloat in academia:

Carlson confirms this sad tale by reporting that increases in administrative staffing drove a 28 percent expansion of the higher education work force from 2000 to 2012.  This period, of course, includes several years of severe recession when colleges saw their revenues decline and many found themselves forced to make hard choices about spending.  The character of these choices is evident from the data reported by Carlson.  Colleges reined in spending on instruction and faculty salaries, hired more part-time adjunct faculty and fewer full-time professors and, yet, found the money to employ more and more administrators and staffers.

Administrative bloat is a problem in every organization.  It would be nice to think that organizations can stay right-sized at all times, but the reality is that they bloat in good times, and have to have layoffs to trim the fat in bad times.

The difference between high and low-performing organizations, though, is often where they make their cuts.  It appears from this example that academia is protecting its administration staff at the expense of its front-line value delivery staff (ie the faculty).  This is a hallmark of failing organizations, and we find a lot of this behavior in public agencies.  For example, several years ago when Arizona State Parks had to have  a big layoff, they barely touched their enormous headquarters staff and laid off mostly field customer service and maintenance staff. (At the time, Arizona State Parks and my company, both of whom run public parks, served about the same number of visitors.  ASP had over 100 HQ staff, I had 1.5).

This tendency to protect administrative staff over value-delivery staff is not unique to public institutions - General Motors did the same thing for years in the 70's and 80's.  But it is more prevalent in the public realm because of lack of competition.  In the private world, companies that engage in such behaviors are eventually swept away (except if you are GM and get bailed out at every turn).  Public agencies persist on and on and on and never go away, no matter how much they screw up.  When was the last time you ever heard of even the smallest public agency getting shut down?

I would love to see more on the psychology of this tendency to protect administrative over line staff.   My presumption has always been that 1) those in charge of the layoffs know the administrative staff personally, and so it is harder to lay them off and 2) Administrative staff tend to offload work from the executives, so they have more immediate value to the executives running the layoffs.

A Milestone to Celebrate: I Have Closed All My Businesses in Ventura County, California

Normally, the closure of a business operation or division is not grounds for a celebration, but in this case I am going to make an exception.  At midnight on December 31, I not only drank a toast to the new year, but also to finally getting all my business operations out of Ventura County, California.

Never have I operated in a more difficult environment.  Ventura County combines a difficult government environment with a difficult employee base with a difficult customer base.

  • It took years in Ventura County to make even the simplest modifications to the campground we ran.  For example, it took 7 separate permits from the County (each requiring a substantial payment) just to remove a wooden deck that the County inspector had condemned.  In order to allow us to temporarily park a small concession trailer in the parking lot, we had to (among other steps) take a soil sample of the dirt under the asphalt of the parking lot.   It took 3 years to permit a simple 500 gallon fuel tank with CARB and the County equivilent.   The entire campground desperately needed a major renovation but the smallest change would have triggered millions of dollars of new facility requirements from the County that we simply could not afford.
  • In most states we pay a percent or two of wages for unemployment insurance.  In California we pay almost 7%.  Our summer seasonal employees often take the winter off, working only in the summer, but claim unemployment insurance anyway.  They are supposed to be looking for work, but they seldom are and California refuses to police the matter.  Several couples spend the whole winter in Mexico, collecting unemployment all the while.  So I have to pay a fortune to support these folks' winter vacations.
  • California is raising minimum wages over the next 2 years by $2.  Many of our prices are frozen by our landlord based on past agreements they have entered into, so we had no way to offset these extra costs.  At some point, Obamacare will stop waiving its employer mandate and we will owe $2000-$3000 extra additional for each employee.  There was simply no way to support these costs without expanding to increase our size, which is impossible (see above) due to County regulations.
  • A local attorney held regular evening meetings with my employees to brainstorm new ways the could sue our company under arcane California law.  For example, we went through three iterations of rules and procedures trying to comply with California break law and changing "safe" harbors supposedly provided by California court decisions.  We only successfully stopped the suits by implementing a fingerprint timekeeping system and making it an automatic termination offense to work through lunch.  This operation has about 25 employees vs. 400 for the rest of the company.  100% of our lawsuits from employees over our entire 10-year history came from this one site.  At first we thought it was a manager issue, so we kept sending in our best managers from around the country to run the place, but the suits just continued.
  • Ask anyone in the recreation business where their most difficult customers are, and they likely will name the Los Angeles area.  It is impossible to generalize of course, because there are great customers from any location, but LA seems to have more than its fair share of difficult, unruly, entitled customers.   LA residents are, for example, by far the worst litterers in the country, at least from our experience.  Draw a map of California with concentric circles around LA and the further out one gets, the lower the litter clean-up costs we have.  But what really killed it for me in Ventura County was the crazy irresponsible drinking and behavior.  Ventura County is the only location out of nearly 200 in the country where we had to hire full-time law enforcement help to provide security.  At most locations, we would get 1 arrest every month or two (at most).  In Ventura we could get 5-10 arrests a day.  In the end, I found myself running a location where I would never take my own family.

And so I got out.  Hallelujah.

PS-  People frequently talk about taxes in California being what makes the state "anti-business."  That may be, but I guess I never made enough money to have the taxes really bite.  But taxes are only a small part of the equation.

Update:  Wow, reading this again, I left out so much!  An employee once sued us at this location for harassment and intimidation by her manager -- when the manager was her sister!  It cost me over $20,000 in legal expenses to get the case dismissed.  I had an older couple file a state complaint for age discrimination when they were terminated -- despite the fact that our entire business model is to hire retired people and the vast majority of our employees are 70 and older.  And how could I have forgotten the process of getting a liquor license?  I suppose I left it out because while tedious (my wife and I had to fly to California to get fingerprinted, for example), it is not really worse than in other places -- liquor license processes are universally bad, a feature and not a bug for the established businesses one is trying to compete with.   We gave the license up pretty quickly, when we saw how crazy and irresponsible much of the customer base was.  Trying to make the place safer and more family friendly, we banned alcohol from the lake area, and faced a series of lawsuit threats over that.


Business Model Ripped From the Pages of My Book BMOC

Apparently, a company named "Sumpto" has adopted a business model right out of my novel BMOC (written about 7 years ago).  This is a scene where entrepreneur Preston Marsh is interviewing and trying to recruit the protagonist Susan out of business school.  They are discussing the business model of his company called BMOC.  Half of its business model was that companies paid BMOC to place their products in the hands of influential high school students.

[Marsh:] The real innovation, though is… do you know what a product placement is?”

[Susan:] “Sure. It’s when a company pays to get their product into a TV show or movie – like when Reese’s pieces were used in the movie ET or I guess if you showed Seabiscuit eating Purina Horse Chow.”

“Exactly! And product placements are particularly effective. They act like an ad but they can’t be ignored like an ad. Anyway, we have taken product placements one step further: We get paid by major manufacturers to place their products not in movies but in the hands of the most popular kids in high school, the ones who really lead opinion as to what’s cool and not cool who we…”

“Who you happen to have on retainer anyway.”

“Exactly. But be careful how you think about ‘on retainer.’ The natural reaction is to assume this means money, but in our case it’s not. We keep the most popular people on retainer merely by …”

“Giving them free products,” Susan interrupted again, with growing excitement, “that manufacturers are already paying you to put in their hands.”

This is from Sumpto's web site.  (You will have to click through, for some reason even copying it as text is crashing my site, not sure why).

A big hat tip to reader Don, who not only found the site but paid me the indirect complement of having remembered my book.  Thanks!

Yet another case when I was 7-10 years too early (at Mercata were were about 10 years too early to cash in on social media as Groupon did with a similar model to ours).  But honestly, I was trying to make up quasi-outrageous business models.  For god sakes the other two major business ventures in the book were building fountains to harvest the coins thrown in them and selling musical tones for elevators.  I had no idea I should have been getting venture funding.

By the way, for the dozens of my literary fans, I am almost done with my next book, which is  really going to be good.   This novel writing thing really is about practice.  Teasers to follow...

Best Buy Says It's Not Afraid of "Showrooming". Really?

Best Buy says it is not afraid of showrooming, the practice of testing products at a physical retailer and then buying it online.  Best Buy says it is confident it can convert visitors into buyers, even if their intent was to buy online.

Well, that is a brave front.  And I wish them luck -- I certainly like having bricks and mortar retailers around when I need something fast and can't wait for the UPS truck.  But it probably was no accident that the article was illustrated with this picture:



What don't you see there?  CD's, DVD's, speakers, DVD players, computer games and most of the other stuff that used to make up a lot of Best Buy's floor space.  Because they have already been demolished by online retailers in those categories.   The picture above is of appliances, one of the few high dollar categories that has not migrated to the web.   Go to Best Buy and you will see appliances, health equipment, and TV's, all categories where bricks and mortar stores have some advantages over online.

This makes perfect sense, but don't tell me Best Buy is ready to take on the online retailers.  They are bobbing and weaving, ducking this competition wherever they can.

Postscript:  Best Buy is hoping that having "trained" sales people to help customers will garner business.  There are two problems with this.  One, the training of their sales staff has always been spotty, and likely will not get better as their financials go south.  And two, I find that reviews are far more helpful, and often more knowledgeable, than most in-store sales staff.   But on the positive side, who doesn't enjoy getting hassled for an extended warranty at checkout?