Posts Tagged ‘Economics and Finance’

The “Power Law” is one of the most useful concepts for making predictions and decisions in business and management.

The power law shows how two variables–one dependent, the other independent–covary. Mathematically, one varies as a function of the other by being raised to a certain power (exponent).

The following diagram shows this type of relationship. Often these are depicted on log or log-log graphs, but I show the “power curve” as an asymptote on both axes of the graph to highlight the non-linearity of the relationship between the two variables.

power-law-basic

A concrete example will help. The great majority of earthquakes are of very low magnitude. High magnitude earthquakes are much rarer than low magnitude earthquakes. In fact, their magnitude varies in inverse exponential proportion to the total number of earthquakes. In practice, this means that there are literally thousands of earthquakes every day around the world, but magnitude 6, 7, and 8 ones are much rarer. The most powerful earthquakes of all, over 9 on the Richter, scale are very rare. They can happen only a few times a century, or even less. This doesn’t mean that the magnitude of any particular earthquake can be predicted. It does however imply that given a sufficiently large sample, we will eventually see a frequency-magnitude distribution that resembles the graph above.

This type of relationship is ubiquitous in nature, and that includes our human and social natures. There was a whole book written on this topic–The Long Tail, by Chris Anderson–with emphasis on the right side of the graph. In his book, Anderson described how the internet has made many businesses or ideas viable which would not previously even have been known. He called this the long tail because there are musicians, artists, artisans, crafts workers, professionals, etc. who can provide their productions and services to people around the world, even though they can’t compete with the more traditional providers who dominate markets by occupying the left side of the power curve. This makes for much more diversity and many more opportunities to get known and appreciated, and to develop a following because it lowers traditional barriers to entry and long-term viability.

This type of relationship is also depicted in the following diagram. I show the relationship between number of clients and the number purchases, interactions, or value of each category of client that characterizes the market and product distributions of most, if not all, companies (including my own clients).

power-law-of-clients-and-value

For instance, I’ve been working with a banking client. This graph shows the relationship between number of clients and the number of products/services that each client has with the bank. The total market size for this bank is about 80,000 potential users of its services. Of these potential users of its services, the great majority, about 85 %, have no business relationship with the bank. Of the 13,000 or so that do use the bank’s services, the majority only use less than 3 of over 20 products and services. As we move to the right, there are less clients, but their interactions with the bank are more intensive. In other words, there are are many fewer clients in categories to the right, but they use many more of the bank’s services, which in turn generate much greater value. On the other hand, there are no actual clients who do all of their banking and meet all of their financial needs and objectives, much less use all of the bank’s services. This is why we can depict the lower right part of the curve as an asymptote. You never actually reach complete saturation or use.

We’ve all noticed these types of power-law relationships in our professional and personal lives, our management and business experiences, and even in some natural phenomena. This relationship is often referred to as the 80/20 law, Pareto’s Law, or Zipf’s Law. It shows up in such truisms as: 80 % of my problems are caused by 20 % (rates can vary) of my people; most of my sales and profits come from a small number of sales reps; only a few of my clients provide most of my revenue and profits; this product category accounts for 45 % of my sales, but 70 % of my profits; etc., etc.

The following diagram is a further illustration of the principle. It comes from an online article by Mark McLean of the Toronto Real Estate Board (TREB) and shows an almost perfect example of a power-law distribution in the number of deals done by different categories of real estate agents who are members of TREB.  We can see that only a very small number of agents in TREB can be considered highly successful, prolific even.

treb-gif

Of those agents having completed 6 or less deals in a year, a similar relationship holds, although it’s less stark:

treb-6-and-under

Whatever we wish to call them, power-law distributions and relationships underlie much of the correlations and dynamics that surround us. We can use them in making general predictions and, along with the S-curve phenomenon I described in a previous post, we have two very powerful tools and concepts for understanding the world around us. Moreover, power laws and S-curves are not only ubiquitous, they tend to show what’s called “self-similarity,” or a fractal pattern. I’ll discuss that third powerful concept next week.

© 2016 Alcera Consulting Inc.

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We seem to live in an era when words are more like bullets—a way to injure and defeat others, to get one’s own way—than a way to communicate in a genuine manner, seeking understanding, insight, and mutual respect.

As I write this, the Paris climate summit is underway. We have just about all the countries in the world represented and we’re told this is the “last chance” to “save the planet.” Last chance. Really? Save the planet? I would think the planet doesn’t need us to “save” it. But, like the gospel inspired song said of That Lucky Old Sun, the earth will surely go on rolling around heaven all day. We may be in danger of disrupting our habitat or of damaging it beyond repair (that remains to be seen), such that we, as a species might be endangered. However, a cursory review of earth’s evolution over geological eons will show that it’s been through much worse before and life has gone on.

The zeal with which enviro-enthusiasts (or should I say fascists?) are claiming that it’s our last chance to keep the planet’s temperature from rising by more than 2 degrees is more religious than scientific. The same can be said of the attempts to claim a scientific consensus, as if scientists all agree with everything that’s claimed about environmentalists.

There may be a scientific consensus about the law of gravity, or evolution through natural selection, because the empirical evidence is overwhelming in favour of those theories. I doubt there is even close to the same level of agreement within the climatological community, which is really the only one that counts scientifically. And yet we keep hearing that 95 % of scientists, or whatever the figure is, believe that global warming is a reality. That may be the case, but being a scientist doesn’t automatically qualify someone to judge the validity of scientific theories outside their field of expertise. Just talk to medical doctors with different specialties to see how divergent the knowledge, skills, and judgment are on any particular illness or condition to realize how important these specialized competencies are to coming to a proper diagnosis and prognosis, much less the best treatment plan.

I’m not necessarily a skeptic about climate change and human-caused warming. However, there has been too much environmental change over the eons on earth to claim any kind of stasis in the matter. After all, what caused the end of the most recent ice age 10 or 12 thousand years ago? Perhaps the woolly mammoths and giant ground sloths were expelling too much methane as they chewed their cud. And what caused the planet to plunge into a deep freeze 130 thousand years ago when the current ice age started?

On the other hand, I am a skeptic when it comes to claims that “the science is settled.” Moreover, I find the current climate (pun intended) against questioning this so called common sense consensus to be a dangerous trend. It’s also very convenient for those with a statist centralizing agenda who wish to restrain economic growth and capitalism, because they claim they are the cause of global warming, at least indirectly. How convenient that there be a such an apocalyptic menace for our collective well-being. Nothing less than total war is needed to combat impending doom. And in war, all manner of propaganda and control mechanisms are warranted to defeat the common enemy. Many of the poorest countries in the world are already clamoring for a transfer of wealth from the wealthy countries to pay for African wind farms and human scale solar power units. After all, nothing should be excluded in order to “save the planet,” because this is our “last best chance.” Once again, I’m not arguing against such a wealth transfer (although there are good arguments against one). But I don’t think that haranguing people into feeling guilty is the correct way to go about it.

The use of language as a weapon and words as bullets is just as pernicious in other areas. Activists—or should I say bullies—at the University of Ottawa have gotten management to discontinue free yoga lessons for handicapped people on the grounds that yoga is “cultural appropriation.” In other words, they claim that you can’t use any idea or activity that comes from another culture if that culture was at one time subjugated by another. Presumably, the reference is to British imperialism in India. Is it okay to have Indian cuisine, or Chinese food? Can we Zumba, or do the limbo? After all, they come from Latin America and the Caribbean, originally all slave societies.

Just to be egalitarian, I don’t think war mongers come off any better. The Islamist inspired attacks in Paris, the Middle East and anywhere else are horrible and the Jihadist threat must be met militarily and politically with appropriate means and strategy. But I don’t think we’re in a “war on terror” any more than we’re engaged in wars on inequality, cultural appropriation, climate change, or global capitalism.

Language and words should help us understand and think better, not separate us into sloganeering tribes with faith-based creeds and intolerant beliefs. After all, words aren’t bullets.

Richard Martin is The Force Multiplier. He brings his military and business leadership and management experience to bear for executives and organizations seeking to radically improve performance, grow, and thrive in the face of rapid change, harsh competition, and increasing uncertainty.

© 2015 Richard Martin. Reproduction and quotes are permitted with proper attribution.

The increasing success of Uber, the direct-to-driver taxi service, has led me to reflect on the most recent trends in business strategy. I believe we’re now witnessing the demise of intermediaries.

In everything from retail, to entertainment, travel, event management, taxis, and classified ads, businesses that have traditionally earned their keep by providing information or funnelling goods from producers to consumers are being bypassed.

Uber is a revealing illustration of this process. Anybody can register with Uber to hail a driver to go from point A to point B in a city. There are now over 200 cities throughout the world with Uber service. Users get to rate drivers out of 5 (a driver with an average score below 4.5 gets eliminated from the service) and they can use their smart phones to order a car using online payments and the built-in GPS receiver and map. Fares also vary according to demand, which means that you can get a car at any time if you’re prepared to pay a higher rate. And there’s nothing wrong with that. That’s how supply and demand is supposed to work, by finding the right price at the right time.

Taxi drivers and dispatchers in most cities where Uber is present are furious and are fighting a rear-guard battle against the company and the “unlicensed” cars. Weapons include intimidation of Uber registered drivers, vandalism of Uber cars, and municipal regulations. But none of that is stopping customers from using the service. What we’re seeing, therefore, is the demise of one particular type of intermediary, the taxi dispatcher. Increasingly, if you want to drive a taxi Uber will be the way to go. Uber has also created other services, such as package delivery. Could this also have an impact on Fedex and other parcel services?

A few weeks ago Netflix was called before the Canadian Radio-Television and Telecommunications Commission (CRTC). The company has refused to hand over its extensive data on its Canadian clients to the commission. Up to recent years, Canadians have been restricted to broadcast and cable content that has been approved by the CRTC. The objective has traditionally been to protect Canadian producers of content, and by extension, culture. But now with Internet access, Canadians (like people anywhere the Internet isn’t censored) can watch or consume whatever they want, regardless of where it’s from. Even if there are restrictions on streaming, say, videos outside its producer’s home country, there are ways around that. You can set up a virtual private network (VPN) and access it as if you were in that country.

The result is that nationally protected content producers and distributors are competing directly against foreign producers whether they like it or not. As with taxis, customers are either buying directly from suppliers or going through a different type of intermediary. The latter are still intermediaries, but instead of hundreds or thousands, there are now a few companies acting mainly as information warehouses. Customers get the information they need when they need it and can deal directly with sellers. The new type of intermediary is either just an ordering service or an information repository.

There are numerous other examples. Google has put a serious dent in advertising intermediaries, itself becoming the marketplace where advertisers words and pictures, and buyers’ eyes, meet. Search engines and the Internet in general have eliminated Yellow Pages as a viable business. Craigslist and similar web services have undermined local classified and help wanted ads. What’s more, like Uber and Netflix, it’s all done remotely with a lot fewer employees and a lot better accessibility and flexibility for users.

You’ve got to wonder what the impact of physiological and health data generated by smart watches and other devices is going to be on the healthcare industry. If I were in life or health insurance, any kind of health care, or even funeral services, I’d be looking at what the potential impacts could be.

It’s always prudent to look for how your business can be undermined or overtaken by new entrants and competitors who come out of nowhere with substitute products and services. However, if you’re in any kind of business where you’re mainly an intermediary, it would be high time to look at your strategy and business model to see how vulnerable it is to getting bypassed by future “Ubers” and “Netflixes.”

The best defence is offence, so it makes sense to find ways to launch a spoiling attack and see how you can outmanoeuvre new entrants by creating substitutes that undermine your own positions.

Richard Martin is a Master Strategist and Leadership Catalyst. Richard brings his military and business leadership and management experience to bear for executives and organizations seeking to radically improve performance, grow, and thrive in the face of rapid change, harsh competition, and increasing uncertainty.

© 2014 Richard Martin. Reproduction and quotes are permitted with proper attribution.

A few weeks ago I was having lunch with one of the most successful real estate brokers in Canada. At one point, she asked me what I thought of the economy. My instinctive answer was that there is no such thing as “the economy.”

What do I mean by this? Simply that we are fed on a day to day basis by the media, financial advisors, politicians, business leaders, etc., that the economy is growing, or shrinking, or whatever else economies are supposed to be doing. This attitude discounts the particular experiences and realities of individuals and organizations, the fact that for every person and business in a country, economics is a concrete concept. GDP, employment and interest figures represent a highly abstract averaging of economic and social activity; each person and organization has its own particular growth figures, interest rate, and supply and demand curves.

I have come to appreciate that each one of us is our own economy. In Canada there is something like 34 million economies. Add in businesses, corporations, associations, various levels of government, including municipalities and government agencies, and there are millions more. In the US there are probably at least half a billion economies by that measure, and in the world as a whole, perhaps 20 or 30 billion, if not many more.

As an example, Sears Canada has just announced the selloff of the company’s flagship location at Eaton Centre in downtown Toronto, in addition to many other prime real estate locations across the country. The company has been struggling for years in Canada and the US, while other retailers have been expanding and making a killing. Sears is in full retreat in Canada, but Target is expanding here. Two similar companies, two completely different economic realities. There may be some general retail trend in Canada, but how should we interpret it in the face of such different micro-economic realities? The same applies to every specific micro-economy, whether an individual, a small business, or a large corporation.

Gross economic measures are just that—gross averages and metrics that subsume millions of subtle factors, inputs, and outputs that impact on individuals and groups working to earn a living, generate wealth, improve their clients’ conditions, and deliver value. These metrics may be useful for macro-economic management at the political level, but do they really have meaning for people and executives trying to make their way in the world?

One of the limitations of macro-economic measures is that they become a ready excuse for under-performance and lack of productivity, innovation, and customer satisfaction. If someone can’t meet their sales targets, it’s because the economy has slowed, or people aren’t spending, or government policies are hindering growth. These all may be true to some extent, but the overall trend in an economy is just one factor to be considered among many.

The average person and business has much more control over their economic conditions than is conventionally recognized. Employees and job seekers must be willing to upgrade their skills to remain relevant in the job market. Businesses and entrepreneurs must be willing to innovate and take prudent risks to change their products and services, to reach out to new customers and to develop leaner and more effective processes and systems.

Each company and person has its specific credit rating, interest rate, and risk level. We all have different and constantly morphing opportunities and threats. One size does not fit all. We have to be aware of our particular situation and create plans and actions that will help us meet our goals. It’s not enough to blame “the economy,” because in that case you have to look at yourself in the mirror and ask yourself if you’re doing everything possible to create demand for your services and products, and to be economically valuable.

Richard Martin is a consultant, speaker, and executive coach. He brings his military and business leadership and management experience to bear for executives and organizations seeking to exploit change, maximize opportunity, and minimize risk.

© Alcera Consulting Inc. 2013. We encourage the sharing of this information and forwarding of this email with attribution. All other rights reserved.

The economist Joseph Schumpeter is famous for saying that capitalism is a process of creative destruction. Actually I think the concept goes back to Karl Marx. The point is essentially that in a free society, human ingenuity will lead to new products, services, and ideas. Many, if not most, of these novelties will die, but many won’t, and eventually they overtake the products, services, and ideas of existing companies and organizations.

Just last week, Publicis and Omnicom, two of the largest advertising firms in the world, decided to merge in order to fight off the aggressive inroads of Google, Facebook, and other tech companies that provide highly variegated yet precision information to advertisers. The ability to gather detailed data on the habits and preferences of individuals can be transformed into precision-strike ads for their screens. The same process is occurring in digital cameras. According to the Wall Street Journal, sales of low-end point-and-click digital cameras by Japanese manufacturers are down about 45% in the last year. This is obviously due to the inclusion of still and video camera capabilities in smart phones, along with the ability to upload and transfer the images immediately.

But it’s not just new products and services that can be disruptive to incumbents. One of my clients has been facing a downturn in purchasing in its industry for close to five years now, with little end in sight to the belt-tightening. An acquaintance of mine in a completely unrelated industry is facing lengthening timelines on payment, with very large clients squeezing their suppliers and forcing them to finance their cash flow. A former client is in the financial industry. She works for a very profitable and growing company that is cutting budgets in order to increase profits and hoard cash. Finally, several insurance executives have told me that continued low interest rates have a major impact on the profitability of their business. All of these phenomena impact on business just as much as new competitors, substitute products, or new technologies.

We have to be constantly ready to recreate and reinvent ourselves whether things are going well or going poorly. Obviously, it’s best to make our own products, processes, and services obsolete before others do, especially when we have the wherewithal to do so. But it’s all the more important when in difficulty. IBM is one of the most successful at this process of reinvention over the decades. Throughout this evolution, IBM always built on its existing businesses and expertise in order to transition to new capabilities and markets. Meanwhile, companies like Dell and HP, while making significant gains in IT services, are struggling with their large dependence on hardware, particularly desktop computers.

How does a company make the transition from current business to future business? This is not an easy process, but there are a few principles that can guide in the evolution:

•    Build on successes and strengths. This is what IBM has done well over the years. Google is also masterful at offering new products and services that build on dominance, for example, the Android operating system, which incorporates features and usability that exploit its dominance in search and precision-strike advertising.
•    Proceed by trial and error. Google exemplifies this principle, with its constant experimentation, innovation, and extension of existing concepts and services. Most of the company’s innovation is generated as a result of private initiatives that compete internally for investment and reinforcement.
•    Reward and reinforce individual initiative. Revolution and evolution from above rarely if ever work. They are inherently unpredictable and percolate from the bottom up.
•    Stop what isn’t working. Obviously, we have to be persistent when something doesn’t work at first, but there comes a time when we have to ask ourselves if further investment in time, energy, and money will lead to growth of the initiative. A rule of thumb I use is that an initiative has to show at least some level of success when it is first mooted. For instance, if I introduce a new service as a consultant and nothing happens, then that is a good indication that it won’t work, no matter how much energy and resources I pour into it. On the other hand, any interest, no matter how small, shows at least some potential that can be built upon.
•    Revive and resuscitate. The Newton was Apple’s first attempt at a handheld computer, but it never really took off. Despite that, the company learned a lot from the experience. When technology evolved to the point that the concept could be explored anew, it led eventually to the iPad.
•    Offer new products and services to existing customers. This may be obvious, but I find that companies often put themselves through agonies to develop completely new products for markets that they’ve never touched before. This is very risky, as there is not only the risk associated with new products and everything that can entail in terms of suppliers, operations, distribution channels, marketing and advertising, but then you have to enter a market that you have very little knowledge of. You’re doubling the risk but no necessarily the reward potential.

I could go on with this list, but the point is to be willing to explore new possibilities. This entails accepting that your best successes and strengths of the past and present may not continue on into the future. We should all be constantly questioning our assumptions. This is something that I learned in my 26-year military career, and as a student of military and business history. All successes eventually become the source of a downfall, unless they are used as a springboard to continuous evolution and revolution.

Richard Martin is a consultant, speaker, and executive coach. He brings his military and business leadership and management experience to bear for executives and organizations seeking to exploit change, maximize opportunity, and minimize risk.

© Alcera Consulting Inc. 2013. We encourage the sharing of this information and forwarding of this email with attribution. All other rights reserved.

Brilliant Manoeuvre
We learn best by doing, making mistakes and gaining minor wins in the heat of battle. Theoretical learning is necessary, but it only provides a framework to build practical experience.

Discussion
One of the things I learned in the army is that the best way to develop good officers is to ensure that they’ve gained a minimum level of experience and competence as followers and junior leaders before letting them command and lead at higher levels. For instance, you don’t necessarily need an officer to command a platoon, but it is essential to have been a platoon commander early in your career to be a good officer later on. Platoon leadership is the best school because it puts the young officer on the front lines leading soldiers and non commissioned officers directly, without the constant intervention of more experienced officers. The young lieutenant has to learn to fend for him or herself by building on the scaffolding taught in officer candidate training. The theoretical lessons therefore become practical experience by doing, correcting, and improving, rather than by rote learning alone. These become valuable lessons learned for the rest of one’s career.

Unfortunately, this is often lost on financial analysts and journalists in the business press, people who, more often than not, have never tried to do what they are counselling business leaders to do. They tell executives how they should manage their companies, sometimes advocating corporate breakups, acquisitions, and other risky manoeuvres simply to improve stock market valuations. Need I say that the valuations are driven by numerous factors, some of which are mostly random? MBAs and other professional qualifications are only the start of the learning process. They must be honed through practical management and leadership before they should lead to giving advice to others.

Tip
The most powerful means of influence is not reward and punishment, but rather to show that it is in the follower’s best interests, intellectually, materially, emotionally, and socially to follow the leader.

Richard Martin is a consultant, speaker, and executive coach. He brings his military and business leadership and management experience to bear for executives and organizations seeking to exploit change, maximize opportunity, and minimize risk.

© 2013 Richard Martin. Reproduction and quotes are permitted with proper attribution.

Brilliant Manoeuvre
You must shape the battlefield to create the conditions for your success.

Discussion
If you’re passive, you get passed. You have to take the offensive in order to (re)gain the initiative and keep it. That is the essence of offense. But too many companies are content with the status quo and stay passive in the face of societal, economic, technical, and scientific change. Take life and health insurance companies. With all the medical and biotech innovations coming on line now and in the foreseeable future, they should be much more active in shaping the environment to their advantage. Instead, they are stuck within the same business model that has prevailed for decades: Wait till a new drug or procedure comes on the market, then determine whether it’s covered or not.

In the last week or so, I’ve read of new procedures and technologies that are enabling the growing of new organs from pluripotent stem cells; recreating tooth tissue and entirely new teeth from same; portable diagnostics in smart phones; and massively detailed images and 3D models of the brain. This is just the tip of the iceberg. Health insurance and life insurance providers should investigate these approaches to determine how to rein in health care and extended living costs. This could mean actively substituting higher performance procedures for lower efficiency and effectiveness ones. It could also mean taking an active role, with clients, in managing in their health and longevity. We don’t know the full extent of these changes and their effects, but they will no doubt lead to entirely new business models in insurance and health care, not to mention completely new businesses that don’t exist right now. What are you doing right now to shape this brave new world to your advantage, so you’re not stuck like a deer in the headlights?

Tip
You can’t just focus on what is in front of you at the present time. You must also watch the bigger picture in the future, assessing nascent and potential threats and opportunities as well as current ones.

Richard Martin is a consultant, speaker, and executive coach. He brings his military and business leadership and management experience to bear for executives and organizations seeking to exploit change, maximize opportunity, and minimize risk.

© 2013 Richard Martin. Reproduction and quotes are permitted with proper attribution.