Embracing Price Gouging

A friend from the UK was telling me, with some anger I might add, that people were ‘getting gouged’ on trains coming back to London through the Chunnel.  That is, with all of the volcano ash grounding air traffic in northern Europe, the train back is the only standard way back to cross the English Channel into the U.K.; and the operators of the train line have raised prices dramatically.  My friend implied that it was immoral to take advantage of the crisis.

My question to him was:  ‘are the trains going into the U.K. empty?’

And of course the answer was:  ‘no’, the trains are quite full. 

This of course doesn’t justify charging higher prices, but it points out that people were willing to pay a lot more than usual.  And it begs the next question: 

If the supply is low and demand is high, by what other means would you distribute the limited supply? 

. . . by, say, lottery . . . by those with political connections . . . by height?

The law of supply and demand tends to deliver the optimal quantity to the most people by using price signals, rather than some other means.  For those whom it’s most important, they will sacrifice more of their limited resources for this outcome.  While others, for whom it’s too great a sacrifice, will choose to wait.  Yes, there will be people for whom there is no choice—as the clearing price is just too high, but that’s always going to be the case in any method of distribution (holding a losing lottery ticket, for example). 

The problem with switching to an arbitrary method is that people tend to engage in counterproductive activities to game that method—creating more waste than the price method . . . often much more.  In short, they begin to bargain with a different currency.  They will trade political favors.  Or, they’ll apply for the lottery, only looking to sell the ticket for profit if they happen to win–i.e. the gouging happens anyway.  This happens all the time, whether it be black markets or, say, stubhub.com which gets extra tickets to people who really want them–at the lower market clearing price when demand is low, or the higher one when the demand is higher . . . given that stadiums fix their price at the beginning of the season—without consideration for whom the team is playing, or how the team is performing during the season.

Given this, price gouging, for all of its unseemly nature is just an extension of this behavior . . . delivering limited resources to those who value them most . . . and doing so in the most efficient way we currently know of.  Any other way is prone to more corruption and waste–the very things we detest in a political economy.  Why would we endorse it, by default, here?

Setting aside the emotional reaction (which I too feel . . . even in my cold, black, capitalist heart–I think I’m kidding), can we accept that someone is always going to be left out . . . that it’s never going to be ‘fair’, whatever that means? 

So, what’s the real problem with doing the efficient thing?

New Rules, Same as the Old Rules

Today’s Financial Times wrote: 

In spite of advances in science and statistical methods and ever-growing accounting regulation, we continue to be plagued by corporate governance problems.  This is in part due to focus on managers and boards of directors and our belief that their actions can be controlled.  But people’s responses to controls are often influenced, often in unintentional and unpredictable ways, by the actions of others, such as a accountants, lawyers, investment analysts and even policymakers and government regulators.

. . . When things go wrong, it is never thought to be the result of the unpredictable or unintentional nature of corporate governance controls or programmes.

Instead, new problems are seemingly uncovered justifying further accounting controls or standards.  These new controls or standards seldom solve existing problems but often compound them. 

In short, what Mr. Stein is saying is that people don’t react as you want them to when you create new rules and things often get worse, not better.  That sounds quite trite and obvious, but it’s worth noting when we applaud legislators and regulators who propose and execute such laws and regulations, while at the same time creating safety nets when the rules fail.

Tim Geithner, U.S. Treasury Secretary, was on the Sunday morning talks shows yesterday suggesting this very thing . . . that this time the rules will work.  I could feel my eyes rolling in my skull.

I have closely watched the evolution of changes in the accounting and finance regulation arenas for the past 25 years and studied it going back for over 100 years.  As the FT article suggests, no matter what’s changed in terms of the rules, the behaviors we don’t like always seem to return.

In 1972, the SEC’s rules led to the average corporate annual report to be 19 pages long . . . today they are hundreds of pages long, including a dozen of the first pages which list all of the risks associated with investing in the company.  In 2000, federal banking regulations were 12,000 pages.  By 2008, they were 18,000 pages. 

And yet, those rules didn’t provide the information or guidance to avoid the debacle almost no one saw coming.

Further, many of the same tactics used by Enron between 1997 and 2002 were used by Citigroup, Goldman, Bear Stearns, Lehman and others in trying to hide risk.  They found loopholes in the rules to do what they wanted to do anyway, which explains why there’ve been so few arrests during this collapse–it was all legal.  And while the corporate risk managers spent their time complying with and evading the new rules, and therefore focused on the short-term implications of their actions, these financial institutions didn’t spend enough time asking whether the risks were worth it in the long-run.  We know now that they weren’t worth it for just about everyone.  The folks who made out the most were the managers and the mid-level credit holders.  The former could escape with their pay and their reputations mostly in tact, given the bailouts, and the latter could escape with their return of capital, again, because of the bailouts.

In short, we incentivized managers to focus only on what was legal and to ignore real risks.  We incentivized the most critical group, the debtholders, to seek short-run returns and largely ignore risks, as well.

How likely is it that our new, new set of rules, which do nothing meaningful to alter the risk-reward calculus, will fare any better?

How have we lost sight of the fact that the market economy, which punishes each of these groups through lost reputation and lost investment if  they take bad risks, is the best way . . . rather than more futile rules and safety nets when the rules fail to operate as intended?

Focus—It’s Simple, But It Ain’t Easy

Here’s what I tell entrepreneurs all the time—both those whom I’ve taught in my class and those for whom I’ve worked over the past 20 years:

Be focused . . .

. . . make the hard choices needed to be uniquely the best for your customer!

It sounds so easy.  It is simple, but almost no one finds it easy, I’ve found.

Presuming you want to be the best at something, why would you allow anything else to get in the way?

Every minute you spend doing something else, distracts you from being the best.  Every dime you spend on something that isn’t part of your focus is 10 cents less you have to invest in furthering your focused strategy.  And both your customers and your competition will know and make you pay for your lack of focus.

You have to define who your customer is.  You do that by defining as many of the following which make a difference to those who want your offering, including by :   geography, purpose, income, gender, education, taste, the type of car they drive, etc.  Many of those won’t apply in different situations, but by narrowly defining who your target customer is, many of the rest of your choices will be a lot easier . . . and more likely the correct ones. 

If you want to open a sign shop, for instance, you might have to decide whether your target customer is the administrative departments of the local university or the local businesses on Main Street in your town—as each may have very different needs.  The university might need high volume to post around campus, while stores need quicker turnaround and higher quality prints–requiring two different sets of processes in your business.  If you choose one and keep compromising your practices to serve the other, without charging them more, you will suffer indeed.

Another choices is, what are the one or two most important things to that target customer at which you can be the best?  Broadly, these are: 

• highest quality,
• best service or
• lower price

. . .  (but it goes a lot deeper, of course).  Usually, you can only offer two of those.  If you try to offer all three, you are all but guaranteed to lose loads of money.  In that case, you won’t be around to please customers. 

I’ve seen many, many entrepreneurs not making enough choices, thinking they can do it all . . . but they always end-up struggling, not knowing why they can’t make any money.

If you open your sign shop’s doors and get the best materials and offer quick turnaround, you will get destroyed if you also don’t charge for these premiums. 

The key is understanding what your target customer’s pain is.  What are the most important one or two elements to making a customer happy in meeting their needs?

Are the stores on Main Street tired of waiting a week for their signs?  If so, how much is it worth it to them to make the switch to someone who can do a great job in just a few hours?

And don’t ever underestimate that:  switching costs, that is . . . the “cost” to your target customer to switch to you.  It’s hard for prospective customers to take a chance on the unfamiliar when what they have now, while not ideal, still works.  You have to be that much better at addressing what’s must important to that target customer, than what they are currently doing.

So, what’s most important to your target customer?  I don’t know—you’d better ask them! 

Good Luck and remember:  Stay Focused!

Hypocrisy Over Free Lunches

In his New York Times Op-Ed piece this morning, Bob Herbert writes:

 A Voice of Reason

The Republican Party is not simply the “just-say-no” party. It’s also a shameless advocate of the free lunch. Ronald Reagan famously told us he could jack up defense spending, cut taxes and balance the federal budget all at the same time.

George W. Bush put two big wars on a credit card. And now we have the perennially clownish Newt Gingrich, in an embarrassing rant against President Obama, assuring the deluded G.O.P. faithful that, yes, the party can indeed bring down the federal deficit while cutting taxes.

In a note of response to Mr. Herbert, I wrote:

I very much agree that it is shameless to advocate a free lunch, Mr. Herbert. Perhaps your voice would resonate with more reason, sir, if you didn’t find yourself doing this so often.

Bernanke, Heal Thyself!

Wednesday’s Washington Post reported:

Federal Reserve Chairman Ben S. Bernanke warned Wednesday that Americans may have to accept higher taxes or changes in cherished entitlements such as Medicare and Social Security if the nation is to avoid staggering budget deficits that threaten to choke off economic growth.

“These choices are difficult, and it always seems easier to put them off — until the day they cannot be put off anymore,” Bernanke said in a speech. “But unless we as a nation demonstrate a strong commitment to fiscal responsibility, in the longer run we will have neither financial stability nor healthy economic growth.”

His stern lecture came as the economy is emerging from the worst recession in years, sending the stock market up considerably over the past year and raising public hopes for a return to prosperity. But the economic downturn — with tumbling tax revenue, aggressive stimulus spending and rising safety-net payments such as unemployment insurance — has driven already large budget deficits to their highest level relative to the economy since the end of World War II. This has fueled public concern over how long the United States can sustain its fiscal policies.

The health-care bill signed by President Obama last month has further stoked the national debate over government entitlement programs, though the non-partisan Congressional Budget Office has projected that the legislation would actually reduce future deficits.

Barely two months after Bernanke was confirmed by Congress for a second term following a bruising fight, he used his bully pulpit to tread into an area of economic policy that is usually the province of the president and Congress. He characterized the budget gap as the biggest long-term economic challenge the nation faces, even as he acknowledged that reducing the deficit immediately would be “neither practical nor advisable” given the still-weak economy.

So, Bernanke sees a big problem with the coming deficits.  His concerns might seem a bit more genuine if he didn’t follow it with a warning that it is “neither practical nor advisable” to do anything about them right now. 

Given that he wants to do nothing about this critical issue he sees, the 2009 Time Man of the Year’s criticisms may very well be designed to obfuscate the unprecedented behavior for which he’s been both praised and criticized and which, in my opinion, may have guaranteed that this economy faces many difficult, or at least very uneven years ahead. 

At the risk of being too generous, we could credit Bernanke with foresight to see the real problem that this causes him.  This fiscal time bomb will cause The Fed to have to print money to pay off these debts . . . which is just another form of taxation, in that it will decrease the value of the dollar.  But that won’t likely effect Bernanke.  It will likely impact his successor, which is why it’s too generous to give him credit for this line of thinking.  That’s because Bernanke’s real fear is being the guy who’s the cause of the next Great Depression. . . . something he wasn’t on the hook for before, but may now be given all of his market manipulations.

Let’s hope not.

So, in short:  Bernanke may be right.  In fact, he is right.  We should do something about these deficits.  But he should be focusing on disclosing his own mess and how he’s going to clean it up, instead of telling others how to clean up a theirs . . . eventually. 

After all, that’s how his predecessor helped get us into the current mess—he wanted to be Maestro of all things market, when he should just have focused on controlling the growth in U.S. money supply.

Quite Taxing

I came across what appeared to be a simple explanation of how much I’m taxed as a proportion of my income . . . in other words, how much one pays out in taxes, divided by how much one makes in income:

How to Calculate Your Effective Tax Rate

The United States and many other countries use a progressive income tax system, whereby the amount you are taxed increases with the amount of money you earn. This results in the existence of a set of tax brackets, which denote different tax rates for different income levels. For instance, in the US, an individual making $20,000 in 2009 will pay 10% on their first $8,350 in income and 15% on the remaining $11,650. In the end, on their $20,000 in income, that person will have paid taxes at a rate somewhere between 10% and 15%. That rate is called their effective tax rate.

That makes it sound so easy.  This must be how I calculate the taxes I pay.  But I seem to recall a lot more that comes out of my pocket at different times of the year.

Hmmmm . . .

Unfortunately, this explanation is mislabeled . . . this is ONLY your effective Federal Income Tax rate.  What this doesn’t include are:  payroll taxes, state income taxes, city/local income taxes, property taxes (including those paid by your landlord on your behalf if you rent), sales taxes, permitting fees, parking taxes, telecommunication taxes, airport taxes, gas taxes, capital gains taxes/alternative minimum taxes (both of these maybe included in above, though), sin taxes, luxury taxes, state and local fees, among many, many others. 

With states in desperate need of funds, many new fees and taxes are on the way, along with increases in the rates of many.

Further, the explanation starts off talking about how the U.S. tax system is a “progressive tax system,” which is misleading as well.  The Federal Income Tax is “progressive,” where 97+% of the Federal Income Tax revenue comes from those earning greater than the average income, while most of the rest is “regressive” . . . meaning it impacts poor people disproportionately more than people with higher incomes. 

All-in, the average American pays out 40 cents for every dollar earned to taxes.  The benefits are widely dispersed, with the average person above the poverty line spending $1.70 for ever $1.00 they earn, while that figure is $0.70 for every $1.00 earned for those above the poverty line.

No one likes to pay taxes, of course.  When asked in surveys, every income level feels it is overtaxed or taxed enough.  Many groups feel other groups are not carrying enough of the burden, but everyone feels that increased needs for tax revenues should be paid by someone else; and most everyone seems to be quite clear that it should NOT be them.

That’s what makes the following fact most troubling.  What’s not counted in any of the above taxes is your share of the estimated $80 trillion in unfunded promises made by the U.S. government for which there is no plan as to how to raise that money.  It includes the $13.5 trillion national debt, along with the underfunded Social Security and Medicare funds.  Spread among the populace, that burden comes to $258,000 for every American alive today . . . and that’s what we’d need to have on-hand today to earn enough interest to cover those expenses as they come due.

With everyone already thinking they pay enough taxes . . . with everyone planning their futures based on keeping what they make now and having the retirement income and healthcare benefits of today’s retirees, who’s going to shoulder this huge (and growing) burden?

Hope . . . Nationalized

Between innings at Washington Nationals home baseball games, there’s a mid-game tradition:  a contest where large puppets of the four Mount Rushmore presidents, Washington, Jefferson, Lincoln and Teddy Roosevelt, race along the edge of the field. 

The race is fixed, of course.  Three of the presidents take turns winning, but the Roosevelt puppet never wins.  It’s supposed to be cute and funny.  But, to me, it isn’t.  To me, it’s a reminder of a big mistake which baseball made and it’s a metaphor what’s wrong with Washington D.C.

You see, the Nationals are like Teddy Roosevelt.  They always lose.  They’ve finished in or near last place every year since arriving in the nation’s capital in 2005—the last two of which include 100+ loss seasons, a hallmark of futility in sports. 

Today is opening day.  The Phillies played the Nationals beat them handedly, 11-1.  The fans were very loud in their support of Phillies, cheering their new pitcher, Roy Halladay and singing “nah-nah-nah-nah, nah-nah-nah-nah, hey-hey-hey, good-bye,” to Nationals’ pitcher, John Lannan, as he was pulled from the game. 

The only problem is that all of the noise is coming from the visiting fans–because the game is being played in D.C.  That’s right, the Nationals can’t even draw a quorum of its own fans on Opening Day—the day when every team still has hope.  Only the Nationals have no such hope. 

Unfortunately, I’m a Washington Nationals’ fan.  Actually, I’m a Montreal Expos’ fan.  But around 2000, Major League Baseball made a deal to sell the Boston Red Sox to the owner of the Florida Marlins and then in-turn sell the Florida Marlins to the owner of the Montreal Expos, so that MLB could buy the Montreal Expos.  It has been suggested by many that the U.S. Congress wanted a baseball team back in Washington, and this is how MLB appeased Congress, so that MLB could stay in good favors with the U.S. government, who provide MLB with exemptions from a lot of laws, including antitrust laws. 

MLB put on a show to offer the Expos to many ownership groups in many cities, including:  Las Vegas, Portland (Oregon) and one in northern Virginia.  But the sale took several years, just long enough to allow a constituency from Washington to get their act together, then just long enough to get D.C.’s city council to overcome several rejections before they compromised just enough to pay for the stadium to be built, at a substantial loss to D.C. taxpayers. 

The Expos were “nationalized”, both figuratively and literally.

And they’ve suffered the same fate as Amtrak, Fannie Mae, Freddie Mac and GM—they’re all failures.

So, what have we gotten for all of the trouble? The people of D.C. spent several hundred million dollars to build a below-average stadium which attracts more visiting fans, than fans of the Nationals.  MLB delivered the worst team in baseball.  And I lost my team.

In years of watching political favors traded and honest business forsaken, none of this is a surprise. 

It’s failure.  It’s what you always get when you try to force outcomes and please everyone. 

And it’s what you get in Washington.

A Message Lost In The Noise

There’s been so much talk of late about the Tea Party.  However, as is the customary practice of the mainstream media, the talk has largely been around the tactics and not the underlying message. 

Now, I’m a firm believer that violence and hyperbole only go to weaken your point.  I think that the Tea Party members who’ve resorted to such behaviors should be treated as we would anyone else:  ignored when they say something stupid and punished when they violate the Rule of Law. 

That, then, leaves us with the underlying message.  From what I’ve seen, it’s got a basic set of principles, but then fractures quickly from there.  The basic message is that government should be smaller and less intrusive, but should protect us.  I can get on board with that, but only to a point—the point where the protecting us part causes the government to be larger and more intrusive on us and others, without a large and direct threat.  

It’s this contradiction that causes me to believe that the Tea Party can easily be co-opted by the Republican Party, a process which is already well underway. 

My local Tea Party hosted a meeting of candidates for the Congressional seat in my district.  The 11-term incumbent, a Democrat with a straight party line voting record, didn’t show.  But three Republican wannabes did attend.  An empty seat was left on stage to represent the missing.  From records of the event, it’s clear that the candidates exchanged their nuanced Republican views spun, er, I mean tailored to the Tea Party audience—painting the Democrat as the enemy, without addressing the conflicts of their own message with that of the Tea Party’s basic principles. 

Here are some of those points, spun, er, I mean tailored from my perspective:

• subsidizing businesses and individuals in an attempt to steer markets and economic activity,
• force projection in support of the military industrial complex,
• lower taxes, without actually controlling spending in entitlements or defense, and
• legislating family and religious values.

The distance one needs to travel to morph those Neoconservative principles to that of a smaller, less intrusive government involves crossing a giant chasm . . . without a bridge.  Yet, very few seem to be focused on this.  Within the Tea Party movement, some might be.  However, given the efforts by the organizers of the Tea Party to court Republicans, like Sarah Palin or the three within my district, it becomes obvious that the Tea Party’s message is morphing into that of the Neoconservative’s.

I believe that if the Tea Party members were really interested in pursuing the basic goal, they’d look at what impediments exist to achieving the goal.  Both parties have been pursuing larger, more intrusive government.  How can the Tea Party address the real problems, without stepping outside of the existing framework?

I believe that if more of us were focused on the underlying message rather than on the silly and stupid tactics of what I believe are a few, the hypocrisy would be painfully clear.  If the media and the public at large asked pertinent questions, Tea Party organizers and members might be forced to focus on erasing the hypocrisy in pursuit of the core principle.

As it’s becoming, the Tea Party is set to be a loud voice within the Republican Party to reduce discretionary spending and lower taxes.  But, it is also going to be an advocate of increased defense spending and keeping us on our course of driving entitlements off of the onrushing cliff.  

In short, the math just doesn’t work. 

The hypocrisy creates the failure in achieving the principle.  But, who can discover that, when the message is lost in the noise?

Less Is More

The Washington Post reported, this morning:

As firms begin to disclose last year’s bonuses ahead of annual shareholder meetings, it is becoming clear that companies across a wide range of industries are paying executives in ways that officials worry will not discourage the kind of excessive short-term risk-taking that led to the financial crisis. 

The Treasury Department said it is not looking to limit the total pay executives receive. Kenneth R. Feinberg, President Obama’s special master for compensation, wants to change pay incentives, giving executives a greater stake in the long-term performance of their firms. That would mean, for example, smaller up-front cash salaries and fewer perks, more compensation in the form of company stock and a longer wait to receive it. 

“I see no indication whatsoever that the business community is paying any attention to the administration’s suggestions,” said Nell Minow, co-founder of the Corporate Library, an independent corporate governance research firm. “On the contrary, I think pay is worse this year than it’s ever been.” 

So, Ms. Minow is worried “that the business community isn’t listening to the administration’s suggestions.”

What Ms. Minow doesn’t seem to understand is that those in the business community pay attention to ALL of the incentives and weighs them accordingly.  The President’s political goals are of interest only to the extent that they represent perceived opportunities or threats to maximizing outcomes for CEO’s, their customers and their shareholders.

Included in those incentives are:

• the likelihood of bailouts for them or competitors if businesses fails
• the likelihood that more regulation or subsidies will help competitors and hurt them
• the cost/benefit of lobbying for more regulations or rule changes or subsidies for themselves . . . with costs including being beholden to politicians when they want something down the road
• the likelihood that more laws will make it harder to employ people at market rates in order to get products/services to customers at a competitive price
• anticipation of when the substantial increases in taxes will come to pay for all of the growth in government and whether it makes sense to suck resources out now, versus invest in an increasingly uncertain future

. . . and that’s on top of the already very difficult problems a CEO has in satisfying customers better than competitors.  

Right now, Congress and the President are trying to (re)write as many laws and regulations and spend as much money as possible, before the bill arrives in the form of curbs on the ability to borrow at these cheap rates.  Yet, the Administration is critical of what they perceive as the very same behaviors in CEOs, who are trying to rig compensation to hold  on to the bird in the hand, before all the new taxes and regulations scare away the two in the bush.  I’m not certain that the second is actaully happening, but the irony given the first requires that the hypocrisy be identified.

Other than scoring cheap political points or pretending to address the mythical bogeyman of “preventing another crisis”, if customers and shareholders get satisfied, why do politicians care what CEOs take home pay is?  Why aren’t shareholders left to make that call?

If the President and Congress really cared about maximizing outcomes, and not doing favors for their friends and growing their own budgets, they’d curb spending to relieve the tax burden on businesses (which just pass such burdens onto customers and employees, anyway—whereby everybody loses when jobs are lost or commerce doesn’t get transacted).  They’d also leave businesses alone to satisfy customers’ demands, change shareholder laws which prevent them from having a fair say in how the business is run and turn away businesses’ and other special interests’ cries for favoritism.

As the old saying goes, ‘less is more.’

Labor’s Expensive, That’s Why Productivity Equals Prosperity

A friend asked why people costs are the most expensive costs in a business.  As an example of why it’s so confusing, he said/asked:

Accountants as a profession have existed spanning centuries.  In the present, technology has sped up the process thus able to handle more client accounts.   But the costs of said accountant continues to rise.  Why?

My response:

Other than, say, land, some would say that labor is the only expense, at the end of the day. It takes labor or labor-saving devices (which are designed/built by labor or other labor-saving devices) to harvest the raw materials, move them, convert them into products, then market them and put them to consumers . . . as well as manage and administer the process.  And the logic then follows that the key to our prosperity is dependent on how productive that labor is:  how much more output can you get from the same labor?  Productivity comes from specialization, mechanization and trading with others who are more effecient than we are in other areas.

Regarding how expensive it is . . . as with most such things, it depends on supply and demand. 

Accountants’ jobs have changed dramatically over the centuries.  There are sooooo many factors, one can hardly know but a few. Technology is just one.  The product of accountants is information.  Better information yields better decisions.  Better decisions yields growth.  Growth yields the need for more information. Growth also yields competition.  Competition requires more specialization in order to compete.  More specialization creates more opportunity for more businesses to rise.  Then, the cycle repeats.

As a proportion, there are fewer dollars of accountant wages in the price of products than there ever were, so the yield from each accountant hour is greater.  That, coupled with the complexities involved are why accountants can charge more–they generate more value.

Another factor is the accreditation required.  The requirements to become a CPA are tougher than they’ve ever been (although the bar hasn’t been raised as quickly as it has in other fields–teaching being one).  Guilds such as the AICPA have always increased pricing through barriers to entry.

Further, we’ve created artificial complexities.  The tax code, after being somewhat simplified in 1986, has become very dense again as our politicians hand-out favors and conduct social experiments with the tax code.  The SEC’s requirements had 10-K annual reports at about 19 pages in 1970 . . . now they’re hundreds of pages, even for small businesses.  There are also many more complexities in how businesses are allowed to be structured, which has created the need for more expertise.

There are many, many other factors.

In short, it’s complicated.