VeraSage

Best Books 2011

Ron Baker - 02/01/2012

Reading business books is tedious, as former management consultant Martin Kihn reminds us:

Business books are boring. They are bloated compendiums of half-baked ideas committed in fourth grade prose. Their purpose is to transform a commonsense concept or two into a consulting career through the catalyst of hollow jargon.

If you’re over reading business books, here are my ten favorite books from 2011, which I thoroughly enjoyed.

Steven Levitt and Stephen Dubner. Super Freakonomics.

An enhanced version of the hardback book. It does contain more information, much of it quite interesting. If you read the original hardcover, though, this one is probably not needed, but still a fun read.

William J. Bernstein. The Birth of Plenty.

I enjoyed this book immensely; it is a tour de force of history, economic growth, and the importance of institutions.

The author, a Medical Doctor, has truly done his homework. His question is simple: Why did economic growth explode when it did (1820)? Until 1820, per capita economic growth was near zero. He concludes it’s not geography, climate, exposure to microbiological agents (as Jared Diamond has argued in his books), but rather four factors:

1. Property rights
2. Scientific rationalism (positing and falsifying theories)
3. Capital markets
4. Improvements in transportation and communication
   

Which of the four is most important? All of them are like ingredients to a cake, all are equally important to produce a just dessert.

It’s not physical objects (materialism) that matters, but rather institutions. Yet here I believe the author doesn’t go deep enough. What about Human Capital, and not formal education, but attitudes, entrepreneurship, linguistics, and faith in the future? I think Deirdre McCloskey is closer to the answer with her book series on Bourgeois Virtues.

Also, the importance of trust in expanding the number of strangers we can deal with is critical to free markets.

And yet for all it’s virtues, there are major points where I disagree vigorously with this author.

He claims that government needs to regulate the stock market to prevent accounting scandals, fraud, and protect investors. He should read George Stigler’s work on why the SEC is ineffective.

We’ll never reach perfection, nor zero fraud, nor is riskless risk an option. He points out market failure but never discusses government failure. In the real world intentions don’t matter; results do.

He does the same with the Great Depression, without ever mentioning the recent economic research that shows the government and New Deal policies prolonged and deepened the Great Depression.

He claims that income and wealth inequality rises during periods of rapid industrialization as a few prosper at the expense of the rest of society. Yet this is zero-sum thinking, and it’s economically illiterate.

He’s a “gapologist” who believes inequality matters. But relative inequality is another word for envy. What matters is absolute poverty. I rather be poor anywhere in the world today than 200 years ago.

Nor does he seem to realize the poorest people are not the same people over time—we do have tremendous mobility in the USA and other free market economies. He’s read Thomas Sowell on history, he should read his work on income and wealth inequality.

But the only known antidote to poverty is wealth, and while this book is an exploration of how wealth is created, the author seems to revert to the socialist idea of redistribution rather than creation.

He also pulls out the old canard about CEO pay, again so what? It’s not his money, and if it is, sell your stock if you think Apple pays Steve Jobs too much.

The author states near the end that property rights are expensive to enforce. So what? This is one of major reasons we have government, so the price is worth paying.

The book rarely uses the word freedom and liberty, except in the discussion about property rights. But the author seems to be too enthusiastic to suspend these rights in his quest to close the inequality gap.

As long as you are grounded in the works of Thomas Sowell and George Gilder, read this book for a great historical tour, but ignore his conclusions for a better ordering of the universe. He’s off the mark too often.

Top Choice: Kevin Williamson. The Politically Incorrect Guide to Socialism.

This is a fantastic book! It is well written, irreverent in places, and an excellent historical tour of the failures of socialism and communism.

Kevin Williamson is an editor at National Review. He begins by defining socialism, and not as the “ownership of the means of production” but by two factors:

1. Public provision of non-public goods; and
2. Economic central planning.
   

Even a mixed economy like the USA can have pockets of socialism—public schools, Medicare, Obamacare, Social Security, etc.—just like communist/socialist countries can have pockets of free markets.

There is a learned discussion of the enormous difference between the Labor Theory of Value and the Subjective Theory of Value, and the importance of the role of prices.

Williamson devotes a chapter each to debunking the socialist paradises of India, Sweden, North Korea, and Venezuela, and one on why socialism is really bad for the environment (the ten dirtiest cities in the world are all in socialist or former socialist countries).

If you think the BP oil spill was bad, it’s nothing compared to a government run company that takes zero responsibility and pays no damages to injured parties.

I also loved how he lambasts the idea of “US energy independence,” a centrally planned socialist dream if there ever was one. Why should we be independent with respect to energy? This is the road to poverty, not wealth.

He even does an excellent job at explaining why mark-to-market accounting is so wrong, and how it contributed to the Great Recession of 2008. This is because GAAP cannot predict value into the future, but rather only record it after a transaction has taken place.

I highly recommend this work, and it makes me want to read other books in the series.

Top Choice: Guy Sorman. Economics Does Not Lie.

What’s scarcer than bird crap in a cuckoo clock? A French intellectual who champions the free market. This is an excellent book, well written and researched, on how societies create wealth and how economics leads the way.

The enemy of human development is bad economic policies. Since the 1980s, 800 million people have escaped mass poverty, especially in China and India. The book is a wonderful exploration of how wealth is created, and the author believes in the premise of explaining wealth, not poverty (which is rare in circles other than economics).

He devotes an entire chapter to Paul Romer’s New Growth Theory and the necessity of ideas. And while economists know how to create wealth and avoid poverty, they cannot guarantee prosperity for any one individual anymore than a doctor can heal every patient.

The author favors globalization, and cites the leading economic thinkers who defend it as one of the most effective ways for countries to escape poverty.

Just look at the countries that were isolated (USSR, China, India) and how they only escaped by opening up to trade. Look at the countries that remain isolated to see how the alternative works (North Korea).

The author rightly points out that the Chinese Yuan has become a scapegoat for outdated US companies, and how China’s prosperity depends on US consumers.

It never made sense to me why we fear China, India, or indeed any other country, becoming rich. If China invents the cure for cancer, aren’t we all better off even though we didn’t get the jobs?

The author devotes a section to the limits of rationality, and discusses behavioral economics. As for the argument that behavioral economics will lead to statism, he argues that this is unfair to the theory since it also accounts for the irrationality of government actors (as does Public Choice Theory).

There’s a chapter on the Asian Tigers, India, and Brazil. Another chapter explains why China’s capitalism is not a third way, but rather the result of capitalism being highly diverse and capable of handling many types of regimes—from Hitler and Pinochet to Francos.

Another chapter looks at Europe and the USA, with some very interesting insights on which is declining. Another looks at the setting sun of Japan, and another asks if the Greenhouse Effect will leave us broke? The answer is no.

The author even explains why the Kyoto protocols aren’t working in Europe; because you cannot create a market by decree.

The only disagreements I have with this author are minor: his claim that diversity in universities create better business managers is more conventional than wisdom, and his views on why insider trading laws are necessary. But these are minor quibbles.

His concluding chapter lays out a synthesis of the findings of economics into 10 propositions, a consensus, if you will, among economists:

1. The market economy is the most efficient of all economic systems.
2. Free trade helps economic development.
3. Good institutions help development.
4. The best measure of a good economy is its growth.
5. Creative destruction is the engine of economic growth.
6. Monetary stability, too, is necessary for growth; inflation is always harmful (this last point is debatable).
7. Unemployment among unskilled workers is largely determined by how much labor costs (why Europe’s labor markets are so rigid—it’s expensive to fire).
8. While the welfare state is necessary in some form, it isn’t always effective.
9. The creation of complex financial markets, despite excesses, has brought about economic progress.
10. Competition is usually desirable.
    

This is a refreshing, optimistic book. Coming from a French intellectual—in the mold of another Frenchman who understood capitalism, Jean-Francois Revel—makes it that much more pleasant. Highly recommended.

Donald Luskin and Andrew Greta. I am John Galt.

This is an innovative book, and the authors have really done their homework on Ayn Rand.

They compare the heroes and villains from her novel, Atlas Shrugged, to real-life people from today, drawing some interesting parallels, while demonstrating how prescient some of Rand’s fictional scenarios have turned into ugly reality.

Some of the heroes: Steve Jobs; Bill Gates; John Allison, of BB&T, the 12th largest bank built on Objectivism principles, and a bank that refuses to loan to developers who seize property through eminent domain; TJ Rodgers of Cypress Semiconductor and an outspoken capitalist; and the last chapter is devoted to Milton Friedman, the Champion of Liberty, even though Rand had some disagreements with his views.

The villains are also interesting: Paul Krugman—the one author, Donald Luskin, actually founded the Krugman Truth Squad blog, whose purpose was to debunk his NYT editorials with facts, evidence, and the truth; Barney Frank is exposed for his major role in the housing crisis, which is also covered in depth and brilliantly in this work; and Angelo Mozilo from Countrywide Mortgage fame for his role is sub-prime lending, illustrating the perils of moral hazard created by government entities Fannie and Freddie.

If you’re a Rand fan, you’ll enjoy the parallels to her books, as well as the chapter on Alan Greenspan ("The Sellout"), who was a Randian insider, and to this day believes in her philosophy. A good, cogent read.

Todd Buchholz. Rush.

In the spirit of The Rational Optimist, Todd Buchholz has written an uplifting book. He makes the very counterintuitive claim that happiness comes from us rushing around.

There’s no evidence that cutting out the frenzy in our lives would make us happier. In 1900, the average life expectancy was 47; today it’s fast approaching 80. Could it be that competition and stress actually extend life?

Buchholz cites a lot evidence—from all fields—that they do. He takes on the “Edenists” who believe we are all on a hedonic treadmill. But it’s not envy, greed, or keeping up with the Smith’s that keeps us rushing around. It’s the drive to improve ourselves, create, build, and earn our keep.

Why else would anyone attend college, take the Bar, or CPA exam?

This drive is encoded into our genetic nature. Aristotle believed in cultivating good habits, and the very term “second nature” recognizes we have a first, while holding out hope it can be changed.

What separates humans from animals is our ability to create for the future; indeed, Buchholz says we spend 12% of our time thinking about the future. Personal control predicts happiness much better than income.

Why aren’t you happy is the wrong question. Social scientists ask the wrong question a lot: like, what are the root causes of poverty? (rather than what creates wealth?), or why do bad things happen to good people? (why don’t bad things happen all the time?).

I also love Buchholz’s discussion on how an advanced economy relies on transactions among strangers. It’s strangers, not neighbors or a village, that creates wealth. Commerce fosters the Rule of Repeats, which turns strangers into partners (think of how your life is the hands of an airline pilot).

This is the virtue of a competitive economic system. Reputation counts:

Trusting someone we have just met—or even more astounding, trusting someone we will never see face-to-face—that is the trick to moving from mud huts to prosperity. ...It requires more flexible brain patterns. We are a face-to-face species.

He also discusses the Industrial Revolution, saying perhaps it should be called the Industrious Revolution.

Also, even though GDP is a flawed measurement, happiness measurements are worse. At least GDP shows a strong correlation with longer life, higher IQs, more charity, and less crime.

Buchholz also debunks the Emotional Intelligence and self-esteem fads. He even takes on Dan Ariely’s work along with behavioral economics. Relying on young people, in contrived laboratory experiments, has major biological flaws.

But what he wants the Edenists to answer is when should we stop moving forward. 1776? 1900? If so, we wouldn’t have airplanes and polio vaccines.

Without the Twentieth century’s progress, we’d all be watching television by candlelight, according to Milton Berle.

The philosopher Kierkegaard called anxiety the dizziness of freedom. If everything is stress, then the only answer is Timothy Leary’s “turn on, tune in, drop out.”

Surely that’s not the answer. We are fine-tuned for adaptation and survival, much less so for happiness.

Yet we try, even though it’s elusive. The stress, competition, and struggle is what keeps us all going. On balance, it’s all good.

Top Choice: Thomas Sowell. The Thomas Sowell Reader.

As usual, brilliant!

Paul Johnson. Humorists.

This is the fourth book in Paul Johnson’s excellent series; the first three being Intellectuals, Creators, and Heroes (all reviewed on my Shelfari shelf).

He starts by stating that comics are probably the most valuable of the four, as the world is a “vale of tears,” and the central force that creates laughter is chaos, contemplated in safety.

As with any Johnson work, this book is full of interesting historical facts, and no one profiles historical figures better than he does.

We learn that both Karl Marx and Jeremy Bentham thought punning was beneath them, the latter calling it “an atrocity.”

Where else would you learn that Field Marshall Helmuth von Moltke, the leading nineteenth-century Prussian strategist, laughed only twice: once when told that a certain French fortress was impregnable, and once when his mother-in-law died.

Also that the catch-phrase was invented in the 18th century. His first profile is Hogarth, then Ben Franklin, who invented the one-liner in Poor Richard’s Almanac, and maybe even the term “smart aleck.”

We learn that Charles Dickens used to write a paragraph, stand up and act out the scene, including facial expressions, in a mirror. Not very efficient; but highly effective.

Reason itself is a matter of faith, which is why “poets do not go mad—but chess-players do.” See Bobby Fisher. Maybe this is how House, M.D. will meet his end?

Damon Runyon is profiled, as is, of course, W.C. Fields, who along with J. Edgar Hoover hated Eleanor Roosevelt.

Fields was full of one-liners, “Women are like elephants. I like to look at them but I don’t want to own one.” Mae West is also mentioned, along with one of her favorite jokes: “She was Snow White, but she drifted.”

Charlie Chaplin comes in for some criticism, his biggest moral failure being he never criticized communism. His most famous movie, Modern Times, was an attack on industrial capitalism, but the movie was banned in Nazi Germany and Fascist Italy.

Laurel Hardy and the Marx Brothers are included, with some great one-liners from Groucho: “I never forget a face but I’ll make an exception in your case.” “I’ve been around so long I can remember Doris Day before she became a virgin.”

The book ends on a note of pessimism on the state of humor. Johnson points out that over the last generation Political Correctness has created “hate terms” and allegations of “racism,” creating the most comprehensive system of censorship since the days of Hitler and Stalin.

He writes:

The future of humorists thus looks bleak, at the time I write this. The ordinary people like jokes, often crude ones, as George Orwell pointed out in his perceptive essay on rude seaside picture postcards.

Let’s hope that our comedians are braver than the forces of PC, for the only line drawn in humor should be whether or not the joke is funny. Would you agree, Greg Kyte?

Mark Steyn. After America.

Mark Steyn is one of my favorite writers. Not only does he provide brilliant commentary, he does it with an acerbic wit that’s a joy to read.

His column in National Review, and blog, are must-reads. His latest book is a force to be reckoned with.

Using the acronym ARMAGEDDON to arrange the book, Steyn touches on the world’s woes.

Here’s what it stands for: Addiction; Redistribution; Monopoly (i.e., government); Arteriosclerosis; Global Retreat; Engineering; Decay; Disintegration; Open Season; and Nukes Away.

Steyn offers excellent analysis of: Europe’s idiocy; cultural decline; demographic decline (the future belongs to those who show up for it); how debt is a moral issue, not an economic issue; the strangulation of the human spirit from government regulation and Nannyism (big government makes small citizens); the failure of Keynesian economics’ the self-deluding self-esteem movement; and of course, PC lunacy.

He thinks the USA’s inability to replace the World Trade Center after a decade is a shame, noting that the Empire State Building was built in 18 months during the Great Depression.

Today, you couldn’t build the Hoover Dam, and even if you did, it would be shut down for not being wheel chair accessible.

That’s not to say I agree with everything he writes. He seems to believe in “manufacturism” and the materialist fallacy, since he cites the Boeing 747, Concorde, and the Moon Landing as the era when human capability peaked (1965-1975).

This ignores Google, Apple, and a host of other advances since then.

I find Matt Ridley’s The Rational Optimist far more compelling on why our future will be better.

Steyn also seems to believe that buying a house is the surest route to wealth for most Americans. But surely human capital is far more important, which he recognizes when he chastises China for destroying so much of it.

He also uses the line “They have our souls who have our bonds.” But this is debatable. What does it mean that China buys our debt? Is that a sign of weakness or strength?

Nevertheless, you will LOL at many places in this book. Steyn is incredibly entertaining, probably more so Than PJ O’Rourke. This is well worth reading, and pondering. It will, no doubt, change your mind on a variety of issues.

Mark Kramer, et. al. The Black Book of Communism.

This is a somber, but critically important, book. It sets out to answer the question, Why?

Why did communism exterminate its enemies. Why was it bloody no matter where it was implemented? It claimed it needed to break eggs—and it did, to the tune of about 100 million deaths—to make an omelet. But there was never an omelet.

Why did it inspire other nations, whereas the French Revolution never did (all communist nations were linked by an umbilical cord to the Soviet womb)?

Why was there no Nuremberg trial, no stigma, no accounting for the massive crimes of this regime?

Why was there never a “benign” period in the evolution of communist regimes? All were bloody form the start.

The Tsarists, between 1825-1917, committed 3,932 deaths. This number was surpassed by the Bolsheviks in four months.

Communism didn’t just commit criminal acts; it was a criminal enterprise.

Whereas Nazis killed based on race and territory, communism murdered based on class.

All I could think of as I read this work was Stalin’s memorable line: “One death is a tragedy; one million is a statistic.” The death toll is almost unbelievable:

• USSR = 20 million
• China = 65 million
• Vietnam = 1 million
• North Korea = 2 million
• Cambodia = 2 million
• Eastern Europe = 1 million
• Latin America = 150,000
• Africa = 1.7 million
• Afghanistan = 1.5 million
• International Communist movement not in power = 10,000
  

This approaches 100 million deaths. By (gruesome) comparison, Nazism murdered about 25 million.

Yet the French government’s National Lottery actually used an image of Stalin and Mao in an advertising campaign. Could you imagine if some enterprise dare used Hitler or Goebbels? At least Nazis were made to account for their crimes.

The book catalogs the crimes of the USSR, from the Red Terror, Great Terror, Great Famine, collectivization and dekulakization, The Gulag, the Katyn massacre, up to Khrushchev’s Secret Speech.

In chapters, it explores communism around the world: Spain, Poland, communism and terrorism, Central and Southeast Europe, China, North Korea, Vietnam and Laos, Cambodia, Latin America, including Cuba and Nicaragua, Africa, and Afghanistan.

What also makes this book amazing is that the authors are a group of French scholars, many of whom were actually supporters of communism at one time, but now are rethinking that position.

This has not made them popular with their left-wing friends, but as they say, they have to go where the truth leads them.

I’m not sure this book answers the question as to why. Maybe there is no answer, excepts man’s unbelievable capacity for cruelty in the quest for Utopia.

No one can read this book and walk away without feeling an incredible hatred for not only a bad idea (communism) but also the ruthlessness of the people who acted in its name.

This is a heavy book, and it is a bit dated (1999), since more research is coming out everyday from the opening of archives in the former Soviet Union. However, it is one volume that chronicles, in graphic detail, the murderous regimes and should be read by anyone interested in the history of ideas.

Economics in One Game

Ed Kless - 09/19/2011

Earlier this month I spoke to the Allen Area Patriots, a local Tea-Party related group with the goal of making basic economics more understandable to we (myself included) non-economists. The title of the presentation is Economics Made Simple.

This is an extended version of the material that Ron and I use during the Firm of the Future Symposium.

Now, thanks to Bryan McAninch, chair of the Collin County Libertarian Party, the presentation is available for viewing on youtube.

Part 2 of 7 is mostly the game and can be skipped without losing any major content.

For those interested I also created a follow-up reference guide as a post which includes the slides and links to source materials.

ET HORA LIBELLUM DELENDA EST

Digital Electric Meters and the Future of Energy Pricing

Ed Kless - 09/01/2011

In the not too distant future, many of us will have the option of switch from our standard analog energy meters to digital ones. Along with this will come the ability (depending on the level of deregulation in your area) to purchase energy in different ways.

For example, you will be able to control the energy usage of major appliances such as air conditioners, washers, dryers, etc. This will allow you to load balance your electrical usage. You will be able to set a budget for say your air conditioner. When the price of electricity goes up, the thermostat will automatically rise so you do not spend as much.

Even better, if and when battery technology improves, you will be able to purchase more energy in the evenings at a lower price and store it for use during the day when prices are higher. It is very cool stuff.

One possible additional benefit will be to allow you to purchase you electrical energy from different sources, or at least from different plans based on provider. This would mean that you could buy a “green plan” which will tell your provider to purchase more from green or alternative sources on the grid. Cool huh?

Now, what if I told you that these green plans will cost two to three times the traditional plan. Would you opt for the green plan? Why or why not?

Thank Fidel for Amazon

Ron Baker - 08/30/2011

Mike Bezos was 15 years old when he escaped from Cuba and fled to the USA, working his way through the Univ of Albuquerque.

He gave his stepson, Jeff, a 1988 Chevy Blazer, and while Jeff’s wife Mackenzie drove across the country to Seattle, Jeff typed up the business plan for Amazon.

Not bad for a first generation immigrant. Thank Fidel for Amazon!

I remember George Gilder writing that Fidel wanted to create the world’s greatest city in Cuba, so he expropriated all of the physical capital, suffering from the “physical fallacy"—the idea that wealth resides in tangible things.

Fidel did create a great city—in Miami—since the most important capital fled.

Profit is an index of altruism

Ron Baker - 08/29/2011

Because George Gilder believed (and wrote) the following, Ayn Rand denounced him.

The moral code of capitalism is the essential altruism of enterprise. The most successful gifts are the most profitable—that is, gifts that are worth much more to the recipient than to the donor. The most successful givers, therefore, are the most altruistic—the most responsive to the desires of others.

The circle of giving (the profits of the economy) will grow as long as the gifts are consistently valued more by the receivers than by the givers. A gift is defined not by the absence of ANY return, but by the absence of a PREDETERMINED return. Unlike socialist investments, investments under capitalism are analogous to gifts, in that the returns are not preordained and depend for success entirely on understanding the needs of others. Profit thus emerges as an index of the altruism of a product.

Rand despised altruism, but I believe Gilder is right.

The most profound thing I have ever read on the morality of capitalism is Gilder’s ”Soul of Silicon” speech delivered to the Vatican in May 1997. It’s not a light read, but well worth the investment.

The Diamond Planet

Ed Kless - 08/29/2011

A recent cosmological discovery got me thinking once again about the what George Gilder and others term the materialist fallacy. From a Reuters report from last Thursday:

Astronomers have spotted an exotic planet that seems to be made of diamond racing around a tiny star in our galactic backyard.

The new planet is far denser than any other known so far and consists largely of carbon. Because it is so dense, scientists calculate the carbon must be crystalline, so a large part of this strange world will effectively be diamond.

Materialists, including many of my Libertarian friends who favor a return to the gold standard, will have to conclude:

• This planet is more wealthy than we are. After all it is a diamond with the mass Jupiter. 
• We would be better off if this heavenly body were to break free of its orbit and be sent on a path to impact (or maybe just orbit) the Earth. Perhaps T. Boone Pickens and DeBeers can concoct a plan to (as they say in the Beltway) “effort” this. 
• The really good news is that there are likely more of these throughout the galaxy and universe for it is only recently that we as a species have been able to detect these orbs.

This is materialist wealth creation at its finest!

Side note and bonus material:

I am not sure why, but my brain was reminded of this classic Bugs and Daffy cartoon. Enjoy!

Firm of the Future Symposium

Ed Kless - 06/08/2011

On August 9-10 in San Francisco, Ron Baker and I will once again be presenting our Firm of the Future Symposium sponsored by Sage North America.

This symposium will be dedicated to the possibility that a professional organization can be run more effectively when it becomes a knowledge firm rather than a service firm. Creating such an organization is hard work and not for everyone as it requires professionals to think differently than they have in the past about what it is that they do.

Objectives

• From a focus on revenue to a focus on profit
• From a focus on capacity to a focus on capital management
• From a focus on efficiency to a focus on effectiveness
• From a focus on cost-plus pricing to a focus on pricing on purpose

Sage (Ed’s employer) has agreed to open a limited number of spots for firms that are not partners of Sage. If you are interested in joining us, please send me an email and I can get you registered. The price is $2,500 per person and comes with a 100 percent money back guarantee!

One of the more interesting stories to emerge from our previous FotFS, was that of Peter Coburn of Commercial Logic. They are publishers of, you guessed it, time and billing software. Peter underwent a conversion of sorts and posted a terrific article on it.

An Economic Theory of Everything

Ed Kless - 06/05/2011

One of my all time favorite TEDTalks is by Rory Sutherland, a principal at the advertising firm Ogilvy. His brilliant analysis was on display again at Zeitgeist 2011.

 

The lessons here are many, but for me key learning is the link between Austrian and Behavioral economics:

• All value is subjective, AND.
• All prices are contextual.

The implications of these two statements together are profound and in my opinion amount to an economic theory of everything.

Book Review: Technology, Management, and Society, by Peter Drucker

Ron Baker - 02/27/2011

Legal Intelligence–an oxymoron

Ed Kless - 02/24/2011

Yesterday, the Wall Street Journal ran what is I believe an annual story on lawyers who bill more than $1,000 per hour.

With the exception of those who list Bankruptcy as their practice area, who I understand are required by the courts to track their time to the tenth of an hour, I submit that this is the list of smartest, but economically ignorant people in the United States.

Here is the “time is money” quote from the article - ”Harvey Miller, a bankruptcy partner at New York-based Weil, Gotshal & Manges, said his firm had an ‘artificial constraint’ limiting top partners’ hourly fee because "$1,000 an hour is a lot of money.”

Yeah, the “artificial constraint” is called the almighty billable hour! At least poor Harvey is a bankruptcy attorney, so maybe he knows better.

On Creativity and Profitability

Ed Kless - 02/03/2011

Matthew Burgess, an attorney at McCullough Robertson in Brisbane, Australia and member of the VeraSage Community, sent me a link to this great example of how creativity can increase profit.

Is this an outlier? Sure, but the point is that we need to increase our creativity even when is comes to the mundane.

This will be added to my power rotation on videos I show during my presentations.

Hourly Billing is a “Shadow Price”

Ron Baker - 12/05/2010

Ok, this is an esoteric post, so feel free to skip it unless you have a mordant interest in what the failure of communism and central planning have in common with hourly billing.

Back in October I read a great book, Red Plenty, by Francis Spufford, British Fellow of the Royal Society and teacher of writing at Goldsmiths College.

The book is all about how the post-Stalin USSR was going to usher in era of prosperity, under the leadership of Nikita Khrushchev, with the magic of the “planned economy” run by apparatchiks, whom Stalin referred to as “The engineers of human souls.”

But how?

Austrian economist Ludwig von Mises argued that a centrally planned economy would never be able to replace market prices since the calculations involved would outstrip the capacity of even supercomputers, let alone fallible human beings.

But there was a group of Soviet economists who argued that a market was nothing more than a mathematical device for allocating goods and services to the highest bidder, which you could reduce entirely into equations—the materialist fallacy, or even, the McKinsey fallacy: What you can measure you can manage.

Karl Marx concurred, arguing that markets were not very important, since they merely reflected the labor that was embedded in commodities.

Oskar Lange, an economist from Warsaw, even argued that the marketplace was a “primitive pre-electronic calculator” that in the age of the vacuum was an anachronism, moving at the speed of “a babushka in a headscarf.”

The problem of capitalism is that it cannot calculate optimum prices for an entire economy at once. Soviet economists believed they could.

But how?

Shadow prices, an idea developed by Leonid Vitalevich Kantorovich (1912-1986), mathematician and economist, who was the USSR’s nearest equivalent to John von Neumann, and the only Soviet economist to win the Nobel Prize for Economics.

Here is how Francis Spufford explains what replaces the subjective value of consumers (pages 164-65):

What we need is a planning system that counts the value of production rather than the quantity. But that, in turn, requires prices that express the value of what’s produced.

The value to whom?

Not just the value to the producer, or even to the consumer, because that only gives you capitalism again, surging to and fro, doing everything by trial and error.

It’s got to be the value to the whole system; the amount it helps with what the whole economy is trying to do in the present plan period. And it turns out that a set of prices exist which will do that.

But—in order to work, they have to be active. They have to keep changing along with the changing possibilities of the economy…

So, in order to get them [we need] one big connected cybernetic system. With software...written by great minds.

So how are these “shadow prices” computed?

Here is how Spufford explains Kantorovich’s concept (page 380):

[Shadow prices]: The multipliers on which Kantorovich’s solution to optimization problems depended.

Essentially, they were opportunity costs: they represented the cost of choosing one particular arrangement of production in terms of the amount of production foregone by choosing it.

Their ideological significance lay in the way that, without making any reference to demand or to markets, Kantorovich had discovered a demand-like logic in the structure of production itself.

In his scheme, it was the volume of planned output that was to be maximized, not the customer’s satisfaction, but he had still introduced the idea that utility of the output to somebody should be the guide to how production was configured.

Sound familiar?

This is the billable hour!

I can’t count how many times I’ve heard that the billable hour is a “market price” since it represents the “opportunity cost” to the firm, as well as being within a band of competitive hourly rates among the competition.

Neither of which has anything whatsoever to do with value to the customer!

Spufford doesn’t refer to his book as a novel, but rather as a Russian fairytale.

One could say the same about the billable hour. It simply has no correlation with value to the customer.

It’s the Trabant of our times, no different than the now-defunct USSR’s shadow prices.

The Efficiency vs. Effectiveness Debate Continues

Ron Baker - 11/26/2010

We here at VeraSage never shy away from folks who disagree with us. We learn more from those who disagree with us rather than those who agree.

Jim Caruso, a CPA colleague, recently left four comments on four different recent posts.

Rather than replying to them individually, I wanted to start a new thread so others could chime in with their experience.

This just goes to show how controversial—and difficult to comprehend—this entire efficiency vs. effectiveness debate truly is for firm leaders.

Here’s Jim’s first comment to my post The Seven Moral Hazards of Measurement:

Ron,

I agree with much of what you wrote and with the general thesis that metrics have dangerous limitations. 

However, I continue to believe that, in general, efficiency cannot possibly be (and does not need to be) completely ignored in order to achieve effectiveness. One sentence in your post that I particularly disagree with is this: “Efficiency and effectiveness cannot be balanced like tires because they are entirely different things.”

Balancing entirely different things is one of the critical success factors for good leadership. CEOs have to balance short-term profitability with longer-term growth initiatives. CPA firms have to balance immediate client service needs with longer-term business development opportunities. Managers need to balance day-to-day urgencies with longer-term improvement initiatives. We all have to balance work priorities with family priorities, or the need for time to ourselves with time for friends and loved ones. The examples are endless.

I reject this premise of balance, Jim. Let’s hear what David Whyte, a corporate poet (and author of many excellent works) has to say in his book The Three Marriages: Reimagining Work, Self and Relationship:

Poets have never used the word balance, for good reason. First of all, it is too obvious and therefore untrustworthy; it is also a deadly boring concept and seems to speak as much to being stuck and immovable, as much as to harmony. There is also the sense of unbalancing that must take place in order to push a person into a new and larger set of circumstances.

My mentor, George Gilder, says this with respect to work/life balance:

One of the things that really makes me laugh is when I hear about the “workaholic.” Workaholics are what the make the world go. Show me a success in any field, and I’ll show you an obsessive. If your life is “balanced” by languid afternoons at the museum, you cannot develop a new business, break an important story, or make a contribution to the world. ...Our task on earth—laboring in the service to others—can only be satisfied thru hard and unbalanced work.

My VeraSage colleague Dan Morris wrote that ”Work-life balance is politically correct for ‘slacker.’” Dan has a point.

This is why management thinker Charles Handy uses the metaphor of a “portfolio life"—putting together a packet of different jobs, customers, and types of work.

He also dismisses the very concept of work-life balance as misleading “because it implies that work and life are two different things.”

Nobody is suggesting that you “completely ignore” efficiency. We aren’t Luddites here at VeraSage.

I am arguing that efficiency is not a competitive advantage since it can be so easily copied by your competition.

In addition, if you employ knowledge workers, efficiency gains will take place in the normal course of experience.

I will be more “efficient” doing my 100th tax return than my first few. If this is not true among knowledge workers, you have made a hiring mistake.

Moreover, measuring the “efficiency” of knowledge workers based upon time spent is meaningless. Was Einstein efficient? How about Paul McCartney, is he efficient? How would you know?

What matters is the results of their output, not the efficiency of the inputs. I don’t care how long it took Jonas Salk to develop the polio vaccine; I’m only glad he did.

But even beyond that Jim, economists have taught us for centuries that there’s no such thing as “generic efficiency.” It all depends on what your objectives are and how much you are willing to spend.

Jim’s next comment was to Ed Kless’s post On Timesheets and Cost Allocation:

Ed,

I am completely on board with the negatives of hourly billing. While I know the VeraSage folks don’t like to talk about “efficiency,” one of the most succinct ways I use to explain to others the folly of hourly billing is that it rewards inefficiency and punishes efficiency (from the service provider’s perspective; from the client’s it’s obviously the opposite). 

But I still cannot see time-tracking being totally irrelevant. You mention target costing, which I agree is the appropriate pricing practice. But how can you plan your time requirements in advance if you have no historical data on how long certain activities take?

I run an outsourcing practice that provides a fully-managed accounting function—what ADP does for payroll, we do for the entire finance function, including the CFO/controller roles for emerging growth companies. If I have no idea how long it takes to do a weekly A/P check run of 50 payments, how can I plan the resource requirement in advance and do target costing? Regarding your comments on project profitability, how can I say “who cares” if over the past year it took a full-time equivalent (FTE) to serve the client while the price I received failed to cover an FTE’s salary?

I will let Ed respond to this in more detail.

But Jim, you have an empirical problem with this line of argument:

There are over 1,000 firms out there that don’t operate with timesheets.

Please don’t argue that it can’t be done. It is being done, and more and more firms are ditching timesheets every single day.

Don’t you think they’ve answered all of your questions with superior methods?

If I were you, rather than arguing that it can’t be done, I would examine how they are doing it (some of their stories our in our Trailblazers section).

When you see empirical evidence that contradicts your world-view, do you change your mind, or do you stay wrong?

Jim’s next comment was on my Modern Measurements post:

Ron,

The Ritz-Carlton example is compelling. However, Ritz-Carlton’s strategic positioning is based upon the type of stellar service you describe and measuring “efficiency” might indeed be counter to that. However, a Super 8 motel might be appropriately concerned with efficiency, as their strategy is based on being a low-cost provider. 

I’ll wager that BOTH chains are concerned with efficiency in certain business processes, such as how many rooms are made up daily by each attendant. In this regard, Ritz-Carlton may have a very different target metric than Super 8, but their respective economic models cannot possibly fail to consider it. The Ritz-Carlton housekeeping staff person might go out of her way to do something special for a guest, but either that will be the exception to the rule and barely move the measurement, or it will be commonplace enough to be part of the historical data and make its way into the future targets. I cannot imagine that Ritz-Carlton would not care if for some reason they had to increase the housekeeping staff by 10% at a certain property because fewer rooms per staff person were being cared for when compared to the corporate-wide averages.

I would wager that the Ritz-Carlton maid is just as efficient as the Super 8 maid over time. So what?

The point is, that Ritz-Carlton is focused on effectiveness.

If you want be the low-cost provider in your sector, more power to you. Wal-Mart and Southwest are very efficient.

However, they are also very effective, otherwise no amount of efficiency would matter.

Again, I cite Peter Drucker from his book, People and Performance:

Efficiency means focus on costs. But the optimizing approach should focus on effectiveness.

Effectiveness focuses on opportunities to produce revenue, to create markets, and to change the economic characteristics of existing products and markets.

It asks not, How do we do this or that better? It asks, Which of the products really produce extraordinary economic results or are capable of producing them?

...It then asks, To what results should, therefore, the resources and efforts of the business be allocated so as to produce extraordinary results rather than the “ordinary” ones which is all efficiency can possibly produce?

This does not deprecate efficiency. Even the healthiest business, the business with the greatest effectiveness, can well die of poor efficiency. But even the most efficient business cannot survive, let alone succeed, if it efficient in doing the wrong things, that is, if it lacks effectiveness. No amount of efficiency would have enabled the manufacturer of buggy whips to survive.

Effectiveness is the foundation of success—efficiency is a minimum condition for survival after success has been achieved.

Efficiency concerns itself with the input of effort into all areas of activity. Effectiveness, however, starts out with the realization that in business, as in any other social organism, 10 or 15 percent of the phenomena—such as products, orders, customers, markets, or people—produce 80 to 90 percent of the results.

The other 85 to 90 percent of the phenomena, no matter how efficiently taken care of, produce nothing but costs (which are always proportionate to transactions, that is, to busy-ness).

A business is an interdependent system, and to argue that by increasing the efficiency of each component (or each hour) is the equivalent of arguing you can build a world-class car with the best parts of a Ferrari, BMW, Porsche and Lamborghini.

You could not; you’d have a pile of very expensive junk, since each car is interdependent, and not simply the sum of its parts.

Jim’s last comment was on my post Wal-Mart Audits?:

[Ron writes]: “Efficiency is no basis for competitive advantage, since your competitors can adopt the same tactics.”

Maybe so, but that doesn’t mean it’s not important. Assuming equal effectiveness (again I believe it’s a balance between the two), if it takes my firm 20 people to handle a portfolio of audits that another firm can handle with 15 people, how can that not be relevant?

Efficiency might not be a competitive advantage, but that doesn’t mean it’s not necessary. The first gas station that installed “pay at the pump” technology had a competitive advantage over the gas station across the street that did not.

So when gas station #2 decides to implement the same technology, it does not give them a competitive advantage; but still they have no choice but to do it, just to stay even and survive.

Which brings up another point. Look again at the statement, “Efficiency is no basis for competitive advantage, since your competitors can adopt the same tactics.”

This can be said about many other tactics that your competitor later copies, such as the gas station example above.

Again, no one is arguing that you not pay attention to efficiency, just that’s it not a competitive advantage.

If your firm takes 20 people rather than 15 for a portfolio of audits maybe it’s because your people are delivering a hire level of customer experience, delivering more value-added services, etc.

If you price it right—meaning your customers are willing to pay for it—having 20 people may be very economically viable, and more profitable.

Excellent customer service is incredibly hard to duplicate, which is why Nordstrom, Ritz-Carlton, Amazon, and Zappos have such effective business models.

They are not obsessed with efficiency, but rather effectiveness.

Jim, I’m afraid you are far too focused on internal metrics at the expense of outputs, results, and value.

You can’t price for 100% efficiency, especially in a knowledge firm such as your.

But it’s true in any business. This is a lesson Ben & Jerry (of ice cream fame) learned early in their career.

It was an epiphany for them, and I hope one day it will be for you.

Those aren’t swans—swans are white

Ron Baker - 10/31/2010

Ask VeraSage: Accounting for Intellectual Capital?

Ron Baker - 07/13/2010

I’ve been having a dialogue with a consultant for the last two years, and we recently had a very interesting discussion on intellectual capital (IC).

I thought you might find it of interest, since IC is what the professional knowledge firm is all about.

Our exchange focused on whether or not it is possible—or even desirable—to attempt to value IC, and perhaps placing that value on the financial statements, or a set of parallel statements.

Doug was not advocating this approach, just questioning the validity of doing it, and what the impact would be. I’ve had many other discussions with consultants and CPAs about, for instance, placing the value of a company’s brand on its balance sheet.

Should we account for IC, like GAAP accounts for transactions? Should IC be on the financial statements?

We both conclude no. Here’s why.

Hi Doug,

We do use IC as an integral part of a professional firm’s business model, which is why we refer to them as Professional Knowledge, not Service, Firms. PKFs sell IC, not time.

As for measuring IC, I find the work of others in that area interesting, and have met my share of firms that offer formulas and frameworks to value IC. All fascinating, but I’m still trying to answer, “What’s the point?”

Some insist they want IC to be put on the firm’s financial statements, which will and can never happen, since accounting is designed to capture value after a transaction, not value it before hand.

You certainly could devise parallel financials for IC, but again, what’s the point? The argument is to force managers to think about it, value it, etc.

But it seems to me that this is the “What you can measure you can manage mentality,” and with IC, effectiveness is always and everywhere more important than efficiency (the latter of which is always a measurement, where the former is always a judgment).

Since value is subjective, any formula or model for IC will be flawed from the get go. Not that it’s not a worthwhile exercise, such as how Interbrand values the world’s leading brands, but it’s the illusion of accuracy and precision. I’ve seen companies pay well over IC value calculations because value is subjective.

So, I come back to what’s the point of this? What’s the service being offering by valuing IC? What’s the value of doing so? I don’t think it’s as obvious as IC folks make it out to be. As you know, I wrote an entire book, Mind Over Matter, on this topic, but didn’t try to value IC—it can’t be done with any reliability.

Thanks Doug, look forward to your thoughts.
Ron

Thanks very much, Ron. 

This is exactly the kind of response I was hoping for—informed and critical. I’m slowly committing Mind Over Matter to memory, so I have deep respect for your opinions. 

I have a lot of skepticism myself. I take your point about accounting being the trail of the past. I have heard the argument that by putting NPVs on assets, is bringing the future into the present, and isn’t it true that IC is exactly about the future, and that is why [we need] a breakthrough in accounting? It is supported by IASB standards on intangible assets and impairment, which also track with FASB standards 38 & 38.

But the IC side intrigues me, because so many people believe there is such a need to recognize (and quantify and monetize) your subtitle (intellectual capital is the chief source of wealth). I think this belief is even more strongly held in the wake of the debacle over people pumping up risky underpinnings (lousy mortgages, among others) into highly leveraged clouds of crap. A wealth creation engine based on human knowledge, experience, relationships, performance, and results seems like a more positive economic foundation. But how to capture, how to harness? 

Thanks again for your quick and thoughtful response. One of these days I’ll buy you a beer, or a glass of your favorite wine

Cheers, and great thanks,

Doug

Hi Doug,
I understand the argument, my problem is knowledge is also a social construct—it simply cannot be quantified, tracked, and put into a formula.

There is certainly value in valuing IC for a business sale, and indeed that is what happens. This is why accountants call the sales price over the book value “goodwill"—just a word that describes their ignorance, i.e., their inability to value an enterprise, only capture it after a transaction takes place.

But even formulas for IC won’t capture the subjective value of an enterprise. How many times have you seen a company pay way above a company’s value, as assessed and computed by business valuators? It happens a lot, and that’s because value is subjective.

And no, I do not think putting NPVs on assets is bringing the future into the present. Accounting can’t do that, and even if there existed formulas, they would be full of errors and inaccuracies.

Here’s another reason: knowledge is actually about the past, whereas entrepreneurism is about the future, and you can’t capture the Black Swans of entrepreneurialism by formulas. No amount of sophisticated IC formula could have predicted, captured, or harnessed eBay or Google. It takes the
risk-taking of entrepreneurs to create new wealth. Anything we can capture, measure and harness is almost by definition about the past that is already dying.

I’ve come to the conclusion that we’ll never be able to measure IC. So what?

We know it’s there—like dark matter in the universe—but there are too many variables. It’s spiritual, not material—meaning you can’t measure it.

To believe otherwise is the materialist fallacy—that everything needs to be measured to be understood. It doesn’t work—see the USSR, Cuba, North Korea and any other communist country.

This doesn’t mean we should ignore IC, only that trying to measure and value it is futile—like plunging a ruler into an oven to determine its temperature. It’s the wrong device.

There’s lots more to say on this topic, but it does make my brain hurt.
Ron

Doug made the final salient point about IC, what Joseph Schumpeter called the Creative Destruction of capitalism:

The key point is that the value does not arise from the accounting of it, however elaborate the accounting scheme might be, but rather in the context of a marketplace that is focused on performance and results, enhanced by a skunkworks generator, etc. 

Would love to hear your opinions on this topic.