Businomics Blog

The Economics of Pricing New Technology: A Gun Story

Read about it on my Forbes.com page: Pricing Technology Breakthroughs: The Glock Lesson.

Benjamin Franklin on Economic Disasterists

I was reading the Declaration of Independents, a really fun read, and they mentioned the autobiography of Benjamin Franklin. I had not read it, but thought maybe I should be familar with it, so I went to the computer and learned that it was available as a free download for Kindle. Sixty second later I had my own copy of Franklin's autobiography, for free, and I reflected on how GDP was not increased, even though my own satisfaction was well increased.

The book is engaging. Here's a great and very relevant passage:

There are croakers in every country, always boding its ruin. Such a one then lived in Philadelphia; a person of note, an elderly man, with a wise look and a very grave manner of speaking; his name was Samuel Mickle. This gentleman, a stranger to me, stopt one day at my door, and asked me if I was the young man who had lately opened a new printing-house. Being answered in the affirmative, he said he was sorry for me, because it was an expensive undertaking, and the expense would be lost; for Philadelphia was a sinking place, the people already half-bankrupts, or near being so; all appearances to the contrary, such as new buildings and the rise of rents, being to his certain knowledge fallacious; for they were, in fact, among the things that would soon ruin us. And he gave me such a detail of misfortunes now existing, or that were soon to exist, that he left me half melancholy.

Had I known him before I engaged in this business, probably I never should have done it. This man continued to live in this decaying place, and to declaim in the same strain, refusing for many years to buy a house there, because all was going to destruction; and at last I had the pleasure of seeing him give five times as much for one as he might have bought it for when he first began his croaking.

Mr. Mickle's descendants continue to be as pessimisic as he. And people of Franklin's energy, honesty and intellect continue to be as successfu.

 

Economic Causes of the Decline of Rome

Will Durant sums it up well:

"The economic causes of Rome's decline have already been stated as prerequisite to the understanding of Diocletioan's reforms; they need only a reminding summary here. The precarious dependence upon provincial grains, the collapse of the slave supply and the latifundia; the deterioration of transport and the perils of trade; the loss of provincial markets to provincial competition; the inability of Italian industry to export the equivalent of Italian imports, and the consequent drain of precious metals to the East; the destructive war between rich and poor; the rising cost of armies, doles, public works, an expanding bureaucracy, and a parasitic court; the depreciation of the currency; the discouragement of ability, and the absorption of investment capital, by confiscatory taxation; the emigration of capital and labor, the strait jacket of serfdom placed upon agriculture, and the caste forced upon industry: all these conspired to sap the material bases of Italian life, until at last the power of Rome was a political ghost surviving its economic death."

Durant is an historian, not an economist, and occasionally his lack of theoretical economic framework hampers his analysis. Generally, though, his conclusions are consistent with the evidence and very convincing.

 

After the discussion of economic causes of the decline, he addresses the political:

"The political causes of decay were rooted in one fact--that increasing despotism destroyed the citizen's civic sense and dried up statesmanship at its source. Powerless to express his political will except by violence, the Roman lost interest in government and became absorbed in his business, his amusements, his legion or his individual salvation."

He notes Gibbon's conclusion that the Christian religion was a cause of the decline of Rome, but responds, "... the growth of Christianity was more an effect than a cause of Rome's decay." He elaborates, but I'll spare you the details.

The careful reader of this blog will note the long periods between my comments based on Durant (Economic Lesson from Ancient Rome in video, Italian Financial Crisis: A.D. 33, and What's Wrong with Egypt's Economy) The book is full of great information, but it's not exactly a page-turner. (And don't ask me how Gibbon is coming.)

If you're looking for an easier explanation of Roman history, try the History of Ancient Rome from the Teaching Company. I'm part way through the audio course, and the lecture is lively and engaging. (And the Teaching Company offers old-fashioned customer service. I called about a cracked CD, they answered the phone on the second ring, and they promptly sent a replacement, at not charge.)

The Future of Books and Libraries--and Education?

Seth Godin has a stunningly useful commentary on books, libraries and librarians.

"The librarian isn't a clerk who happens to work at a library. A librarian is a data hound, a guide, a sherpa and a teacher. The librarian is the interface between reams of data and the untrained but motivated user."

I learned this truth too late in life.  The librarian is not the keeper of the book warehouse, but is a knowledge guide. Let me take it one step further and apply Seth's concept to education.

In the medieval university, books were scarce and expensive, far too scarce to expect every student to buy a half dozen textbooks. So professors lectured. It was a cost-effective way to transmit information.

Today, most professors still lecture. Not just in seminars covering rare information, but in basic courses taught in every college in the world: introduction to economics, first year chemistry, Calculus I, etc. Think about that. There are books covering everything said in the lectures. There are videos of great professors lecturing on the common topics. It's a colossal waste of time for every professor to lecture.

Most anything can be learned by a dedicated person studying on his own. However, most of us do better with some structure, and efficiency calls for a guide to the material and a person to answer questions when we get stuck. That should be the role of the modern professor. Design the body of material to be studied for a particular course. Recommend reading, videos, exercises, problems and projects that will help students. Be available to help students who get stuck. Ask stimulating questions. Promote discussion. Evaluate student performance, and advise on how much progress is being made. The teacher becomes a consultant.

One great teacher, Soo Bong Chae, opened a class I was in with these words: "I am a teacher, but I do not teach. You learn."

It's time for education to step out of the medieval era and heed Seth Godin's words.

 

 

 

The Economics of Cities

Every business leader should understand the role that cities play in economic--and corporate--growth. A good way to get that understanding is Ed Glaeser's new book, The Triumph of Cities.

Glaeser makes the critical point that cities are where people communicate the most. That communication includes:

• Business opportunities ("Fred's company is looking for a new marketing firm.")
• Business methods ("Mary's found a way to re-design her product to reduce waste.")

It's also where many people come to trade. Going to the city means that there will be specilized resources (goods, services, employees) available for purchase, as well as companies and people who may want your highly specialized service. Adam Smith started the Wealth of Nations talking about the wonders of specialization, then explained that the specialization is limited by the size of the market. (Small towns might support a baker and a blacksmith, but not a bookbinder or tool and dye maker.)

McKenzie Quarterly has an interesting set of articles and interactive maps about Global Cities of the Future.

Business Strategy Lessons About Cities: Whether you are located in a big city, a suburb or a small town, keep in mind the communication needed to advance your firm. Employees up and down the organization need to meet with other people: customers, suppliers, and even competitors. Don't neglect people in seemingly unrelated businesses. It's not unusual for companies in one industry to learn a trick from other industries. In big cities, a lot of this happens naturally. However, it can always be improved. If your business is located in a suburb or small town, senior management should try to facilitate and encourage interaction between employees and other business people.

One idea for stimulating thought and discussion: bring in someone to meet with your senior management team and present ideas about the business challenges and opportunities that he sees in the world. It will broaden your team's horizons. Here's an excellent choice for a speaker to business leadership teams.

 

Businomics Interview: Business Cycles and Management

Here's a video of me discussing the best book on economics and management.

 

Smart Pricing: New Ideas on an Old Problem

Very few of us do a good job setting prices. I have seen several companies, large and small, set prices, and it's not nearly as rational and analytic as it should be. And when it is rational and analytic, the process is usually too narrow, ignoring several important issues.

A good step forward in thinking about pricing is the new book, Smart Pricing, by Jaqmohan Raju and Z. John Zhang. The blog Knowledge@Wharton has an interview with Raju and Zhang.

The book has two key values. First, it offers a list of major pricing strategies. Managers often get so used to doing things one way that they don't reconsider whether they are using the right method. Smart Pricing is a guide to strategies that every business should consider.

The second value is that the book occassionally shakes up one's thinking. That's especially true (at least for me) of the chapter on price wars. I have advised clients not to engage in a price war. Raju and Zhang explain why my blanket advice is wrong. There are times when a price war is the right strategy. Certainly there are many more times when it is the wrong strategy, but it's a tool that should be in every manager's toolkit.

Step One for managers with the worry that maybe their pricing strategy is not the best possible: think about it, considering a wider range of options than you have discussed in the past. You should also consider bringing in a consultant (hint, hint) to help broaden your thinking.

Many Prices for One Product

The Christmas tree included a great book that got me thinking about the economics of pricing. No, my family did not bless me with an economics text. However, my son Peter gave me a delightful book, The Man Who Loved Books Too Much: The True Story of a Thief, a Detective and a World of Literary Obsession. The title pretty much says what the book is all about, but as I learned about avid book collectors, I started wondering about rare editions of my favorite books.

My first searched turned up a first edition of Adam Smith's the Wealth of Nations, priced at $150,000. That's a bit out of my budget for a single book, even one printed in two volumes.

A wider search for the Wealth of Nations turned up a much more affordable fifth edition, printed in 1789 (rather than 1776 of the first edition) and priced at only $6,500. That may sound like much, but it's actually affordable to many people, if only they made it a priority. The Survey of Consumer Expenditures shows that the middle quintile of households spends an average of $2,106 on entertainment goods and services. That fifth edition Wealth of Nations would require a few years of savings for an average family, but it is within reach if the desire is strong enough. There's also pure entertainment in some of the other categories of consumer spending. My car has heated leather seats, which aren't really a necessity. Similarly, our spending on housing and food includes plenty of luxury purchases mixed in with some necessities. So a middle income family could afford that book if they scrimped and saved across their budget.

I looked at my trusty copy of Wealth of Nations, which I purchased used many years ago for $4.95. It's a nice hardback Modern Library edition. I don't know when it was printed, but the introduction is copyright 1937. Similar volumes are selling on Amazon for about $10, so I've double my money--but over 30 years or so, I would guess. Not a great ROI.

When I want to grab a quote from Smith, though, I don't turn to my bookshelf. Instead I go to the Libary of Economics and Liberty online, which has a searchable copy--for FREE!  I can search, then copy and paste a quotation into my word processor. That's far better functionality than a physical book provides.

The Christmas tree also had under it a Kindle. I was able to get a free Kindle version of the Wealth of Nations, so I could take it with me on travels without lugging a heavy volume around.

So, what does The Wealth of Nations cost? Correct answers range from free up to $150,000. That may sound a little "soft" to you mathematical types, but it reflects an important point with significant business implications: different consumers have different desires and motivations associated with the purchase of a seemingly identical good or service. Those different desires and purchases can translate into different price points.

For example, a round a golf is, for some people, primarily a social experience. For others, it is the challenge of a difficult physical activity. For yet others, it is something to occupy oneself on an otherwise boring vacation. One activity, three different purposes. Possibly three different price points. Don't get caught up in the idea that your product has only one value. It's worth differing amounts to different people. Take that into account when devising pricing strategies.

Good Book on Manufacturing Management: The Goal

The lessons of Eliyahu Goldratt's The Goal are broader than manufacturing management, but that's the context for the lessons. The book is fairly old, first published in 1984, and I'm not sure how I missed it. It's a very good read. The book is actually a novel, though shelved in the Business Management section of most bookstores. And in fact, it's got a clear business lesson. The author has used the fiction format effectively, though. He poses a problem for the protagonist, gives a little information, and invites the reader to solve the problem. Gradually, we see the point, and much more effectively than if we were presented with bullet points and diagrams.

The Goal introduced the world to Goldratt's Theory of Constraints. Here's the simple version: imagine a factory. Every factory has a bottleneck that limits production. Think of the bottleneck as a machine, though it could be any process, such as packing the finished product in shipping boxes. The value of operating the bottleneck is equal to its production rate (X widgets per hour) times the value of the final product (NOT the value of the widget produced by the bottleneck).

Example: you are making a $1000 electronic product. Each product needs an on-off switch, which you manufacture. If your switch machine is the bottleneck, then the value of each switch produced is $1000!It is the switch that enables the sale of the final product. With this insight, two operating practices are derived: 1) resources to support the bottleneck are tremendously valuable. For instance, adding a worker to ensure that the switch machine never lacks raw materials is worthwhile, given the high value of its output. 2) resources used in non-bottleneck processes are value-less, at least at the margin. Making another power supply does not add to your ability to sell another product, if the limiting factor is the on-off switch.

This all makes sense to me, who is definitely not a manufacturing guy, but it apparently flies in the face of some cost accounting practices commonly used in manufacturing.

Overall, it's a worthwhile read, with applicability to many other businesses.

Austrian Economics Follow Up

Two days ago I wrote "Austrian Economics: What Business Executives Should Know."  Today the Wall Street Journal's blog Real Time Economics has an article about Friedrich Hayek's The Road to Serfdom.  So I guess it is an important topic.  If you read the article, be sure to add Don Boudreaux's cogent response on his blog, Cafe Hayek.

On a personal note, I had dinner with Hayek many years ago.  I attended a seminar on Austrian economics (thank you Institute for Humane Studies) at which Hayek was the final dinner speaker.  As we were taking our places in the banquet hall, none of my fellow scholars dared to take the seat next to the Nobel laureate.  I sat down, introduced myself, and had a grand chat with one of the greatest economists of the 20th century.