Proprietary IT and competitive success

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In the WSJ, Christopher Mims wrote,

IT spending that goes into hiring developers and creating software owned and used exclusively by a firm is the key competitive advantage. It’s different from our standard understanding of R&D in that this software is used solely by the company, and isn’t part of products developed for its customers.

Today’s big winners went all in, says James Bessen, an economist who teaches at Boston University School of Law and who recently wrote a new paper on the policy challenges of automation and artificial intelligence. Tech companies such as Google, Facebook, Amazon and Apple—as well as other giants including General Motors and Nissan in the automotive sector, and Pfizer and Roche in pharmaceuticals—built their own software and even their own hardware, inventing and perfecting their own processes instead of aligning their business model with some outside developer’s idea of it.

The research is by James Bessen. Robin Hanson has comments. He wonders why good internal software could not be made available to other companies.

I have not read Bessen’s work, but I worry about two related issues.

1. Survivor bias.

2. Correlation vs. causation.

If you were to ask me what I think of the idea of developing internal software vs. using stuff off the shelf, I would advise most companies not to go for internal software. It’s easy to mess up, and once you mess up, you are at a dire competitive disadvantage. My guess is that developing proprietary software is a very high-risk strategy. Granted, some companies at the top of the outcomes distribution have gone that route. But I also expect to find plenty of firms who tried that approach at the bottom of the outcomes distribution.

As for cause and effect, you can’t build an effective software system around a chaotic business process. My guess is that the companies with the most well-analyzed, logical business processes have the best software systems. But the software system is not the driver.

My Recent Reading

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a. Jeffrey Pfeffer’s book, Power. Nothing really stuck with me, other than a brief passage pointing out that autonomy and power are not the same thing. If you want autonomy, you may not want to pursue power.

b. Ichiro Kishimi and Fumitake Koga, The Courage to be Disliked. I found this to be one of the most interesting self-help books that I have read, but I am still not sure whether I find it useful. Some notes:

1. Rather than suggest seeking power, the book offers advice to stay out of power struggles.

2. The book credits all of its ideas to the psychology of Alfred Adler, but you won’t find much in common with other summaries of Adler’s work. Very different points of emphasis, if nothing else.

3. There is a brief but very pointed passage stating that “You don’t know what it’s like to be ____” is a power play, and an ugly one at that.

4. I didn’t find the book immediately relevant to any problems in my life. Possibly I do not have the sorts of problems that animate the book. Possibly I fail to recognize that I have the sorts of problems that animate the book. Possibly the hard part of applying the book’s advice is acknowledging that your problems fit its thesis.

5. I think it would be a very interesting book to discuss, if my readers would like to do so.

Noise and statistical analysis

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Tyler Cowen quotes a story in the Atlantic about a study that finds that genetic variation can explain 11 percent of the variation in educational attainment.

consider that household income explains just 7 percent of the variation in educational attainment, which is less than what genes can now account for.

In any statistical study of this sort, I think it helps to think about the sources and impacts of mis-measurement of key variables.

For example, if you measure “educational attainment” as years of schooling, you are ignoring differences in quality. You also have to deal with artificial factors that push people toward specific numbers. If you count graduating high school counts as 12, then a lot people who are actually below that will have been carried along to that point, and some people who continue to teach themselves in a non-school setting will be stuck on that point.

Also, household income is a noisy measure of overall economic status. Maybe this year the household earned much less than usual, or much more.

Measurement error in either the independent variable, the dependent variable, or both, will drive down the percentage of variation that is “explained” by the independent variable.

Also, genetic characteristics and household income may be correlated. If the former is measured more precisely than the latter, then the former will appear to matter more.

Industrial policy

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A commenter pointed me to this Dan Wang essay.

I think that technology ultimately progresses because of people and the deepening of the process knowledge they possess. I view the creation of new tools and IP as certifications that we’ve accumulated process knowledge. Instead of seeing tools and IP as the ultimate ends of technological progress, I’d like to view them as milestones in the training of better scientists, engineers, and technicians.

. . .The decline of industrial work makes it harder to accumulate process knowledge. If a state has lost most of its jobs for electrical engineers, civil engineers, or nuclear engineers, then fewer young people will enter into these fields. Technological development slows down, and it turns into a self-reinforcing cycle of decline.

I think that if you polled economists, you would find many who agree with all of the following.

1. Our manufacturing sector is definitely not too big.
2. Our financial sector is definitely not too small.
3. Industrial policy is a bad idea.

Odd that. Although I would be one of them.

The wireless last mile

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Peter Diamandis writes,

By 2024, we are connecting every person on Earth to the web with bandwidths far beyond what Fortune 500 CEOs and heads of nations had daily access to just a couple of decades back.

. . .With plans for wide-scale deployment in 2020, 5G will be 100X faster than 4G, and 10X faster than your average broadband connection.

From his email newsletter. Years ago, I predicted that the last mile would be wireless, but I thought that it would come from mesh networks, not from cell carriers, balloons, and space-based networks, which is where Diamandis sees this coming from.

Incidentally, these folks were not as aggressive in their predictions for 5G wireless. They discuss the obvious implication that once 5G does become ubiquitous consumers won’t need cable or FIOS anymore.

It also strikes me that all this bandwidth will invite bandwidth-hungry apps to soak it up. Virtual reality, video-conferencing, and video calls come to mind.

Subscriptions and durable goods rental

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In the WSJ, Philip Delves Broughton reviews Subscribed by Tien Tzuo with Gabe Weisert.

Husqvarna, the Swedish maker of forestry and garden tools, maintains what it calls the Husqvarna Battery Box out of a Stockholm parking lot. The handyman’s hut offers subscribers access to hedge trimmers, chain saws, leaf blowers and other equipment; users pay a flat monthly fee to borrow the tools and return them when they’re done.

My guess is that a central issue in these sorts of businesses is pickup/delivery/installation logistics. Take the yellow, green, and orange bicycles that lately I have seen strewn around the area. I suspect that, on average, the users of this bikes disperse them to less convenient locations than where they pick them up. That leaves the company with the task of going around and retrieving the bikes and moving them closer to where people might want to start biking. I doubt the business model in that case.

Pessimistic meta-induction

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Charles Chu explains what it means.

Much of what we believe today is doomed to join other infamous dead theories like Lamarckism (“Giraffes have long necks because they used them a lot.”), bloodletting (“Let me put a leech on your forehead. It’ll cure your allergies. I promise.”), and phrenology (“I’m better than you because I have a bigger head.”).

Philosophers have a name for this concept. To help make it memorable for undergraduates, they kindly titled it the “Pessimistic Meta-Induction from the History of Science”.

The essay makes the case for intellectual humility and for challenging yourself to take the ideological Turing test.

Thinking about privilege

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A friend’s son has a job orienting college students on the subject of privilege. The highlighted sources of privilege are primarily race and sexual orientation. Parental wealth also may get throw in.

The sources of privilege that are not mentioned, as far as I can tell, include:

–being tall
–having attractive features (or at least not being extremely unattractive)
–being naturally outgoing (extroverted)
–not having mental disorders, such as autism, depression, or schizophrenia
–not having debilitating physical ailments or physical handicaps
–growing up with your biological father (particularly if you are male). See Autor and Wasserman.
–having artistic gifts

Like race or sexual orientation, these characteristics are generally given to a person at birth and during childhood. On average, and other things equal, someone with one of these characteristics will wind up higher on the social scale than someone without them. I would bet that some of them have stronger impacts on average outcomes than race or sexual orientation. So to me, these characteristics look like privilege.

Is there a non-politically-motivated justification for only looking at race, sexual orientation, and economic class as sources of privilege?

The business model of a new university

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Reviewing Warren Treadgold’s The University We Need, John Leo writes,

Mr. Treadgold thinks that a new private university may be needed, not an explicitly right-wing one but one that reflects the intellectual opinions of a spectrum of educated Americans outside academe. When Leland Stanford founded Stanford University in the 1880s, Mr. Treadgold notes, he possessed a considerable fortune, though it would be too small in today’s dollars to put him on the Forbes 400. A lot of even wealthier donors are now available, and many of them are troubled by universities’ hostility to free speech, capitalism, religion and traditional education. A gift of $1 billion, he believes, would trigger the rest of the donations needed to launch such a university. A planning group could seek and find roughly 1,000 good scholars willing to join the faculty. The college itself need not, he says, be larger than Princeton—i.e., about 5,000 undergraduates.

My thoughts:

1. The proposed student/faculty ratio is 5. If each student takes 10 courses a year, then each faculty member has to teach 50 students a year. A faculty member could do this by teaching one course a semester with 25 students in each course. That sounds like a low bar. Maybe the student-faculty ratio could be a little higher.

2. Suppose you pay each faculty member $200K per year. If there are 5 students per faculty member, then each student has to pay $40K per year to cover that.

3. So you don’t need a $1 billion endowment to compete on the basis of bread-and-butter teaching. You need it to compete on amenities. Some of the “amenities” at existing colleges are administrators who seem from the outside to be superfluous. Others, like fancy sports facilities and coaches, appear to be expensive relative to any educational value.

4. If everybody woke up tomorrow with no memory of our higher education system, and educators had to start from scratch, chances are we would settle on a very different model. The problem is that students and parents know the current model, and from their point of view, any deviation from that model is risky. If you define complacency as an unwillingness to try significant innovation, then our higher education system is steeped in complacency.

Nobel Symposium on Banking

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John Cochrane writes,

I attended the Nobel Symposium on Money and Banking in May

Diamond and Rajan say that debt is necessary, because it disciplines managers. Debt holders are constantly monitoring management, and running at the first sign of trouble. In direct contrast, Gorton’s debt holders are paying no attention at all most of the time, and then dump debt out of blind fear.

One weak spot of the conference was that everyone was being too polite. Well, everyone but me. Here we have a glaring difference in views. Which is right? I asked the question.

Rajan’s response was very informative: Yes, most retail debt customers are “information insensitive,” and likely even most corporate treasuries using repo as a cash substitute. But among the New York banks who are funding each other very short term, yes indeed they are paying a lot of attention and will run when they see trouble. So the “discipline” story is narrow, for this class of lender and borrower. That seemed to me a nice reconciliation of dramatically opposing views that has troubled me for some time.

I have watched several videos from the event, including the one where the exchange between Cochrane and Rajan occurs.

Cochrane asked another question, which I don’t think anyone answered. In some sense, I think he was asking how there can be a shortage of liquid assets, given how easy it is to trade assets, including stock mutual funds. My thought is that if this phenomenon of a shortage of liquid assets is real (or was during the financial crisis of 2008), it is because of the enormous balance sheets that some of the financial institutions had assembled on very little equity, leaving them with tiny margins of error.

On the general topic of how financial intermediation operates in the economy, I keep saying that we need to appreciate the layering that takes place. Finance is a complex ecosystem, with many niches. Beware of models that simplify it. I would wager that many of the conference participants could not have been able, as of 2005, to explain the nature and significance of repo haircuts, super-senior CDO tranches, or credit default swaps on mortgage securities.

I think that Doug Diamond and Gary Gorton are a bit too much invested in the issue of runs on short-term debt. And from Cochrane’s second post on the conference, I gather that Ben Bernanke is the most invested of all.

Instead, I preferred the speakers, like Alan Taylor, who emphasized dramatic changes in asset values, rather than liquidity. Yes, a sort of run took place in 2008 in the inter-bank lending market, and that run really got the attention of Wall Street and policy makers. But the big build-up in mortgage debt and house prices, followed by a crash, was not a liquidity crisis.

Do you remember my post on the Eric Weinstein interview? One of his glib, provocative comments was

The so-called great moderation that was pushed by Alan Greenspan, Timothy Geithner, and others was in fact a kind of madness, and the 2008 crisis represented a rare break in the insanity, where the market suddenly woke up to see what was actually going on.

I would like to have seen some of the conferees respond to that remark.