Category Archives: business economics

A theory of the glass ceiling

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My latest essay.

the corporate CEO, operating with a limited information set that arrives indirectly, must use more abstract thinking. We may think of the CEO as trying to navigate in a confusing forest using only little scraps of a map. The CEO operates with a theory of the business and fits those little map scraps into the theory.

. . .What Baron-Cohen calls systemising may correspond to a propensity for abstract thinking in business. In that case, that could explain the predominance of males as CEOs.

Read the whole essay before commenting.

Preston McAfee on big firms

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He says,

The thing that shocked me the most was how inefficient large firms can be. Sure, there is government waste, but it is commensurate with size and clarity of mission. In one sense, I already knew that large firms could be inefficient — the failure of Kodak and Blockbuster are examples — but it is another thing to live through it.

I have a much deeper appreciation that slow optimization is a better model of human behavior than full optimization, and indeed, I’ve often used evolutionary models rather than optimization models in my work. People do respond to incentives, and they respond faster to stronger incentives, but along the way there are lots of mistakes and bad choices and hysteresis.

I like to say that anyone who is scared of a giant firm has never worked for one. Learning that lesson is one of the reasons that economics programs should require internships in business. Having experience in business would lead you to be less committed to theories of optimization and more likely to regard the market as what I call The Great Miscalculator. That latter essay is a powerful indictment of the entire paradigm policy analysis that permeates academic economics.

Preston McAfee on tech firms doing venture capital

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In this interview, he says,

It’s unsurprising that Silicon Valley’s version of the multidivisional firm is to say we’re going to run a venture capital firm inside.

. . .Venture capital does a great job, and it’s a competitive market. So the idea of trying to replicate venture capital inside the company is usually misguided.

A tech firm may have an upside to funding failed start-ups that a venture capital fund does not have. That is, the tech firm probably can retain the best employees from the start-up.

Too little, too late?

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In the WSJ, David Pierce writes,

For $10 a month, you get access to what Apple says is more than 300 titles. I counted 251 magazines in the library, from “ABC Soaps in Depth” to “Zoomer.” Every popular magazine I looked for was available in some form. Besides Wall Street Journal articles, the rest of News+ includes content from the Los Angeles Times plus digital publications like Vox and theSkimm.

This sounds like what I argued for 18 years ago.

Pierce concludes,

As it is now, though, News+ feels like a product several years too late.

Software development and Austrian economics

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Clive Thompson writes,

Coders might have different backgrounds and political opinions, but nearly every one I’ve ever met found deep, almost soulful pleasure in taking something inefficient—even just a little bit slow—and tightening it up a notch. Removing the friction from a system is an aesthetic joy; coders’ eyes blaze when they talk about making something run faster or how they eliminated some bothersome human effort from a process.

Thompson draws parallels with the capitalist system, and I think he is onto something. The hard-core computer programmer he describes is reminiscent of Israel Kirzner’s description of an entrepreneur as someone who is “alert” to unexploited opportunities for efficiency and profit.

Another Austrian aspect of software development is that production keeps getting more roundabout. Crops are harvested by people using machines that were manufactured by other people who also used machines that were manufactured by. . .Similarly, an new smartphone app uses software already embedded in the phone which in turn uses software in the operating system and software that is embedded in the Internet, etc.

Talent matters

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Sam Walker writes,

What no one saw coming, however, was the sheer size of that correlation—something Gallup calls “the single most profound, distinct and clarifying finding” in its 80-year history. The study showed that managers didn’t just influence the results their teams achieved, they explained a full 70% of the variance. In other words, if it’s a superior team you’re after, hiring the right manager is nearly three-fourths of the battle.

You can see where that would make sense. If you have a boss that people want to work for, then you’ll have a good staff. If you have a boss that turns people off, the good people will leave and you’ll be left with people who can’t or won’t go elsewhere.

High-impact geeks

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Tyler Cowen quotes from Clive Thompson’s new book on high-impact geeks.

The 10Xers he [Marc Andreessen] has known also tend to be “systems thinkers,” insatiably curious about every part of the technology stack, from the way currents flow in computer processors to the latency of touchscreen button presses. “It’s some combination of curiosity, drive, and the need to understand. They find it intolerable if they don’t understand some part of how the system works.”

1. I have argued before that CEOs with a coding background have an advantage. You make better decisions when you understand how software development works.

2. In 1989, when I was at Freddie Mac in charge of developing simulation models for calculating the cost of mortgage prepayment and default risk, I first taught myself option pricing and understood the importance of the entire path of interest rates over the life of a mortgage. Also, one of the first decisions concerned a programming language. We went with C, in large part because the investment bankers were working with C. But first I had to teach myself C and do some of the coding myself, to make sure that it “felt” right.

3. In 1994, when I launched my Internet business, I had an understanding of the economics and basic operation of the Internet, based on the working-paper version of Hal Varian and Jeffrey K. MacKie-Mason’s analysis and Ed Krol’s Whole Internet Catalog. I also launched it when I was very high in personal Minsky cycle, basically conceiving the first version in a single sleepless night.

4. When Netscape introduced server-side JavaScript, I learned that. I started a local “users’ group” for the Netscape server, and I found a software developer at that users’ group.

5. He was even more into understanding “every part of the technology stack” than I was. In those days, nothing was reliable. The typical Windows computer crashed several times a day. Browsers were poorly implemented. The Internet itself was not all that reliable. Server software was often unreliable. Many web sites relied on Perl scripts, which someone once aptly described as looking like comic-strip curse words, so that they were nearly impossible to modify or debug.

6. When Java was released, I took a course in it, so that I would understand it. I formed the opinion that it would be more useful on the server side than on the client side. This was fortunate, because the Netscape server was a disaster, and when the Java Web server was released as a beta product, we went with it, and it was much more stable. I continued to code, even though my net contribution was close to zero (my developer had to spend time fixing some of what I wrote). Again, I needed to have a feel for everything, so that I could understand the decisions he was making. We got the point where every page we served was assembled on the fly by pulling elements out of a database.

7. In 2008, when the financial crisis hit, I coined the phrase “suits vs. geeks divide.” I could tell that some of the central players, including executives at large financial institutions and the leading policy makers, did not understand the behavior of options that I learned about in (2). The suits did not know what they were doing. They enacted TARP, an $800 billion program, under the assumption that you could just buy up the bad mortgage securities and hold them for a while. I knew that this was not the case, and after a few months they gave up.

8. About five years ago, I tried another start-up. I wanted to do some of the coding myself this time. But I did not understand how much the software world had changed. It seems to be all about stitching together different packages. I was too much of a dinosaur.

Anyway, I hope that the book is as interesting as Tyler says it is.

What is a firm? an organizational culture

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I just received a review copy of Tyler Cowen’s latest, Big Business, which will be released in a week. As is my habit, I started reading it from the outside in, and I quickly landed on the appendix, in which he writes

in lieu of the Coase and Williamson transactions-cost appraoch, I typically view a corporation in terms of the following properties:

  1. It is a collection of assets, assembled at favorable purchase prices (or at least the prices were favorable for the case of successful corporations.
  2. It is a nexus of external and internal reputation and norms.
  3. It is a carrier of contractual and legal responsibility.

My inclination is to elaborate on (2). I might describe a firm as an organizational culture.

I think we need to distinguish among types of firms. The local restaurant run by a family of recent immigrants is not the same as Microsoft.

I want to ignore most types of firms, including the restaurant, and instead focus on young, ambitious firms and mature, established enterprises.

I would describe a young, ambitious firm (or a “promising business” in Amar Bhide’s terminology) as an organizational culture embodied in its top management layer. To be successful, the members of this team must:

  • generate good ideas and discard bad ones
  • have the skills, experience, and drive to execute on ideas
  • work well together
  • manage the transition to a mature, established enterprise

In a mature enterprise, the organizational culture permeates the entire firm. A set of rules, systems, processes, habits, and institutional knowledge is deeply ingrained in every layer of the organization. One of the things that struck me about Minerva, the innovative college, is the terminology that I called “Minerva-speak.” This sort of firm-specific terminology can contribute to a shared organizational culture.

When Tyler points out that bureaucracy is both good and bad, I interpret that in terms of the tension between organizational culture and individual initiative. I picture Minerva in those terms. Its culture is more clearly defined than that of a typical college, but ultimately that could feel stifling to some faculty and students.

Recall that one of my rules for work and financial life is:

When you have little left to learn on a job, it is time to move on.

A lot of what you learn when you work at a firm is its organizational culture. Moving within a firm means you learn new subject matter, but you are largely staying within the same culture. The psychologically more challenging move to a different organization gives you an opportunity to experience a different culture, sort of like spending time abroad.

Large, established enterprises are in one sense easy for a CEO to run and in another sense very difficult to run. With a deeply-ingrained organizational culture, an enterprise can operate on auto-pilot in a stable business environment. In a changing environment, which seems to be more prevalent nowadays, the CEO has to know when and how to discard cultural baggage. Changing the culture of a large organization is risky and wrenching. In a large corporate merger, cultural integration is both challenging and very important.

Perhaps the biggest challenge faced by top management in a large organization is to know what the organization needs to learn and to unlearn as its environment changes. I can think of many examples where the environment changed quickly and a large enterprise unlearned too slowly. Or maybe the value of its legacy rules, systems, processes, habits, and knowledge was decimated by the new environment, and there was not much that top management could do about it.

But I can think of at least one example where a new top management layer insisted that the organization unlearn its approach and the outcome was tragic. That was when Freddie Mac’s board brought in Richard Syron as CEO. Syron and his executive team discarded the organizational knowledge about credit risk, which included a reluctance to deal in “low-doc” mortgages. Under Syron, Freddie Mac dove into the “low-doc” business, with results that were disastrous, both for the company and for the country.

The West was lucky to win

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I have been delving into J.S. Sharman’s Empires of the Weak, which argues that the story we tell of the triumph of the West as inevitable is quite misleading. In general, he questions the assumption that competition will automatically strengthen states through the processes of learning and selection.

Victory and loss in war are a result of complex and varying combinations of factors, many of the most important of which, like leadership and morale, are intangible. (p. 20)

We tend in hindsight to see correctness in what the winner did and mistakes in what the loser did. We also tend to narrow the list of critical factors. In fact, we may very well be emphasizing the wrong factors, we may misclassify some decisions as correct when they were mistakes and vice-versa, etc.

I think that this is true in business as well.

On the issue of selection, Sharman argues that there is not enough extinction among states for selection to operate effectively. I suppose that because firms go out of business much more frequently than states disappear, one can have some hope that the process of selection leads more reliably to improvement in the case of firms than in the case of states.

Mom-and-Pops have not died?

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Esteban Rossi-Hansberg, Pierre-Daniel Sarte, and Nicholas Trachter write,

When Walmart enters, the total number of establishments in the ZIP code increases, though by less than one-to-one (about 3/4). In other words, Walmart generates some exit, but the net result of opening a Walmart store is a greater number of competitors in the market for at least seven years after entry. This case is paradigmatic, but there are many others across all major sectors. For example, the expansion of Cemex, the top firm by sales in 2014 in the ready-mixed concrete industry, led to a similar decline in local concentration and an expansion in the local number of establishments in the industry.

I found this surprising. I always thought that the national giants, especially Walmart, were driving lots of Mom-and-Pop stores out of business.

But if you follow the link and read carefully, the authors look at Walmart in the discount department store business. Maybe they don’t drive out of business a lot of discount department stores, but they do drive out of business some mom-and-pops. Or maybe the mom-and-pops disappeared well before Walmart came along.