The Blue Line Imperative 1/x

Kevin Kaiser, S. David Young

Kevin Kaiser used to teach at INSEAD and I’ve heard excellent reviews of the courses he had read. So I bought the book and started reading it. Here’s the Amazon link for it.

1/ What is Value?

MK: you can skip this chapter if you want to get to the meat.

• Value Destruction – sacrificing the long-term sustainability of the organisation to achieve a short-term target. It’s very common to achieve goals with more resources than are reasonably needed. It happens everywhere: governments, non-profits, commercial organisations, etc.

• The concept of value is different between functions – value to a marketer is different from the value to an accountant. The inability to come up with an agreeable definition hardly allows for “managing for value”.

• According to the book, value is not a social construct, it’s an objective measure, irrespective of opinions, beliefs and biases. The book also runs on the assumption that humans are driven to make their lives better over time, creating ongoing value in the process.

• From a consumer perspective, value is a synonym for happiness. [MK: it’s arguable that everything that makes us happy is good for us, which the book also implies, but let’s not focus on this now.] “Happiness” means “more comfort”, “more excitement”, “more entertainment”. Happiness is relative to each person and is determined by the social class, living conditions, financial abilities, etc. Consumerism is popular because of the choice It creates for people. People, however, don’t know what they want and need to see the product first before buying or ignoring it. Too much choice may be debilitating, but its origins are still rooted in the search for value.

• Value creation for businesses is finding what makes people happy and deliver it to them at a reasonable price while sustainably earning a competitive return on invested capital. Anything short of it will kill the firm rather sooner than later.

• The book touches on two pricing strategies for increasing happiness – “more for same” (higher quality products or services for the same price) and “same for less” (a drop in price with constant quality). [MK: I wonder why they didn’t include the other two strategies – “less for much less” and “more for much more”, but hopefully we’ll find the answer later.] It also touches on the customers’ willingness to pay for new features, which can be A/B tested in the case of digital products.

• Disposable consumer income as a concept is less than 70 years old. And the focus on a consumer has been around for less than 150 years; one had a much higher chance of success inventing better weaponry or tools to produce better weaponry. Until not so long ago there were wide-stretching rules about what people could buy or wear. Even if people were able to save a bit of something that they could exchange for money, there was not much use for the money.

• Before 1800s, capital decisions in the past were made based on the relationships and not the business case. The hardest thing was getting access to the right people with the money who undoubtedly wasted their money on random projects.

• Consumerism, trade and affordability of things previously only available to the rich made earning more (and saving up) a more valuable proposition, especially when more labour could lead to higher output and monetary rewards. Mass production put things into the reach of less affluent population who started to want more. These “things” first and foremost improved people’s lives. Consumerism started eroding the class differences.

2/ The Global Capital Market

• Access to capital has been hard until very recently. At best, the interested parties created incentives in the form of prizes for solving a particular practical challenge. While still a push for innovation, such challenges very limited in scope and came from customers, not something the innovators observed and tried to commercialise.

• Capital markets (starting with the Dutch East India Company) became the means to attract capital and have the company deploy it with value creation in mind. Limited liability sealed the deal making it safe to invest in companies.

• Diversification is a new phenomenon: since in the past people invested predominantly into their immediate circle’s ventures (due to the obvious issues of trust and governance), this by design limited the diversification opportunities. Returns used to be all or nothing (a trade ship either returned full of valuable goods, or it sank / got lost at sea / got captured by pirates). Liquidity was non-existent up until the moment of starting the sales of the newly arrived goods.

• The expansion of capital markets and their geographies created diversification opportunities (lower the investment downside) and improved liquidity (more capital available and different timing of returns). Capital markets also create rules of disclosure, reducing information asymmetries, aid price discovery and increasing the willingness of participants to transact. Most importantly, capital markets have the influence over capital allocation: what products and services get funded and or not.

• People stay in the investment (ignoring inertia, diversification and transactional costs) for as long as their returns are equal to or higher than the opportunity cost of capital (in other words – there’s not alternative investment with a higher return).

• Diversification makes it hard to keep on top of one’s portfolio – inevitably control has to be passed down from shareholders to business managers. The agency costs can be huge (think of US top managers’ multi-million bonuses and perks). Another way of looking at the agency cost is making a mental exercise of comparing the existing company valuation with the “what would it be if all top managers were thinking of ethically maximising company value first and foremost?” possible valuation.

• MK: The authors make a flawed argument about the wisdom of the crowds leading to the market efficiency where no one is in charge, and no one is trying to push things in one direction or another. Reading on.

• MK: The authors make another argument that relationships in business are detrimental to value creation because they “compromise objectivity and skew the collective democratic brain”. To me it looks like a straw man argument with plenty of examples available to prove both sides of the argument.

• Moral hazards in many societies look like this: I’ve worked day and night to save up some money, but because of the family pressure I need to financially support my no-good cousin or invest in his business. The lack of the negative feedback leads to the proliferation of the freerider problem and the unhealthy establishment of financial safety net for those whose only “achievement” is being related by blood.

• MK: indeed, cultural norms exist, biases exist, and yes, deliberately avoiding the factors that are known to be harmful to financial decision making can potentially increase the quality of such decision making. But it feels… quite cliché, I’d say.

• At the same time, there’s a strong argument that while individuals are full of biases and can’t be relied upon, the behaviours of large enough groups of consumers can be analysed, modelled and exploited by firms building new products or providing services. Probably the most recent phenomenon is the mass belief of consumers in the human-caused global climate change, leading to certain behavioural changes as well as the shift of purchasing choices.

Part 2.