Scott Schaefer

Economist. Business Professor.

Some Q & A

Filed Under: Utah Economist Blog

I was teaching a bit last week (an MBA Strategy course), and students have been sending in some questions.

I normally like to post the Questions and my Answers so all students can see them, but don’t have a good way to do that for this group of students.  So I’ll put them here:

Could you elaborate why the triangle under the demand curve but above price represents consumer surplus?

Sure.

You emphasized that we should think through profit = (Avg Price – Avg Cost)Quantity as an objective when formulating strategy.  What about if the objective is to “maximize shareholders’ value”, “maximize growth”. How do we formulate our business strategies?

On page 7 seven of the slide deck from the first class, I wrote that the firm wants to maximize the profit formula you listed above and then said “probably some risk-adjusted present value thereof.”

The points that you are asking about hit the “risk-adjusted present value” point.  If we’re talking about “growth”, then we’re probably talking about giving up profits today by investing to grow and get profits in the future. This is a present value point.  If we’re maximizing present value, then we’re discounting future cash flows at a given discount rate when comparing to current cash flows.  “Shareholder value” is a present value adjusted for risk. As you’ll learn in future finance courses, stock market valuations are essentially present value adjusted for how risky the payoffs are.  The specific risks that matter for market valuations are the risks that are not diversifiable.  Both cases are simply complications of our basic formula.  That is, if you’re going to build strategic logic out of a growth strategy, you need to connect your logic to higher P, lower C or larger Q at some point in the future.  If you’re doing to build strategic logic for shareholder value, you need to connect the logic to present value or a reduction in the non-diversifiable risk. In either case, you’ve got to be thinking about P, C and Q, either now or at some point in the future.

 

Taking Silk Espresso as an example, what should be the growth strategy for a company like this?

As we write in the book, Silk Espresso has a very hard growth problem, and our assessment is that this is simply a firm that cannot grow beyond their single location without completely changing their strategy.  Growth for Silk can, however, take the form of adding products and services at their one location.  This brings up the important point that not every firm can grow profitably.  To grow profitably, you’ve got to have some returns to scale — for example, some reason why average cost falls (or at least doesn’t rise) with quantity.  If you’re trying to maximize your profits, you should try to find the size that maximizes your profits.  If growth will reduce profits (because P falls or C rises too much as you increase Q), then growth will not be a profitable strategy.

 

In all the case studies, it seems there is a flow of thought to analyze the case in order to come to the most sensible solution.  Are we only able to do it through accumulated experience or is there any systematic way of doing so? 

My recommendation is that you begin analysis not by thinking about the company, but instead by thinking about the frameworks.  Take the “Frameworks in Nine Sentences” document I showed the last day of class and think through how all of the ideas apply.  That is, for Maersk, start by thinking about profit, and specifically the relation between average cost and quantity.  Are there significant scale economies in this business?  What is the relation between price and quantity?  Then think about Value (B – C).  Who is the customer?  Where does B come from for that customer?  What is C?  What types of costs does Maersk have?  Then think about consumer surplus…  etc.

Not every framework will be useful for every case, but this insures that you don’t miss anything.  Once you’ve thought through all the ideas, then try to reflect, integrate and summarize what you’ve learned.

Credence Goods and Incentive Compensation

Filed Under: Utah Economist Blog

Credence goods and incentive compensation….  The two just don’t mix.

I recently blogged over on the Eccles Outdoor Industry Club site about how IDFL — a local tester of down and feather products — sells a what economists call a credence good.

And here’s a link to an article from Saturday’s New York Times about another such firm: USIS, a provider of background checks for security clearances for the US government.   Why are they on the front of the NYT?  Here’s a quote:

In interviews this week, former and current USIS employees detailed how the company had an incentive to rush work because it is paid only after a file is marked “FF,” for fieldwork finished, and sent to the government. In the waning days of a month, investigations were closed to meet financial quotas, without a required review by the quality control department, two former senior managers said.

This is a credence good because the government never really finds out if USIS did a good job or not.  To see why, suppose USIS does a thorough background check on an individual with a solid background, and reports to the government that all is clear.  Now suppose USIS doesn’t do a thorough investigation on a shady individual — due to financial pressures, perhaps — and reports, again, to the government that all is clear.  In one case the firm did a good job and in the other it did a poor job, but the two cases are indistinguishable to the government.

If you’re selling a credence good, your customer’s trust is pretty much the most important asset you have.  So, putting in place incentives for your employees to violate that trust — as USIS did by tracking time spent on cases and imposing short deadlines on its investigators — is a bad idea.  Credence goods and incentive compensation just don’t mix…

 

 

 

Does Utah Deserve an F for Women?

Filed Under: Utah Economist Blog

Today’s print-edition Salt Lake Tribune (yes, I’m old-fashioned) ran this front-page headline:  “Report:  Utah is Failing its Women.”  Here’s a link to the story.

The story is about a report by the Center for American Progress that ranked Utah 49th out of 50 (take that, Louisiana!) for “inequalities in areas critical to (women’s) well-being.”  A box on page 1 of the Tribune shows that Utah women are farther behind men in political leadership positions, business management jobs, and wages, compared to women in other states.

But does this mean that Utah is failing its women?

The Trib just last week ran a story summarizing 2010 Census data, and wrote

Utah also has the lowest percentage of children under age 6 where all parents are working, 51.8 percent compared to a national average of 64.9 percent.

In response to this, I wrote

Women in Utah spend, on average, more of their lives on non-market, home production, and this reduces the time they spend acquiring the skills that are valued by the market.

My issue with the Center for American Progress study — and with the Tribune’s coverage of it — is that the study isn’t making an apples to apples comparison.

If you really want to know whether Utah is failing its women, you need to think about two women — one in Utah and one in, say, Illinois — who make the same choices with regard to investments in valued-by-the-labor-market (or valued-by-the-political-“market”) skills.  And then see how each do in terms of their ability to compete with men for political leadership, business leadership, and wages.

Surely some of the on-average differences between Utah women and Illinois women are attributable to the fact that Utah women make, on average, different choices.  And if we really want to know if Utah is failing its women, we need to account for this in doing our statistics.

 

 

Measuring the Gender Wage Gap

Filed Under: Utah Economist Blog

Here’s a quote from the Salt Lake Tribune’s article today about the gender wage gap in Utah:

On average, Utah women who work full time made 70 cents on the dollar compared with Utah men last year. That is the fourth biggest wage gap in the country — and is about 8 cents per dollar worse than the national average, according to new estimates in the Census Bureau’s American Community Survey .

This number — 70 cents on the dollar for women compared to men — is often used to suggest that women face discrimination in the labor market.  While women may indeed face discrimination, this number doesn’t tell us much about whether that’s true.  The issue with the raw number is that it’s not making an apples-to-apples comparison of men and women.  Yes, women make less on average, but women also make different choices, on average.  A person who has spent his/her entire adult life in the labor market will probably acquire  lots of valuable skills, and competition among employers for those skills will drive that person’s wage up.  A person who hasn’t spent his/her entire adult life in the labor market will probably not acquire the same level of valuable skills, and competition among employers for those skills won’t drive that person’s wage up to the same degree.

If men are more likely to work their entire adult lives than women (which they are), then we’d expect men to earn more on average even if the labor market is completely blind to gender.

Given this logic, it’s entirely unsurprising that women in Utah would earn less relative to men than women in other states.  Another note from the 2010 Census in today’s Tribune states

Utah also has the lowest percentage of children under age 6 where all parents are working, 51.8 percent compared to a national average of 64.9 percent.

Women in Utah spend, on average, more of their lives on non-market, home production, and this reduces the time they spend acquiring the skills that are valued by the market.

The trick for labor economists doing statistical analysis is to do as much of an apples-to-apples comparison as possible.  That is, we’d ideally like to compare a man and a woman who made exactly the same choices with respect to occupation, education, and investment in skills, and see if there’s a gender wage gap between those two.

It turns out that as you control for more and more of the “different choices on average” made by men and women, the gender wage gap gets smaller.  But it doesn’t go away.  For more, have a look at this article from Francine Blau and Lawrence Kahn, two leading labor economists who write frequently on this topic.

 

Like Clockwork

Filed Under: Utah Economist Blog

Even a broken clock is right twice a day, and here’s the proof.  Way back in 2008 — just three days after Barack Obama was elected, and way before he took office — I critiqued the idea of using federal stimulus dollars on renewable energy projects.  I wrote

Governments are pretty bad at “picking winners” when it comes to making investments. This is something markets are better at. Entrepreneurs, who have their own personal wealth at stake when making business decisions, are motivated to figure out which forms of alternative energy investments are likely to pay off. This is a setting where markets are likely to make better investments than governments.

And here’s a link from the Washington Post to their coverage of the Solyndra scandal, where a green energy startup collapsed after having been granted $535 million in federal loan guarantees.  Governments — whether Democrat or Republican — are just really bad at this sort of thing.

I wonder how many elementary schools you can build with $535 million?

Venture Capital

Filed Under: Utah Economist Blog

My other occasional on-campus activity this year — besides the Outdoor Industry Club — is a bit of work with the University Venture Fund.  It’s a really great program where students can work with major VC firms investing real money in real deals.  My role is to help students a bit with understanding business strategy.

UVF-LogoI’m not sure why, but venture capital is often thought of as a finance topic, but of course it’s really about strategy.   The fundamental question of strategy is how firms can develop and sustain a competitive advantage.  And a sustainable advantage is exactly what VC firms are looking for when they’re seeking firms to invest in.  So while VCs need to know a bit about finance in order to calculate things like NPV and weighted-average cost of capital, the really crucial skill for VCs is distinguishing business plans containing good strategies from those containing bad.

I’ll be posting slides and notes for UVF students here.

(Oh, and it’s the same for private equity…  while you need to know the NPV stuff, the really important thing for private equity is identifying firms that are applying less-than-optimal strategies, so you can buy the firm, fix it, sell it, make a fortune…. and then be governor of Massachusetts.)

BlackBerry

Filed Under: Utah Economist Blog

BlackBerry

I’ve been porting my old blog posts over from the Utah Economist Blogger site to this new WordPress home page, and it’s given me a good excuse to revisit some of the ideas I’ve written about in the past.

Sometimes I’m even right! (Imagine that, an economist getting it right…) Blackberry seems pretty much dead as a smartphone platform, as I suggested about a year ago.  Smartphones are a two-sided market, and you have to get developers and end-users to coordinate on your platform to win.  The expectations of each side of the market matters for the others’ decisions, which means it can be really hard to catch up once you fall behind (as BlackBerry did).  While the stock got a little bump today on hopes that the MSFT/Nokia deal would spur some interest in BBRY (from whom, I don’t know), it’s been a rough ride ever since the bad news in late June that BlackBerry 10 shipments weren’t meeting expectations.

Eccles Outdoor Industry Club

Filed Under: Utah Economist Blog

 

I’m on sabbatical for the 13-14 academic year, so no formal “teaching” at the U for me this year.  But I will be doing a couple of things on campus.  For one, I’ve recently signed on as faculty advisor for the Eccles Outdoor Industry Club for the U of U’s full-time MBA program.

I’m excited to give it the full Roadside MBA treatment; that is, we’ll get a group of students together, go find companies to talk to, and then discuss how various MBA frameworks apply.  My co-author at Stanford has been doing stuff like this with students there for a couple of years, and he tells me it’s going well.  We’ll also do some other forms of outreach to the industry.

Here’s a link to a blog post I wrote for the Outdoor Industry Club site.  I’ll try to post some impressions of club activity as we go along.