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The Myth of Homo Economicus

When I went to school in the Dark Ages, we were taught in Economics that there is such a thing as Homo economicus, a purely rational human who makes all economic decisions based on “What’s in it for me” — sounds a lot like Chicago aldermen, but I digress. In many ways, this short cut made economics much easier.  We didn’t have to worry about things like people’s desire for respect or willingness to impose “fairness” into our negotiations. But it was also a bit like physics, where we were told to ignore the effects of friction in some of our equations – a shortcut than didn’t really help our understanding of the world we live in.

As time moved on, economists and psychologists started to research whether the Homo Economicus was real or a fallacy.  Scholars like Amos Tversky, Daniel Kahneman, Ian Ayres, Dan Ariely and Richard Thaler ran scientific experiments to see if people really did act rationally when it came to economic decisions.  What they all found, in various ways, was that we are not rational at all when it comes to buying, negotiating, selling, responding to advertisements and even going to the movies. In fact, to steal the title from Dan Ariely’s most famous book, we are Predictably Irrational.

I have recently completed reading the book Priceless: The Myth of Fair Value (and How to Take Advantage of It) by William Poundstone. I had read a number of Poundstone’s books before. He wrote books on secrets and puzzlers like How Would You Move Mount Fuji?, but I wasn’t prepared for the level of detail and research that he had completed to write this book.
The book is structured into 53 chapters. Each chapter takes a specific pricing case and talks about the specifics of the deal. There is also a description of a scientific experiment that describes the psychology of the participants. I had read about a lot of the experiments before, but this book allowed you to tie the results of the experiment with the results of a pricing decision in a very real way.

Poundstone opens the book by retelling of the McDonald’s hot coffee lawsuit, where the attorney for the plaintiff in the case employed a simple scheme to raise the amount of the jury award — he simply asked for an astronomical award from the jury.  This raised the anchoring point for the jury so that while they awarded much less than the asked for judgment, they awarded much higher than any rational person would have considered the case to be worth.  Anchoring also works in the grocery aisle.  Not too long ago, the standard size for ice cream was a half-gallon.  Consumers had in their minds what they normally paid for a half-gallon of ice cream.  Manufacturers wanted to raise prices (their costs had increased) but were concerned that if they raised prices, people would notice and either change brands or even more worrisome, consider alternative dessert items.  So, now if you go into the grocery store, most ice cream is sold in 1.5 or 1.75 quart sizes (a reduction of 12-25%), but the pricing is kept in the same familiar range.  The average consumer doesn’t realize that they are getting less for the same price and the market share of ice cream as a portion of the dessert market is safe. Anchoring at its best.

One of the experiments that gets a lot of play in the book is the ultimatum game.  In this game, one person is given $10 and is told that they can give any part of the $10 to another player.  If the other player agrees, then the deal is done.  If the other player does not agree, neither party receives any money.  This simple game uncovers a lot of different outcomes.  Men perform differently from women, Type A’s perform differently from Type B’s, Liberals perform differently from Conservatives, sober people perform differently from those more tipsy.  Is the proposer most rational when he proposes $1 to be given to others while keeping $9 for himself?  Is the receiver rational when rejecting a deal that would make them $1 richer in order to punish the unfairness of the proposer?  The best example in the book of the ultimatum game in real life is the story of Jack Welch’s divorce negotiation.  While we normally think of Neutron Jack as a most savvy businessman, it was fun to read the story how of his former wife turned the tables on him using the precepts of the ultimatum game.

Each of the chapters talks about ways that we as consumers are manipulated to paying more or selling for less than our mythical ancestor Homo Economicus would have been expected to.  This is certainly important to consumers, because a savvy consumer who is aware of the psychological tricks can make smarter purchasing decisions.  As business people, it is helpful to understand how to price your products and services in order to reduce price resistance.

This book was a pretty easy book to get through with enough concrete examples to catch your attention. In the 1-5 star rating category, I would give this book a solid 4 star rating.

Real Social Networking

As some of you know, I am not the biggest fan of Social Networks.  To me, it seems like a lot of the social networking that goes on is like New Year’s Eve, a time of forced frivolity.  Now, I love New Year’s Eve, but only because it is my daughter’s birthday.

Yes, I know that social networking is a lot of things.  Facebook and Twitter are certainly the types of things that I just don’t get.  Why would I be posting all of my personal thoughts and what I am doing for the world to see and comment on?  Perhaps it is just my age. With all of the social networks out there, how does one really benefit?  I think I have been invited to 4 different Ning groups.  Realistically how does one find the time to actively participate and get value from each? I have a profile on LinkedIn and have seen limited benefit from it.  Lots of people have profiles (like me), but not a whole lot really gets accomplished using the tool.

Blogging seems to work for me.  It gives me a chance to more fully flesh out the ideas that I have and put them down in writing.  The very task of writing makes me provide a (sometimes :)) coherent narrative that I hope is helpful to my loyal readers. But I understand that blogging is mostly a one way communication unless my readers choose to comment directly in the blog.

The most fun that I have is Real Social Networking, as compared with the garden variety social networking talked about above.  Please note that I am not talking about the business networking events that in Chicago tends to be passing business cards around, lying about the success of your business, trolling for customers (or a new job) and drinking adult beverages.  Real Social Networking involves the introducing of people in my network to each other to help solve a business (or personal) problem.  In order to do this to the best effect, you must really understand what each person in your network is about.  Where they went to school, what their politics are, what do they do better than anyone you know, what are their blind spots – you get the picture. You can’t do that when you are amassing “friends” in order to beat Ashton Kutcher’s record on Facebook.  It is hard to do that when you converse with people 140 characters at a time.

My social network is not that large compared to a lot of folks on Facebook. No matter.  I know that if I call on my friends in the network to help another, they will.  If they ask me to help one of their friends because I have certain skills that are needed, I will do so in a heartbeat.

In the past several weeks, I have been involved with 5 or 6 projects that have involved my network.  In some cases, friends have asked that I provide counsel on a project.  In other cases, I have introduced friends to other friends who can help solve an issue.  In another case, I convened a group of friends to brainstorm potential business models for a friend’s fledgling venture. I have introduced angel investors to companies.  I have provided referrals to other friends.  This is the value of real social networking.

If you haven’t tried it, I recommend that you start.  Start small.  Invite someone that you have been introduced to, but don’t know well to coffee.  Ask them what they are most proud of.  Ask them what they do better than most people.  Ask them what they are scared of.  Share your stories. And then ask them, How can I help? You may be able to help right away either directly or through your network.  But even if you can’t, you will have started to build the network.  That is a key asset that is much more than having 5000 friends on Facebook.

New Product, Knowledge and Advice

New Product: I am very excited by the Square credit card processor for the iPhone (and maybe other devices with an audio plug).  This product will revolutionize the way that people can conduct commerce.  Not just businesses, but even person to person.  The device is a small square credit card reader that plugs into the audio jack on the iPhone.  There is software for the iPhone that will process the credit card and transfer money directly to the recipient’s bank account.  Now the founders of Square have done some things right.  They priced the software at $1 and the device is free.  This makes it almost irresistible for anyone who wants to accept credit cards.  Think of craft fairs, your lawn mowing teen or a Craigslist seller. The cost per transaction is reasonable (2.9%) and Square will even donate a penny per transaction to a charity of your choice. More details and a video here.

Knowledge: Steve Schwartz wrote a post on the 3 types of knowledge. While the language is not always appropriate for elementary school, he does explain clearly how these 3 types contribute to our general sense of ourselves.

Advice: Micah writes about giving advice. This one is going to be hard for me to do (given the name of this blog) as I love to give advice almost as much as Micah does, but if he can find a better way, I can try.

Motivation

I have just finished reading a good book by Daniel Pink, called Drive: The Surprising Truth About What Motivates Us. This book talks about the difference between the old way of motivating people extrinsically by providing incentives (Type X, for eXtrinsic), usually monetary, to achieve business goals versus the new way of dealing with workers who are intrinsically motivated (Type I). While there were studies in this book that were familiar to me, I know that I read more business books than the average person and so, the studies may not be known by all. There were a number of ideas that came out of this book that were interesting to me.

In a prior life, I worked at a company that developed software that calculated and paid incentive compensation to employees. They were very much focused on companies that felt they were dealing with a workforce that was extrinsically motivated. The old adage that you get what you pay for was the norm of the day. At one of my clients, I found a compensation plan that was 75 pages long. How did people know what specific things they were supposed to do or if their pay was correct? We never figured that one out.

What we are seeing with our more junior members of the workforce is that they increasingly are interested in the intrinsic benefits of the job. They want to do a good job and as long as they are compensated adequately, they are motivated by doing interesting things. They want their companies to do the right thing.

Certainly we have all heard about Google and their 20 per cent time, where engineers can work on any project they find interesting one day a week. Google has benefited hugely from the 20 per cent time; products like GMail and Google News were developed on 20 per cent time. Younger engineers think of Google as the dream job, in part because of the freedom to explore. Before Google, 3M incorporated free time into their corporate strategy.  The most famous product developed in free time was Post-It Notes.

In another company that I was involved with that had a young workforce, the rank and file petitioned management to approve a program where you could wear jeans on Fridays if you donated $5 to charity. Management wisely agreed. All of the employees had a say in which charity was the recipient each month. Everyone participated and felt empowered.

This change from extrinsically motivated workers to intrinsically motivated workers is going on now. Partially it is a demographic surge. The younger employees in their early worklife are asking for it. In addition, old-line management have seen that the old way of incentive compensation just does not lead to long term success. It leads to gaming the system (look at the way that the Wall Street bankers were compensated). It leads to a never ending cycle of increasing incentives without a corresponding increase in productivity.

The most valuable section of the the book is called the Toolkit. In this section, Pink provides exercises, descriptions and experiments that you can use to help your company (or yourself individually) become more intrinsically motivated. He identifies and interviews 6 business thinkers who “get it”. These include Jim Collins, Peter Drucker and Gary Hamel. He introduces 15 books that help illuminate the Type I mindset. He even includes a link to an online test to see if you are Type I or Type X.

As owners, leaders and managers of our companies and organizations, it is incumbent upon us to develop environments that foster a sense of engagement for our staff.  As we look to develop our organizational culture, Daniel Pink gives us a playbook to use as a basis for engineering our own intrinsically motivating environment.

The Joys of Checklists

I just finished reading Atul Gawande’s newest book, The Checklist Manifesto: How to Get Things Right. Dr. Gawande is a great thinker and I had enjoyed reading his prior two books about the medical community: Better: A Surgeon’s Notes on Performance
and Complications: A Surgeon’s Notes on an Imperfect Science.  In this book, he talks about a simple way to reduce errors in the operating room, a checklist. He talks about how checklists can be developed and how they are used in aviation to reduce errors in the cockpit.

There were a couple of key takeaways for me from this book.  Gawande reports on the research of the science of complexity.  Professors Brenda Zimmerman of York University and Sholom Glouberman of the University of Toronto have developed a distinction between three types of problems in the world.  The first type is simple – like following a recipe to bake a cake.  You may have to learn some parts of it, but it should be repeatable if you follow the instructions.  The second type is complicated – think of sending a rocket to the moon.  In a complicated problem, you can usually break it down into many simple problems, but you will have multiple people or teams, multiple specialties and timing and communication become serious obstacles to be overcome.  The third type is complex – the example given here is raising a child.  Unlike sending a rocket to the moon, if you successfully raise a child, there is no guarantee that your second child will turn out the same.  Experience is helpful, but by no means sufficient. It is possible to successfully raise a child (no matter how you define that), you just can’t predict how it will happen.

In each of these types of problems, a checklist can be helpful.  In the simple case, a recipe is a simple checklist that ensures that all of the steps are completed in the correct order.  In the complex case, a checklist can be used to schedule the work that needs to get done, coordinate the interactions between the different teams and even regulate the communication between teams that is required to iron out issues that arise during the project.  Gawande spends some time in the book detailing a large building project and their use of checklists to ensure that all of the myriad details that must be accounted for during a skyscraper construction project are managed.

It is in the complicated cases that the uses of the checklist have really not been utilized.  For many years, the complicated cases have seemed to be too random to be managed through checklists.  In the surgery, complications are all too often a regular part of the job.  This antibiotic doesn’t work for this patient.  The patient suddenly develops an infection.  The laboratory does not deliver the right type of sample collection device.  But Gawande and a team at the World Health Organization worked on a trial project with 8 hospitals around the world to try checklists in the operating room.  Their goal was not to address all of the potential complications.  They created a list of 19 specific things to check before, during and after a surgery.  Things like, did you check the patient’s name bracelet, did you give pre-surgery antibiotics, if there is a chance for blood loss, did you request blood supplies be available.  In addition, the checklist required that the team all introduce themselves before surgery.  This bit was introduced to help the surgical team function like a team, when the complications arose.

The results from the trial were unbelievable.  Hospitals from the US, Canada, UK, Australia, India, the Phillipines, Jordan and Tanzania participated.  Overall, the rate of major complications for surgical patients in all eight hospitals fell by 36% after the introduction of the checklist, while deaths fell 47%.  Such a simple concept.  But it forced everyone to concentrate on the issues that they had control over, while preparing them to work as a team on the unforeseen complications that inevitably arise.

Now, usually I write about entrepreneurship, so why is this so important?

Well, Dr. Gawande took his message of the value of checklists to experts in other industries to see if there was a correlation.  One of the folks he talked to was Geoff Smart, who wrote a top selling book on hiring called Who: The A Method for Hiring. Smart did a project with Venture Capitalists where he evaluated the style that the VC used to make investment decisions. The VC’s that used a checklist approach had a 10% likelihood of replacing the senior management versus 50% for VC’s that didn’t use the checklist. They were also more financially successful. The checklist users had an 80% ROI versus 35% or less for the rest.

As you look to develop your businesses, it seems like a good idea to implement checklists throughout your businesses.  Even though your outcomes may not result in life and death, like Dr. Gawande, the benefits of using checklists to cull out the simple and mundane errors and focus on the complicating factors will strengthen your business.

Sethx2, The Brain and Microsoft

I haven’t done a recommended links post is a while and so here we go:

Seth: This week Seth Godin directed me to two very cool web resources that I urge you to take time to read and view.

The first is the video Lemonade.  It deals directly with folks in the advertising agency business who have been laid off and how they found their next steps.  Some people feel that it is talking about the need to start a new business, but my take is that it shows that you really can make Lemonade out of lemons if you pursue your dreams.  The video is well made and totally engaging.

The second is a free e-book on pricing.  How exciting can that be, you ask?  Well, the author, Todd Sattersten who has developed the business book review site inbubblewrap, clearly explains the components of pricing, costing and especially margin.  He also delves into the concept of free.  All in all a very quick and information packed presentation.  And the price is right!

The Brain: Harvard Business Review had a nice article on how the middle aged brain (of which I am the proud owner) has some inherent benefits as it relates to businesses.  It is good to hear that while we sometimes can’t remember names, we have built other skills that can help us in the business world.

Microsoft: Microsoft’s perception in the marketplace has changed over the past 25 years. The New York Times has a nice article on what the company has done to put itself in their current market space. This is a good warning to Google as well as any other company that goes through significant growth.

On the Fence with Apple

Apple.  It seems like they are the darling of the technology world.  Just this week, they announced the iPad — the next thing that will revolutionize our world.  Apple is a very divisive company.  People either love them or hate them.  The lovers are passionate and evangelical.  The haters are passionate and focused.

Until recently, I was a hater.  I have been on the PC platform since my first PC in 1984, with one 5.25 floppy drive, since I couldn’t afford the 5 MB (yes MB) hard drive. My resolve broke down when I saw the iPhone.  Here finally was a phone that I could use as a single device for all my needs.  The fact that it could sync with Outlook and keep all my music and run apps was (pardon the pun) beautiful music to me. So last June, when the iPhone 3GS was announced, I overcame my trepidation and bought the phone.  I really love the phone.  It is easy to use, rock solid, has the huge App Store and just works well.  Yes, of course, there are things that I wish it could do, like multi-tasking and more detailed profile settings, but in general I am pleased with my iPhone purchase. I am still not on the Mac bandwagon.  That is going to take a whole lot more magic.

The Apple store is another great story.  I love the Apple store.  Everyone in the store is enabled to make a your customer experience the best.  Want to buy something?  Any Apple employee can make a sale — no waiting on line; heck they will even email a receipt to you. The Genius bar is terrific for solving problems.  You get the feeling that everything that they do is focused on you.  I can’t think of another retail environment that makes me feel like that, with the possible exception of Disney (topic for another blog post).

But, while Apple can make you feel like the smartest consumer ever for choosing to work with their products and their people, it seems to me that in their own way, they also treat you like the stupidest consumer.  How can that be?  Well, they severely limit the types of applications that developers can offer.  Somebody reasonably smart can write a solid profile manager for the App Store, but Apple won’t allow it because it violates what they think should be available. How about a way to automatically expand text typed into an input field — something like tyvm should be able to be automatically expanded to Thank you very much?  Both of these features are standard on the competing Blackberry platform, but even if someone wanted to write these applications, Apple would not allow them.

It gets worse.  Say you lost your iPhone charger.  How much would you expect Apple to charge you to replace it?  Remember that the 8 GB iPhone can be bought for $99. According to Apple website, they want $29.00 for the replacement.  30% of the purchase price for a power charger?  That is crazy.  Yes, I know that you can find a third party charger almost anywhere for $10 or $15, but what does Apple take us for?  Here is an even worse case. The iPhone allows you to store movies for remote watching.  No problem, unless you want to plug your iPhone into your home television so that you can watch on the big screen.  Then you can buy the video cables from Apple for $49.  Too rich for your blood?  OK, find some third party cables and buy them for $10.  I did.  When I hooked them up, the picture showed up on my tv for about 2 seconds then went blank.  I got a message that said that since I wasn’t using the approved Apple cables, they had disabled the video output.  Remember that I did get a picture for a short bit, so it isn’t a technical issue. Ouch.  Starting to make me feel like less of that smartest consumer ever.

They have continued these policies with the iPad.  What a wonderful media player.  But no HDMI output. Too bad that you will need a (you guessed it) proprietary plug to get video output.  Well, I am sure that it must have a USB output.  All real devices have a USB output.  Um, not so much with the iPad.  The answer is that it will be available with an accessory kit.  I have heard that Apple believes that they want to serve the non-technical crowd and don’t want to make things too complicated for that marketplace.  Well, it seems to me that the PC marketplace hasn’t done too badly by giving people options.  If only someone could develop a “gorgeous” device that was open to be customized to our needs.

I guess that my experience has shown that it is possible to be in the middle on the topic of Apple.  I love the customer service and I love the device.  I just wish that the company had the foresight to help me make this my device, at a reasonable cost.  Then I could confidently move into the ranks of the lovers.