Sheryl Sandberg has recently offered advice for talented, career-savvy women: Do what successful men do and work. A lot. I was especially struck by her recommendation to “lean in” given end-of-life surveys which consistently rank “working too much” as one of the biggest regrets in life. Men especially “…deeply regret spending so much of their lives on work…and missing their children’s youth and their partner’s companionship.” In economic terms, many professionals – and men in particular – discount the opportunity cost of all that work until it’s too late for anything but regret Yet this is the unbalanced life that Sandberg extols and follows herself.
This post won’t argue that working long hours isn’t good for your career; it is. But why does working long hours enhance your career? What are the assumptions underlying that relationship, and are those assumptions valid? If not, why not, and what is the true relationship between work, productivity, and value?
Perceived Relationship Between Hard Work and Career Growth
For most, a life spent at – and on – work isn’t the goal but the means to an end: Money, prestige, opportunity, early retirement. At its core, the “work more” rationale is that combining talent and hard work leads to business results which make an employee valuable. In other words, hard workers make a positive impact on the business and are therefore rewarded with career growth. Here’s the assumed relationship:
Talented employees take on increasing levels of responsibility (more on their plate), which leads to heavy work loads and long hours. Those long hours result in getting a lot done – superior results – which leads to career growth. Sandberg’s belief is that without loading up our plate – and working long hours – we can’t deliver results that lead to outstanding career success.
Sandberg’s perspective is widely shared today. Researchers interviewed corporate managers about their perceptions of their employees. Employees who came in over the weekend or stayed late in the evening were seen as “committed” and “dedicated” to their work. A typical comment: “Working on the weekends makes a very good impression. It sends a signal that you’re contributing to your team and that you’re putting in that extra commitment to get the work done.”
I’ve seen – and regret to say, implicitly encouraged – this perspective, especially early in my career. However, having worked with all sizes and manners of companies as a consultant, I’ve come to the conclusion that many of these assumptions are incorrect. In this post I’d like to explore the true relationships between working long hours, getting stuff done, and results.
The Relationship Between Hours Worked, Productivity, and Results
Whether you work long hours enthusiastically or begrudgingly, the assumption is that your effort creates value and benefits your organization. Because if it doesn’t – if companies aren’t better off, or are even worse off when their employees work long hours – then the personal sacrifices are not only painful but unnecessary and counterproductive.
The relationship between hours worked and productivity isn’t linear; an extra hour of effort often leads to different levels of output. Over the course of a day/week, these returns begin to decline, as we get tired and distracted. Work long enough and returns become negative: An extra hour of work actually destroys value, whether it be a defective widget, a flawed business strategy, or anything in between.
So when do we become unproductive? Turns out there’s 150 years of research (see here, here, and here) for blue collar workers: 40 hours per week. We see this in Figure 1 above (point B). Note that our most efficient productivity (point A) occurs at 25 hours – about 5 hours per day.
Blue collar productivity is pretty easy to assess. While the productivity of knowledge workers is harder to pin down, recent research (see here) estimates knowledge workers maximize productivity around 30 hours per week. Thinking requires more focus than sweating.
There is a caveat to these findings: They apply over the long run. Research shows that there are short-term increases in productivity from working longer hours. Below we see the productivity impact of working consecutive 60- and 80-hour work weeks compared to the 40-hour baseline.
In a 60-hour week, maximum productivity occurs at 4 weeks, while breakeven productivity occurs at 8 weeks. (In other words, work 60-hour weeks for 8 straight weeks and you’ll get as much done as if you’d just worked 40-hour weeks the whole time.) Similarly, productivity maximizes at 2 weeks in 80-hour weeks, while breakeven productivity occurs just one week later. Notice also that it takes a week for productivity to recover from an 80-hour week.
Employees that brag complain about how crazy busy they are should really be apologizing for the mess they’re creating. And Sandberg’s boast that “…the days when I even think of unplugging for a weekend or a vacation are long gone…” is hardly praiseworthy from a productivity point of view, even if it might explain the Facebook Home debacle. Ironically, it’s easy to imagine the takeaway for Sandberg is to work herself and her team even harder next time.
The True Relationship Between Long Hours and Career Growth
In my experience, it’s not talent but motivation – perhaps greed, ambition, or fear – that leads to working long hours. As both research and countless anecdotes suggest, long hours negatively impact an employee’s contribution to the business. Yet, in most organizations, long hours still result in career growth. In fact, in many companies, the willingness to work long hours, by itself, “signals” an employee’s fit and commitment and leads directly to career growth, without even attempting to quantify productivity and impact on results. We see the revised relationship below.
Notice that “talent” and “results” are no longer necessary for career growth; they’re hard to assess and measure, so we assume they’re proxied by hours worked (which, to be fair, is sometimes the case). This fits with my experience, where successful employees are often set apart not by skill or measurable results but by willingness to ask of themselves and others to “do whatever it takes.” They fit the current stereotype of a successful business leader, a stereotype that, regrettably, is reinforced by Sandberg’s well-intentioned but misguided advice.
Why Even “Productive” Work Often Adds Little Value
Most of us believe the work we perform is valuable, if for no other reason than to assure ourselves of our professional indispensability. But do we really add value, and if so, how much? The answers, it appears, are “not usually” and “not a lot.”
A 10-year study in the Harvard Business Review looked at both productivity and value, to better gauge both volume and quality of work. The results were eye-opening. Just 30% of work actually added value to the business. Put another way, 70% of all work accomplished was mere busywork – work for work’s sake.
Busywork often masquerades as work vital to an organization’s success. For example, last year I worked with a client looking to improve their website’s customer conversion rate and brand identity. A 6-month website overhaul project was launched, which, by my calculations, consumed 30,000 engineering and design hours in a nearly 30-week blitz of 60+ hour weeks. Tempers and burn out rates were high, mistakes and rework common. And the new website’s impact on conversion and brand identity vs. the old site? None. At the project debrief, all the talk was about how to cushion the impact of all that work – dinner catered, facilities to take showers, even “sleep” zones complete with couches and alarm clocks. The true takeaway, of course, is that efficient productivity is irrelevant if the work itself – vs. the status quo – adds no value.
If It’s Easy to Measure You’re Probably Measuring the Wrong Thing
They say that in business, you manage what you can measure. Well, actual value added by an employee is tough to measure, so organizations focus on something they feel must be related: hours worked. Superficial regard is given to the quality of those hours – whether the work is productive and truly adds value – because that’s inherently difficult to measure.
The present work-is-life mania is neither necessary nor inevitable; it’s something we’ve chosen, if only by our grudging acquiescence to it. Few of us want to live like this, any more than any one person wants to be part of a traffic jam – it’s something we collectively force one another to do. Taken within this context, role models like Sheryl Sandberg do a disservice by encouraging employees to build their lives around the context of their career, to monetize their lives by doing things which are easy to measure – hours worked – and de-prioritizing things that are hard to quantify and measure, but so much more important for most of us and those around us – life outside of work.
Today’s post is on the healthcare industry. Whether it’s described as a bubble or ponzi scheme, there’s no doubt that we’re experiencing one of the most damaging – and misunderstood – economic events in our country’s history. (By way of comparison to the higher education bubble: The estimated amount of waste in the healthcare market – in just 1 year – would pay off every student loan in the country.)
I’m focusing on two areas: 1) The fundamental economics of the healthcare market, as effectively providing healthcare – both how and how much – is inherently an economic question. Even if, as some argue, healthcare is a fundamental right – and hence a moral issue – that does not mean a right to an unlimited supply, provided without regard to cost or benefit; and 2) The relationship between healthcare usage and health outcomes.
The Economics of the Healthcare Market
As a starting point, we can envision that a well-functioning healthcare market has patients with health issues who get the best treatments possible given their personal cost-benefit tradeoffs. We see this relationship below.
Any of us who have participated in the healthcare market know that it doesn’t work as other consumer-driven markets. In part this is because most patients – price-sensitive consumers – neither buy their own insurance nor pay the bills directly. Employers and the government, the largest “customers,” are more concerned with simplicity and expanding coverage than price or efficiencies.
The presence of price-insensitive customers doesn’t fully explain the skyrocketing prices in the healthcare market, however. After all, other industries with similar customer segments – professionals with expense accounts in the airline and rental car markets, for example – haven’t exhibited similar price behavior, despite someone else often “picking up the tab.”
No, there’s something that sets the healthcare market apart – its economic structure as a cartel. In a cartel, suppliers act to make output and price decisions. As we see to the right, suppliers typically restrict supply and increase price relative to a competitive market. Consumer pain is their gain, which we see highlighted in orange.
However, as an economic model cartels have a weakness: reduced demand. As prices rise, some consumers “opt-out” of the market, while others never enter. This price-demand dynamic serves to limit the size of inefficient market structures like cartels, and, in the long run, often results in their obsolescence.
But healthcare spending continues to skyrocket, increasing from $40B to $2,000B in just two generations. Why hasn’t the limiting factor – reduced demand – worked in this case? The answer, as we’ll see below, has to do with the nature of demand in the healthcare market.
Why Prices (Will) Always Rise in the Healthcare Market
I have two daughters and a disturbingly profligate lemon tree. Suppose my daughters open a lemonade stand and sell 5 cups a day for $1 each. One day, in a burst of magnanimity, I decide to buy a glass for everyone in our neighborhood. In an attempt to control how much I spend, I make my daughters an offer: I’ll pay a 50% markup on their costs, which I estimate to be just a dime per cup.
Of course, my daughters’ motivation changes the minute they agree to this deal. They’re no longer focused on trying to sell as much lemonade as possible; my offer ensures they won’t need to worry about customers. Instead they want to increase their costs as high as possible – a new Lemonada 5000 mixer, celebrity sponsors, cruelty-free lemons – because their profits grow as their costs increase.
The Affordable Care Act (ACA) mandates that insurance companies “pay out” up to 85% of their premiums (casinos face similar regulations). While this is claimed as a win for patients (or gamblers), our lemonade example shows it’s the opposite. Premiums are based on insurance companies’ costs, and providers – pharmaceuticals, hospitals, device makers, physicians – recognize that insurance companies want higher costs, because they’ll simply pass those on through higher premiums. Everybody wins!
Perversely, in an attempt to limit how much we spend by linking it to costs – but allowing the industry to determine its own “costs” – we’ve provided the perfect environment for costs – and hence, prices – to inexorably increase. Unlike with healthcare, at least with casinos we get a voice in deciding whether – and how much – we lose.
How the Medical Profession Increases Demand
The tension between the spirit of medicine and the spirit of commerce is ancient. In The Republic, Socrates asks, “Is the physician a healer of the sick or a maker of money?” The answer, of course, depends on incentives.
When our daughter wasn’t gaining weight, our pediatrician referred us to a specialist. Before our first appointment,we researched online, decided to try a different baby formula, and voila – immediate weight gain. Did that dissuade the specialist from ordering numerous tests, scheduling repeat visits, and in general acting as if the outcome we wanted – weight gain – hadn’t already taken place? No, his office kept at it until we stopped returning their calls.
Medicare studies show that in areas with surplus supply (doctors & hospital beds), spend per patient is up to three times higher than in areas with tighter supply. Another study showed that doctors who own MRI and CT scanners are four times as likely to order a scan as a doctor who doesn’t. While in consumer-driven markets, excess supply leads to consolidation and price competition, in the healthcare market, demand and prices increase.
Our approach to healthcare has made it in the doctor’s financial interest to over-supply medical care. Here’s how a recent Citigroup research report summarized it: “The more patients that go to a physician’s office, the more disease gets diagnosed, the more specialist referrals are made, and ultimately the more hospital visits and profit is generated.” The Hippocratic ideal, with its focus on the patient, seems downright stodgy – and certainly less profitable.
Why the Insurance Industry Plays Along
No aspect of the healthcare market is as poorly understood as insurance. We saw above how insurance companies encourage higher prices because of their cost-plus payment structure. But if raising prices by double digits every year isn’t generating enough profits – and there’s no more growth from adding new subscribers – how else can the insurance industry make money? By increasing coverage of course.
This basic economic fact – that insurers only make money if health spend increases – is consistently misunderstood. How else to explain the common belief that insurers have incentives to see customers take better care of themselves, as if us spending less money on healthcare wasn’t bad for insurers? Or that having more procedures covered as preventive medicine (no co-pay) isn’t simply an excuse for insurers to raise premiums for everyone? “Forcing” insurers to cover more stuff simply allows the premium base to rise.
Expanding coverage is always supported by the insurance industry because it dramatically increases the scope of what they can charge for. Ten states require coverage of hair prostheses, while thirteen states mandate coverage of in-vitro fertilization, and in four states your massages are covered by insurance. Most recently, seven states are considering mandating gym memberships as preventive medicine. Just imagine what that will do to the price of joining a gym in those states, when everyone gets “free” memberships. Take that, insurance industry!
The Real Economics of the Healthcare Market
With a better understanding of market mechanisms, we can make some adjustments to how the healthcare market actually operates, which we see below:
There’s no longer a limit on demand based on a patient and their health issues; we’re all “patients,” and cost is based on coverage (easy to expand) rather than illness.
From an economics perspective, we’d say that insurance companies and the medical profession are able to increase demand, resulting in a rightward shift in the demand curve. This permits even higher cartel profits, which we see to the right.
This is, from what I can tell, a unique feature of the healthcare market today. I could find no other example where a cartel was able to control both supply and demand. Any other cartel must trade off higher prices for lower quantities. By giving insurance companies the ability to set price and coverage, and doctors the ability to determine treatment independent of need, we’ve created a hybrid that can increase both quantity and price, representing an historically unique combination that voraciously consumes our national (and personal) wealth. In fact, the distortions created by hiding and distorting prices – and removing the distinction between patient and consumer – results in another feature unique to this cartel: Demand higher than it would be in a competitive market.
Doctors fighting hospitals fighting insurers isn’t a sign of competition – it’s just different cartels fighting over our money while blaming each other for the country’s medically-induced insolvency. Some point to greed on Wall Street as the problem. But it’s not greed that’s to blame, but an industry structure that ensures ever-higher levels of spend, divorced from patient outcomes. I for one would love Wall Street to find a way to profit from real competition in healthcare. As patients (and taxpayers) we’d all be much better off.
What Have We Gained From the Healthcare Industry?
As I was researching and writing this post, my perspective was that while there was undoubtedly waste in the healthcare industry, net-net we are better off with a flawed system than none at all. But is that really the case?
To find out, I did some digging on average healthcare spend and lifespans across countries and over time. We see that below:
It’s probably no surprise that the U.S. has the lowest lifespan and spends the most; that’s the point of this post, after all. However, look at the country to the far right: It’s the U.S. from 1993, where I’ve adjusted for lifespan factors that aren’t directly impacted by the healthcare industry. Things like safer cars, less smoking, healthier fitness and diet habits. With those adjustments, we’ve spent more than $20T over the past 20 years to add a year to our lifespans. (The U.S. is not inherently sicker, fatter, older, or more litigious than other countries – see here).
To put those numbers in perspective: Every person who has died over the past 20 years could have been provided two options: Add that extra year to their life, or have $475,000 to spend as (or on whom) they chose. Put another way: Every new parent today could be given two options: Receive a check for $930,000 (factoring in predicted healthcare spend per year over a baby’s lifespan) to spend on their child as they wish, or enroll the child in our healthcare industry. Is there any doubt which option most of us would choose?
In the 1970’s, the RAND corporation conducted a series of experiments, putting patients into one of five groups, with varying levels of insurance (from “no insurance” to “free and full insurance”). While there was a strong relationship between healthcare usage and insurance, there was virtually no relationship between healthcare usage and health outcomes. Essentially, more insurance meant higher usage (cost) without better health.
There’s a more recent piece of research around healthcare spending and health outcomes: The Oregon Health Insurance Experiment. Here, poor patients are assigned different levels of Medicaid coverage, and their usage and health outcomes are tracked. Similar to the RAND study, while there is a clear relationship between coverage, usage, and cost, there appears to be little relationship between healthcare usage and health outcomes. Bummer.
In ways similar to the higher education bubble, we are seeing massive “investments” in healthcare with little apparent benefit. Just as students are graduating with massive debt and fewer opportunities, so too are patients getting hammered with medical bills that are inflated and delivering very little health benefit. Unlike the higher education bubble, however, the healthcare bubble is large enough to destabilize the entire economy when it pops.
This post has its genesis in some questions a client recently asked me: How does our customer satisfaction compare to what you’ve seen? What can we do to increase it? How will that impact our growth? The relationship between satisfaction and growth is something I’ve been thinking about for a while, but the client’s questions helped clarify my focus.
The notion of being customer-centric plays a prominent role in the mission and growth strategies of nearly every organization. Yet quite often, customer satisfaction levels and growth rates appear unrelated. While many growing companies have satisfied customers, so do companies with slowing or negative growth. And while some companies with abysmal satisfaction scores may be stagnating, I’ve seen companies with mutinous customers growing despite themselves.
Is it true that a focus on the customer is a bedrock strategy to initiate, invigorate, and sustain growth? Or is something inherently appealing (“The customer is always right!”) and seemingly straightforward more complicated than it appears? Once we’ve disentangled assumptions from facts, is a strategy based on satisfying customers a realistic way for most companies to grow? Or is customer satisfaction a flawed measure which simply reflects customers’ rationalizations of their past decisions, but says little about their future intentions?
Perceived Relationship Between Customer Focus & Business Growth
The assumed relationship between a customer focus and an organization’s growth is seen below:
On the surface, these relationships conform to what most of us expect. Listening to and focusing on what customers say matters to them should increase their satisfaction. Higher satisfaction should in turn positively impact loyalty. And loyalty should have a direct impact on a company’s long-term growth.
But a view from the trenches with a variety of clients has led me to question these assumptions, starting with the belief that there’s a direct connection between customer focus and customer satisfaction.
Does A Customer Focus Increase Customer Satisfaction?
Anybody who has worked to improve customer satisfaction understands how hard and frustrating it can be. In their seminal book, “The Discipline of Market Leaders,” Treacy and Wiersema describe three “value disciplines” that companies can follow: Operations, Product, Customer Intimacy. They estimate that fewer than 10% of companies have value propositions, resources, and systems sufficient to “win” with customer intimacy. Yet nearly every company believes their passion for the customer provides them a unique competitive advantage.
There’s no question that different companies have very different levels of customer satisfaction. However, much of this difference is based not on the company itself (including their level of customer focus) but the industry they’re in and the customers they (and their competitors) tend to serve. To show this, I analyzed the ACSI benchmarks by industry and their component companies over time. To the right is a summary of those results, for a variety of industries.
The top number is the compound annual growth (CAGR) in satisfaction by industry, ranging from -0.2% to +0.3% – essentially zero, confirming that improving customer satisfaction is hard and often unrewarding work. Below that is the satisfaction average by industry for the past 17 years. Not surprisingly, TV Subscriptions (cable, satellite, etc.) are dead last at 63, followed closely by Airlines. The number at the bottom is the difference between the best company in an industry and the industry average. The largest difference occurs with Internet Retail, with Amazon (unsurprisingly) the standout at +7 vs. its average competitor. In the other industries, the company with the highest satisfaction exceeds its industry average by less than 5%.
What these and other data show is that most satisfaction rate differences are due to the industry, not the company. Improvements in customer satisfaction – at least in established industries – are very tough to come by, once industry averages are achieved. (A key distinction; satisfaction laggards can and should improve their satisfaction rates.) Even the “best” companies in an industry often have similar satisfaction levels relative to the rest of the industry, due to best-practice imitation and similar customer demands. Further proof of the weak relationship between satisfaction and growth – the widely divergent growth rates of firms within a given industry relative to their nearly equivalent satisfaction scores.
For the few companies that have sustained a meaningful advantage in customer satisfaction vs. their peers, the key is the close tie between their operating model and value proposition (more on this in my next post). Having a passion for the customer simply isn’t sufficient. So to answer the question that began this section: Can a customer-centric strategy lead to satisfaction levels above industry levels? Yes, but not often and usually not for long. Setting aside a passion for the customer, are most organizations capable of truly distinguishing themselves in this regard? Probably not.
Does Customer Satisfaction Lead to Loyalty?
For most companies of course, customer satisfaction isn’t the goal, but the means to an end – business growth. A big driver of that growth comes from existing customers, when satisfaction translates into loyalty – both repeat business and share of wallet. (I touch on word-of-mouth below.) Because in all industries, over time, the growth of new customers slows and then declines, the company that can keep more of its customers will be most successful in the long run.
As expected, research has shown that there is a direct relationship between customer satisfaction and certain aspects of loyalty – things like motivation, emotion, and trust. Of course, trust is great, but what about behavior, what customers actually do? Well there it’s a different story. Turns out there is little evidence that higher customer satisfaction by itself translates to profitable behavior (see here). Researcher Robert Peterson has found that in most customer satisfaction surveys, 85% of an organization’s customers claim to be “satisfied,” but still exhibit willingness to switch providers. And a Bain study found that 60% – 80% of customers who defected to a competitor said they were satisfied / very satisfied on the customer survey just prior to their defection!
The simple fact is that customer satisfaction levels have almost no impact on customer loyalty. Many factors that impact loyalty are outside the immediate control of the company. While a company can, to some extent, influence these factors – focus on different types of customers, increase switching barriers, provide a consistent experience – simply increasing satisfaction will have very little impact on loyalty. Can and should companies focus on increasing customer loyalty? Yes and absolutely. Will customer satisfaction be a reliable way to get there? Probably not.
Customer Satisfaction & Growth – Why Companies Get it Wrong
Recent research tries to tie customer satisfaction directly to growth. As one researcher put it: “Putting instincts aside, is there any proof that satisfying customers is worth the effort, and, in fact, pays off?” The answer is, not really. A broad set of research examined the relationship between employee and customer satisfaction and their impact on growth. The verdict? There’s no consistent relationship. In other words, if you’re focusing on customer satisfaction (or employee satisfaction, for that matter) as the driver of your business growth, you’re probably going to be disappointed.
They say that in business, you manage what you can measure. Well, customer value is very hard to understand, much less measure, so organizations focus on something that they feel must be related to value: customer satisfaction. Companies believe satisfaction is a close substitute for value delivered and thus a good leading indicator of the “health” of their business.
Companies assume that satisfied customers become better, more loyal customers, so companies try to increase satisfaction. But they’ve got it backwards. The real relationship is that better customers tend to be – but are not always – more satisfied. This is a subtle but important distinction. Customer satisfaction and loyalty don’t themselves add anything to customer value. They are byproducts of delivering value, not the drivers behind it. In fact, research shows that high loyalty can result from even low satisfaction situations, when there are exceptional levels of customer value (e.g., low prices). This helps explain the coexistence of low satisfaction and high loyalty. We can therefore revise the original relationship:
Customer value drives loyalty, which leads to business growth. While customer satisfaction doesn’t directly lead to growth, copious research shows that there is a clear relationship between customer satisfaction (especially very low and very high levels) and (positive and negative) network effects like reviews and word of mouth. Customer satisfaction, when combined with loyalty and network effects, can therefore play a contributing role in improving both retention and acquisition.
Companies should be skeptical that they truly – intimately – understand their customers. Instead, treat customers like an iceberg: What you see – their satisfaction level – is only a small part of what motivates them. While a select few companies are able to peer beneath the water because of their distinct competencies and operating model, for most companies, mooring to an iceberg, ignorant of what’s below the surface, can lead to disaster.
To answer the questions posed by my client, I’d say this. Focus on value, not satisfaction. Satisfaction is a consequence, not a driver. Value tells a company what to do (gives it direction), while satisfaction tells the company how it is doing (gives a report card). Doing the wrong things the right way is a great approach if your goal is highly satisfied, former customers.
We reviewed the higher education bubble in two previous posts (see here and here). Today’s post is looking at the fuzzy thinking driving the bubble, as well as the larger issue of which the bubble is merely a symptom. But first things first – I need to congratulate my Duke Blue Devils for assuming their rightful place atop the college basketball rankings! And a preemptive apology to my thesis adviser at Northwestern, who may not care much for this post.
At its core, the bubble in higher education is being driven by the belief that a college education teaches skills that are vital to building a successful career, and that higher levels of education are tied to increased worker productivity. In other words, skills learned in school lead to higher productivity, which is rewarded by employers in the form of higher earnings for the well-schooled. Here’s the assumed relationship:
In Economics there’s the concept of asymetric information, where one party to a transaction has better information than the other party. Virtually all job markets have imperfect information. To cope with this asymetry, buyers look for shortcuts – ways to infer quality – using a process called signaling. In the case of the job market, employers look at both the level (how much) and quality (where) of education to signal the quality of the applicant.
In my professional career, I’ve seen consistently that higher levels of educational attainment lead to higher levels of income. This is especially true with workers under 40, who matured professionally as the higher education mania spread in earnest. We see this relationship in the chart below, based on 2010 Census data:
There’s a clear correlation between levels of education attainment and higher incomes. The more interesting questions involve causality – does higher education cause higher income, and if so, how, why, and should it?
An Important Distinction: Correlation vs. Causation
One of the more prevalent learning disabilities in organizations today is confusing correlation with causation, the notion that umbrellas cause rain or diet soda causes weight gain or even that a rock keeps away tigers. In a professional setting, I’ve seen this confusion lead companies to mistakenly justify expensive marketing campaigns, brand overhauls, even major changes to their strategic positioning. Let me share just one example.
Several years ago we were asked to optimize the Marketing performance of a large multi-channel business. The most successful marketing channel was catalog, with more than 100 million copies being sent to millions of customers every year. Like many direct-response companies, the team tracked if someone received a catalog and then placed an order online or in a store. Based on that key assumption, more and more catalogs seemed the way to go. But, we asked, did the catalog really drive the sale, or was it the umbrella that happened to be around when it was most likely to rain?
There happens to be a very easy way to figure this out (though surprisingly few companies do). We split the customer file into 2 groups. One group received the normal series of catalogs; the second group received no catalogs. Here’s what we saw in terms of sales and profit between the two groups (numbers disguised but directional).
Turns out nearly every customer who received the catalogs and ordered would have ordered without one. The company had mistakenly focused on one variable (received catalog) and seen a correlation with the desired action (bought something). But when we controlled for the impact of the catalog, we saw it was largely unnecessary. Could the same thing be happening with higher education and the job market?
The Assumptions Linking Education & Income
We saw that the relationship between education and income is tied through the assumed impacts of greater skill development and then higher productivity. Turns out, researchers have begun questioning these assumptions. One study showed that a majority of students gain few to no job-related skills while in college. A second study (one of many) showed that there was a negligible impact on worker productivity from higher levels of education. Finally, a Princeton study showed that when you take a student’s inherent skills into account, universities have minimal impact on future earnings. The first 2 studies challenge the assumption that higher educational attainment causes skills and productivity, respectively. The last study severs altogether the assumed causal link between educational attainment and higher income.
The chart above makes this point – there are causal factors related to the “level-of-education decision” which are also related to someone’s level of “skill.” For example, ambition is a causal factor that may lead both to greater consumption of education and to a job-related skill such as hard work. This is where the signalling function, unable to make such fine distinctions within causal factors, mistakenly attributes a skill to more education.
This isn’t to say that higher educational attainment doesn’t cause higher incomes; it does. But the assumptions underlying that relationship are wrong. We’ve assumed that something we can easily measure – educational attainment – is a handy proxy for the thing we really want to measure, productivity. But shortcuts can sometimes lead you astray. If we found ways to identify and measure actual causes of productivity, we might, among other things, stop wasting money on unnecessary education.
Why the Higher Education Bubble Isn’t THE Problem
At first glance, what’s driving the bubble is demand from students. However, the real driver is employers adding, “Degree required, advanced degree preferred,” willy nilly to every job description. If employers modified or severed the relationship between hiring and college education by better understanding the impact of a degree on what they care about – productivity – we could arrest the dangerous spirals of higher costs and poorer returns within the higher education market.
However, the bubble in higher education is caused by a bigger problem; a misunderstanding of what drives productivity and innovation. For example, an increasing amount of research (see here and here) shows the outsourcing of manufacturing has a direct impact on our capacity to innovate. This shift from “sweating” to “thinking” sounds compelling individually, but taken collectively is perhaps the biggest factor driving the oversupply of higher education. As I mentioned in my recent posts on strategy (here and here), high-level strategy (thinking) is founded on a lot of messy digging (sweating). If you don’t get your hands dirty (literally and figuratively), you won’t capture the insights that lead to long-term innovation and productivity.
This is an issue increasingly being studied and given attention. With the direct and opportunity costs we face, the sooner we confront and address these issues, the more confident we can be that our education dollars are being wisely invested, that our kids and grandkids aren’t being saddled with debt they can’t hope to repay, and that the asset that is our workforce – regardless of collar – is properly utilized.
The past post reviewed why getting strategy right is so important in generating sustainable growth. For the small number of firms that look at strategy as competitive positioning, the long-term growth rates exceed more tactical or planning approaches to growth management. This post will review why, despite clear evidence of the benefits of strategy, so little of what passes today for strategy is actually very good. It will also explain why the organizations most focused on growth are the ones most resistant to strategy.
Why Is Good Strategy So Rare?
While almost all organizations say they have strategies, many don’t. I used to think this was because organizations had limited or faulty data, or conducted poor analysis of the industry and competitors. And to some extent, this remains true – failure to understand the internal and external environments limits growth options. But the more I have worked in this field, the more I’ve come to appreciate the more subtle and pervasive obstacles to clear strategic thinking, and how challenging it is for companies to develop and maintain their strategies over time. Some of these inhibitors are described below.
* Operational focus. There’s no question that operational excellence – covering things like quality, productivity, and speed – can have a significant and immediate impact on an organization’s performance. What makes this approach so popular is that it includes a series of best practices that are straightforward to replicate. Michael Porter uses the concept of a Productivity Frontier to describe operational excellence; I’ve added some modifications below to show the dynamic nature of industry operational focus.
There are two dimensions – customer value and price position. Companies choose which operations to optimize – often based on perceived core competencies – providing operational focus. As organizations approach operational optimization, competitive conflict intensifies, often resulting in mutually destructive competition where the customer wins at the expense of industry profit. While productivity frontiers can shift out (via new technologies, for example), the operational focus sparked by Japan in the 1980s has decreased the distance between the average firm and their industry’s efficiency frontier. So while there’s no doubt that operational excellence is a necessary condition for an organization to succeed, it is a mistake to count on past operational excellence to sustain tomorrow’s growth imperatives.
* Resources vs. resourcefulness. Good strategy works by focusing energy and resources on one, or a very few, pivotal objectives whose accomplishment will lead to a cascade of favorable outcomes. Organizations are often evaluated in terms of resources, when the proper perspective is resourcefulness. Recently I met with an executive team to discuss their growth strategy. They believed that an additional round of funding would be needed to ‘size-up’ the company in terms of headcount and capabilities, to be ready to seize new opportunities if they arose. The rationale was, “If only we had more resources, we could be more strategic.” Yet, it was apparent to me that the real issue wasn’t a lack of resources but a lack of focus, an inability to separate the good ideas from the bad, and too little thinking about how to leverage existing resources (versus the capacity to outlast rivals). Showering these executives with more resources without a fundamental improvement in their ability to leverage resources is wasteful; they’ll be back, asking for more.
* Missing skill sets. In most organizations, the executive team is responsible for laying out the strategic course and ensuring proper execution. While excelling at the latter, most executives struggle with being strategic. The skill sets that get managers to senior levels – problem solving, political acumen, drive, resource planning and allocation, department management – are largely irrelevant (or even counterproductive) to creating effective strategy. Strategy involves creativity, something that is hard to quantify and measure, and thus not focused on by most executives. Compounding matters, executive separation from the day-to-day details of the business impacts the quality of their strategic thought. Effective strategists immerse themselves in the daily detail while being able to abstract the strategic messages from it. They connect acting to thinking which in turn connects implementation to formulation. They understand that we think in order to act, but we also act in order to think. When there’s a disconnect between these two, the result is fuzzy thinking, which often leads to bad strategy.
* Failure to balance long- and short-term. Many organizations struggle to reconcile and mutually support both short- and long-term goals. Most companies allocate resources using tactical capital-budgeting mechanisms that stress easy- to quantify measures like cash flow or economic value add. This means that strategic opportunities that defy easy or accurate measurement – longer-term projects, cross-departmental initiatives, brand new initiatives – often times won’t pass the review process and are deferred until next year, when additional analysis may justify them.
* The evolution of capital markets. As the capital (and secondary) markets have evolved, they’ve become increasingly toxic for strategy. The single-minded pursuit of shareholder value, measured over the short-term, has been enormously destructive for strategy and long-term value creation (see my post here). Managers are chasing the wrong goal, spurred on in part by industry experts and analysts who push companies towards “competition to be the best,” where companies are exhorted to look like the current market favorite. Good strategy does the opposite, creating tangible differences between an organization and its competitors. While different is hard, and risky, it’s the only way to sustain long-term growth.
* False consensus. People consistently overestimate the extent to which others share their views and beliefs, through things like confirmation bias, selective recall, and group-think. I’ve been part of executive discussions where the CEO might say, “The executive team is 100% behind our strategy,” then have 1×1 conversations with key executives where it’s clear substantial differences of opinion remain unresolved. Or hear, “I’ve only heard great things from our dealers and customers,” then conduct research that finds significant dissatisfaction. Failure to confront and address disagreements honestly can lead to missing key strategic threats/opportunities or cause organizations to persist with doomed strategies.
So Why is Good Strategy Rare?
Strategy involves focus and, therefore, choice. And choice means setting aside some goals in favor of others. Many organizations are unable to make these choices, coming up with lists of things to do based on what a variety of stakeholders would like to see accomplished. I’ve seen lists of 100+ “strategies” cover every available surface in conference rooms. Calling these strategies doesn’t change the fact that they’re really just things to do. Typically by the end of the retreat, the daunting nature of so many “strategies” is acknowledged by adding the label “long-term” to the list.
The necessity of choice is what causes organizations most focused on growth to be the most resistant to strategy. Trade-offs and limits give the appearance of constraining, not sustaining growth. A conscious decision to limit competitive scope – be it through geographic, product line, customer, or other factors – may appear to place limits on an organization’s growth ambitions. And indeed it may, in the short term. But the alternative, trying to be everything to everybody, nearly always results in an erosion of competitive advantage with target customers and creates confusion and undermines organizational motivation and focus.
The widespread lack of strategy, and corresponding heavy operational focus, is driving competitive convergence, as benchmarking and imitation leaves competitors increasingly homogenous and industries racked by wars of attrition. Industry consolidation continues to accelerate, as organizations, driven by performance pressures but lacking strategic vision, have no better ideas than to buy up rivals. The competitors left standing are often those that outlasted the others, not companies with real advantages. In which case, a strategy of finding undiscriminating investors may not be such a bad one after all.
We see today organizations of all sizes attempting to keep their feet on ground that is slipping away from under them. In many of these organizations, the tug of war between strategy and tactics is increasingly shifted towards the tactical, towards “doing” and away from “thinking.” It’s easy to see why. Tactics are straightforward to execute and provide instant gratification, whereas the creation and outcome of strategy is uncertain and can take years to make a significant impact, if ever. For many – both organizations and individuals – the seemingly urgent drives out the important; the future goes unexplored; and the capacity to act, divorced from the capacity to think and imagine, becomes the measure of leadership.
The Key Question Confronting Every Organization
Most organizations will confront important questions: How can we attract more new customers? Why are our retention rates decreasing? What impact can our brand have on short-term and long-term performance? What are our customer segments, and on which should we focus? Are there product/service changes that can target new buyer segments? Should we grow via acquisition or international expansion? How should we be thinking about innovation? What are our competitors planning? All of these questions ladder up to a broader question confronting all organizations: How do we ensure an acceptable level of sustainable growth?
Achieving sustainable growth is not possible without paying heed to the twin cornerstones of growth strategy and growth competence. Companies that pay inadequate attention to one aspect or the other will struggle in their efforts to establish practices of sustainable growth (though short-term gains may be realized). In many organizations, the sacrifice of the long-term (strategy) on the altar of the short-term (benchmarking and copy the leader) is having a profound impact on long-term growth.
Today’s post will focus on the state of strategy in many organizations today. Subsequent posts will cover why strategy is so misunderstood, ways to think about strategy in a metrics-driven organization, and how best to ensure effective strategic implementation.
The State of Strategy in Organizations Today
I’ve had the opportunity to work with a variety of organizations – from Fortune 500’s to start-ups. Despite many differences, one thing has consistently stood out: An inconsistent or nonexistent approach to strategy and the corresponding impact on the organization’s culture and long-term prospects for growth. An honest assessment would conclude: It’s a mess out there.
In many organizations, there is a nearly exclusive focus on operational execution – these are the tacticians. This approach largely ignores the external environment and often includes only a superficial understanding of internal dynamics and culture. Tacticians believe there are key levers and best practices that drive success in almost any environment, including areas like human capital, customer management, supply chain management, and marketing and sales. We’ll see below that while operational excellence does impact growth, it can’t sustain it.
Other organizations use annual retreats or off-sites to strategize for the upcoming year – these are the planners. This approach focuses on the planning cycle, where financial goals are enumerated, gaps based on current trends are measured, and a series of initiatives are articulated to help close the gap between trends and forecast. This approach is largely a tactical planning exercise punctuated with the occasional burst of heroic (sometimes ill-conceived) “strategic” investments. We’ll see below that this approach rarely makes a significant impact on growth.
Another group uses a set of analytical techniques to identify internal strengths and weaknesses and external opportunities and threats – these are the positioners. Mapping internal capabilities against external realities, it is the strategist’s job to ‘position’ the organization within its environment in a way that makes its position unassailable from current or future competitors. Based heavily on the tradition of military strategy, the ultimate goal is to amass resources with which to consolidate current positions while expanding beachheads into new areas.
Several years ago, strategy boutique BCG presented results from a longitudinal research study looking at growth rates based on different organization’s approach to strategy. Below are the 3 approaches (plus industry growth) and their corresponding growth rates:
Whether by chance or design, organizations that find themselves in a growing or transforming industry can maintain growth simply by treading water in a rising tide. Organizations that don’t recognize this boost can be caught unawares when growth suddenly slows, however. With the tactical approach, we see a very quick and significant boost to growth when best practices are instilled, but this boost can’t sustain growth long term. The planning approach has little impact. Within weeks, as immediate challenges need to be addressed, the agreed upon strategies are shelved until preparation for the next offsite begins. Finally, the positioning approach yields the biggest and longest incremental growth rates, but also requires the most creativity and patience, two traits in short supply in today’s tactics-driven organizations.
In my next post, I’ll explore why strategy is so misunderstood in many organizations today.
The Wall Street crash of 1929 – 1933 that precipitated and exacerbated the Great Depression led to a series of stringent financial regulations. The S&L crisis of the 1980s resulted in the prosecutions of hundreds of executives. What has been called the Great Recession of 2008 has, 4 years later, resulted in neither regulations nor prosecutions, despite a self-professed reformist president being elected in 2008 by an electorate demanding reforms. In Jeff Connaughton’s new book, The Payoff – Why Wall Street Always Wins, we get an insider’s perspective as to why even common-sense, highly popular reforms aren’t enacted: “In Washington, only the Wall Street lobby is concerned about fraud investigations. And their concern is to prevent them.”
For more than 2 decades, Connaughton spent time in Washington as part of the Permanent Class, both within government and as a lobbyist. Tying himself to Senator (and now Vice President) Joe Biden, he used that relationship to make millions as a lobbyist. While technically a Democrat, as a lobbyist Connaughton was indifferent to the politics of his clients. “The rest of the country may be divided into red and blue, but DC is green, and cheerfully so.”
When Biden became Vice President, his senate seat was filled by Ted Kaufman, who immediately declared that he wasn’t going to seek a 2nd term. “I later learned from reporters that Wall Street was frustrated that they couldn’t find a way to harness Ted, because he wasn’t running for re-election” said Connaughton, brought on board as Kaufman’s Chief of Staff. Both Kaufman and Connaughton vowed that they’d spend their two years “fighting for accountability for the financial crisis…to ensure there would never be another one.”
Yet after 2 years, Connaughton admits failure and predicts another crisis: “There have been no high-profile prosecutions…the stock market has become even more dominated by computer-driven trading, too-big-to-fail banks continue to act lawlessly…and regulatory reforms are being written with the help of Wall Street lawyers.” Why is this? How did the biggest financial catastrophe in more than 60 years change nothing? People looking for a smoking gun will be disappointed. “It’s not a tale of bags filled with cash and quid pro quos.” Then what is it?
Simple self-interest: “Party cohesion and the desire to make a munificent living go a long way to enforce silence” and conformity, says Connaughton. Politicians don’t represent the voters, they represent themselves. The simple fact is that of all a politician’s constituents, corporate interests are best able to guarantee a payoff: Money now, to stay in power, and money later, with a career as a lobbyist or other special interest. Few are willing to “burn every bridge…set flame to the ship that would take me back there,” as Connaughton has done.
Politicians are supposed to represent us, the voter, but don’t. But why should this be shocking? In private enterprise, employees are supposed to represent their customers. Be in business long enough, though, and you know how often we compromise our dedication to customers. When exploring how something as horrible like Auschwitz could occur, Theodor Adorno found, “One pursues one’s own advantage before all else and, simply not to endanger oneself, does not talk too much.” If this describes our corporate culture, it surely describes our political culture as well. (I discuss the corporate culture here.)
This book isn’t as well written as something we might see from Michael Lewis. It’s a bit dry, and in some parts it seems most concerned with settling scores (Biden comes off as thoroughly unlikable). But for anyone interested in understanding why nothing substantive has changed on Wall Street over the past 4 years, this book is a must read.
Today’s post on the higher education bubble is the first of three updates of last year’s post. This post will incorporate additional research and insights to help explain how we got where we are today. Subsequent posts will examine ways to deflate the bubble and long-run implications for the higher education industry.
When we look at higher education today, there are 4 key players: Schools, Government, Parents, and Employers. Let’s quickly review how each contributes to the education bubble.
To understand how Schools impact the bubble, we have Bowen’s Rule:
- The dominant goals of institutions are educational excellence, prestige, and influence.
- There is no limit to the amount of money an institution would spend on these goals.
- Each institution raises all the money it can, and spends all it raises.
- The cumulative effect of the preceding is toward ever increasing expenditure.
This rule is not contested by any research, shows how non-profit schools simply substitute wasted spend for profits, and explains why we might not expect schools to contribute to a solution. Former Harvard president Derek Bok states, “Universities share one characteristic with compulsive gamblers: there is never enough money to satisfy their desires.” Per Robert Martin: “Higher education finance is a black hole that cannot be filled.” Or Ronald Ehrenberg: “Administrators are like cookie monsters…They seek out all the resources that they can get their hands on and then devour them.”
To understand the role of Government funding on the bubble, we have Bennett’s Hypothesis 2.0:
- Individually, each college is trying to improve.
- More revenue is very useful in the quest for improvement.
- An increase in financial aid gives colleges the option to raise revenue by raising tuition.
- Most colleges succumb to this temptation; therefore, higher financial aid = higher tuition.
Economics professor Richard Vedder looks at the rapid rise in tuition the past 30 years. “What happened? The federal government has started dropping money out of airplanes.” Economist Bryan Caplan agrees. “It’s a giant waste of resources that will continue as long as the subsidies continue.” Argues Jonathan Robe, “Cheap student loans (backed by the government) make students far less price conscious, and enable schools to raise tuition because they know if the student can’t pay, the buck gets passed on to the taxpayers.”
Parents send their kids to college so they will learn valuable skills while increasing their lifetime earnings potential. Regarding skill development, in Academically Adrift Richard Arum finds that 1/3 of students gain no measurable skills in college, and for the rest, the gains are minimal. Regarding future earnings, data does conclusively show that earnings increase as the level of education increases. Of course, correlation isn’t causation. To this point, Princeton economist Alan Kreuger finds that when controlling for student’s talent, top-tier colleges add no measurable value to lifetime earnings.
It is unlikely that parents would voluntarily reduce the amount of education they demand for their children, given incentives today. Peter Thiel argues that parents are terrified about what will happen to their children if they don’t go to college. Parents are “Paying for college because it’s an insurance policy against falling out of the middle class.”
Finally, Employers, who have also benefited from the bubble. Increasingly business looks at college degrees as a minimum job requirement, not because of any benefit from the degree (or requirements of the job), but simply because they need an easy way to screen applicants (Doesn’t have a degree? Must be lazy or dumb). Argues professor Richard Vedder, “Employers seeing a surplus of graduates are just tacking on that (degree) requirement.” The result is credential creep into many jobs which manifestly do not require a college degree. Employers have little motivation to change the way they operate – they’re hiring overqualified people at bargain rates.
So where do we stand today? Outstanding student debt recently passed $1 trillion, based on costs increasing 900% over the past 30 years (12x more than the price increases that led to the housing bubble). Meanwhile, wages of college-educated workers are unchanged and a recent study found that 53% of bachelor’s degree holders under 25 are under- or unemployed. This combination has led to student default rates of up to 15%. With that number increasing every year, it seems likely that some sort of correction is inevitable. The scale and scope of this correction depends on where things go from here. That’s a topic for the next post.
In the quest for happiness and meaning, bits of wisdom fly at us constantly – from friends, strangers, even fortune cookies. But little sticks. Proust said, “We do not receive wisdom, we must discover it for ourselves.” In The Happiness Hypothesis, Jonathan Haidt beautifully combines philosophy and science into a page-turning, exhilarating exploration of ancient and modern ideas about happiness and the human behaviors that affect it. If Proust is right, and we need to discover wisdom, Haidt provides a great map.
We begin with metaphor – a novice rider seated on an experienced elephant – representing thinking vs. automatic process. What can make the relationship contentious is that while the elephant (our limbic system) has been around for a million years, the rider (our frontal cortex) has been around for only 40,000 years. Our body, not entirely trusting the new part, has cleverly installed an override mechanism for the elephant to take control in times of trouble.
When there is harmony, there is happiness, while disagreement leads to unhappiness. Conflict occurs because the elephant, focused on survival (gene dissemination), sees danger everywhere, even when it doesn’t exist, constantly vetoing our commands to be open and receptive. From an evolutionary perspective, this makes sense. For a rabbit, missing a meal is not the end of the world; another carrot will come along. But miss the owl overhead just once and its game over. For the rabbit (and for humans), mere survival equates with success.
But doesn’t success lead to happiness? For most definitions of success, no. Haidt describes a “hedonic treadmill,” where expectations rise at the same pace as success (wealth/prestige). Even when we do reach our goals, we receive no lasting happiness; all we’ve done is “raise the bar for future success.” Our judgement about now is based on whether it is better or worse than what we’ve become accustomed to. “Adaptation is just a property of neurons: Nerve cells respond vigorously to new stimuli, but gradually they habituate.” Haidt drives this point home by showing that lottery winners and quadriplegics return to their base levels of happiness within weeks of striking it rich or losing control of their body.
It’s ironic how hard it is to permanently increase your happiness. The Greek perspective was fatalistic: “Call no man happy until he is dead.” In the Declaration of Independence, we have “the pursuit of Happiness,” implying a strenuous, potentially unsuccessful effort. Professor Darrin McMahon points out, “In virtually every Indo-European language, the modern word for happiness is cognate with luck, fortune or fate.” Happ was the Middle English word for “chance, fortune, what happens in the world,” McMahon writes, “giving us such words as ‘happenstance,’ ‘haphazard,’ ‘hapless,’ and ‘perhaps.’ ” This view of happiness is essentially tragic: It sees life as consisting of the things that happen to you; if more good things than bad happen, you are happy.
But the heart of this book is optimism and discovery. Not only does Haidt give insight into how to become (and stay) happier, but the read itself is full of insight and learning. The ground covered is eclectic: Western moral philosophy; ideas of virtue in the sacred writings from India, China, and the Mediterranean cultures; the bonds between parents and children; the latest scientific research in biology, psychology, and sociology. Haidt easily explains challenging topics in everyday language, where discussions of the brain rub shoulders with the sayings of the Buddha, and the evolutionary reasons for gossip share the page with discussions of karma.
The Happiness Hypothesis is a wonderful and nuanced book that provides deep insight into the some of the most important questions in life: Why are we here? What kind of life should we lead? What paths lead to happiness? From the ancient philosophers to cutting edge scientists, Haidt weaves a tapestry of the best and the brightest, culminating in a stunning, final chapter on living a meaningful life. A truly inspiring book.
Over the last three decades, the dominant mode of corporate economic thinking has been shareholder value. A reaction to the corporate excesses and wastes of the 70’s and early ’80’s (see the gripping Barbarians at the Gate), this straightforward and seemingly commonsensical theory holds that the primary purpose of a corporation is to maximize the return received by its ‘owners’ – shareholders.
The general appeal of shareholder value is its simplicity: Shareholder wealth is measured by a company’s stock price; through the collective wisdom of the market, the stock price captures a company’s short-term performance and long-term prospects; management is aligned with shareholders through the use of stock-based incentives; and the free market transforms corporate interest into society’s best interests. On the surface, an entirely reasonable and logical approach, with the exception that every assumption is in fact false.
In Predictably Irrational, Duke professor Dan Ariely demonstrates that short-term thinking often dominates long-term thinking, even when the latter is more rationale and leaves us better off. From eating a doughnut to buying an unaffordable car, the benefits of the short-term are clear, while the future costs – health issues, a deferred retirement – are ambiguous, hard to prove, and accumulate over time. The conclusion is that humans are not the fully informed, highly rational beings assumed by market theory. Confounded by contradictions, befuddled and bewildered, the only thing predictable about us is our irrationality. To use Freud’s terminology, our id (the desire for immediate pleasure) dominates the superego (our conscience), despite our ego’s (rational self) best efforts.
We should be skeptical, therefore, of any economic plan that assumes individuals can properly balance the short and long term. Indeed, the father of classical economics, Alfred Marshall, wrote in 1890 that individuals “act like children who pick the plums out of their pudding to eat them at once.” Well-known economist, AC Pigou, opined in 1920 that, “Our telescopic faculty is defective.” No matter how hard we squint, the future won’t come into focus. And so we focus on what we can see, the short term.
By failing to incorporate these fundamental facts of human nature, shareholder value has led to a seemingly endless string of catastrophes. From the frenzy of the housing bubble to the encouragement of highly dubious (and continuing) wagers
in the financial industry, from extreme inequality of wealth, to BP’s Deepwater Horizon catastrophe, the singular focus on short-term shareholder value has had devastating consequences, not only for society but for shareholders themselves. As Lynn Stout persuasively argues in The Myth of Shareholder Value:
In the quest to “unlock shareholder value,” management sell key assets, fire loyal employees, and cut back on customer support; drain cash reserves to pay large dividends and repurchase company shares, leveraging firms until they teeter on the brink of insolvency.
But if shareholder value is based on faulty assumptions (see here and here for powerful critiques and prescriptions), and has wrought such devastation, if even “neutron” Jack Welch now calls it “the dumbest idea in the world,” how has it lasted 30 years? In Hans Christian Andersen’s The Emperor’s New Clothes, two charlatans create a suit of clothes so fine that they are invisible to anyone unworthy. Though the emperor’s subjects think him mad, they all pretend to appreciate his new clothes; to claim otherwise would announce their unworthiness. When charlatans set the rules, it’s easier to prolong a farce.
So if the despotic reign of shareholder value is ending, what will take its place? Some argue that focusing on the customer is the place to start (see here, here, here). Given what we know about individuals, can we expect them – in their roles as customers – to act in a collectively enlightened, long-term manner? I have my doubts – for instance, a customer demand for the lowest prices has led in part to many objectionable practices by Wal-Mart, from outsourcing to bribery to below-subsistence wages. And customers’ insatiable demand for fast, affordable, and tasty food has put a lot of dollars in McDonalds’ pockets while contributing to billions of dollars in medical expenses.
However, I think that individuals are the best focus when they are more fully informed and better organized. What if we had an impartial scorecard to evaluate companies based on how they treat key constituencies – not just shareholders, but customers, employees, their communities, the environment? And what if there was a way for us to organize ourselves, to express our satisfaction or dissatisfaction to companies in a way that mattered to them? It’s unlikely that we as individuals can persuade companies to pursue non-profit motives. However, it is in our power to control their profits, and hence, their behavior, by deciding whether to patronize them. All we need is knowledge, a way to combine our influence, and the will to potentially sacrifice our short-term interest (convenience, price, etc.) for a better future for us and our children. Groupon may fail, but it has unleashed a powerful idea, providing a blueprint for regaining our economic and social equilibrium.
“The only difference between those who have failed and those who have succeeded lies in the difference of their habits. Good habits are the key to all success. Bad habits are the unlocked door to failure. I will form good habits and become their slave.” (Og Mandino)
For adults, the argument between nature vs. nurture has some sense of fait accompli. What we inherited from our parents has long since been determined, and as we age, our environment would seem to make only minor alterations to the tapestry of our lives. However, there’s a layer between “who we are” and “what we are,” namely, habits. “Habits are so strong that they cause our brains to cling to them at the exclusion of all else, including common sense.” What seems like free will, of making carefully considered decisions, is in fact nothing more than acting out our predetermined rituals. In other words, habits govern decision making, and decision making governs our lives. If our life is a tapestry, in each of us resides a tailor.
The noted American psychologist William James developed a lifelong passion for understanding habits. “Begin to be now what you will be hereafter.” James believed that what we are comes from what we do, that what we do is based on habits, and that habits are based on attitude. However, while various psychologists over the years have taken a variety of approaches to changing habits, it’s only now with sophisticated brain imaging that we are starting to see the neurological impacts of habits, giving us new clues into how to identify and change them. While the formula still eludes us (you can only learn so much from shocking rats and stuffing them with chocolate), Charles Duhigg has brought us a few steps forward in his book, The Power of Habit: Why We Do What We Do in Life and Business.
According to one Duke study, over 40% of our day is done on autopilot, like getting dressed, commuting, even our relationships. While autopilot is the brain’s way of conserving energy, it tends to shut out the present moment and all that it may contain: dangers, opportunities, insights, connections, warnings, and solutions. Yet we know that neuroplasticity remains with us through our adult years. Which begs the question: If our brains can change, then why is it so hard to erase bad habits?
Duhigg draws on the research from a variety of areas – advertising, sports, addiction, religion and others – to show how habits are created and endure. We learn about the three-step “habit loop” and how our brain looks for ways to save effort by first looking for “cues” or triggers, followed by a “routine” to follow that is physical, mental or emotional and finally a “reward” that determines if the loop is memorable enough to become a habit. Duhigg does a fine job of explaining habits, how they work and indeed how to change them.
The more we do something, the less thinking we do – it becomes hard wired into our brains. Which means using willpower will be insufficient, we’re literally fighting our brain. To change the behavior, we have to establish a new rut, until it becomes hard wired. That’s the good news: Once something becomes hard wired, it’s very hard to change, even if you want to. The key is doing the thing enough times that it becomes a habit, has created its own rut. This is called “chunking” – the brain converting a sequence of actions into a routine.
Some habits are incredibly powerful – Duhigg calls them keystone habits – because they seem to trigger a cascade of other habits, which, taken together, can quite literally change everything. For instance, studies show that families that practice the habit of eating together instill between homework and academic habits in the children. These key habits are different for everyone, but Duhigg offers guidance for how you can find yours.
The book isn’t perfect. Duhigg points to habits as the underlying cause for everything from successful marketing campaigns to Super Bowl victories. While it’s possible that the Indianapolis Colts won the Super Bowl because of habits, a simpler explanation might be that a historically great quarterback was steering the ship. This isn’t to say that the examples aren’t compelling, just that they should be taken with a grain of salt.
For people looking for a formula to changing your life, this isn’t the book for you. Says Duhigg, “This book doesn’t contain one prescription. Rather, I hoped to deliver a framework for understanding how habits work and a guide to experimenting with how they might change.” So read this book as a way to glean insights into your own life. And be grateful that, unlike a laboratory rat, you control if your life is filled with sweets or shocks.
“What’s the use of running if you’re on the wrong road?” (German proverb)
“A man of thought who won’t act is ineffective; a man of action who won’t think is dangerous.” (Nixon)
Perhaps no business concept is as debated and often misunderstood as strategy. Professionals often hear the advice, “Be strategic,” but few understand what exactly that means and how to go about it. There’s a vague sense that they should be “doing” less and “thinking” more, that their focus should shift from the trenches to the battlefield. And in some ways this is true; strategy needs to encompass a broad perspective that takes many pieces and players into account. However, many would-be strategists fail when they don’t base their strategies on a solid foundation of facts.
There are several critical components to developing effective, even game-changing strategies. The first is access to unfiltered data, raw information. This can take many forms: proprietary databases, website analytics, industry publications, customer surveys, and in-the-field interviews. Just having data isn’t enough, though. You need to know the right questions to ask, which patterns to look for and how to interpret them. The analysis is what generates insight, and it is from insight that potential strategies are formed. Strategy, then, is developed from an intimate and analytical knowledge of a company and its ecosystem.
In most organizations, the generals setting strategy have little interaction with the troops, the ones with boots on the ground. There’s a dividing line that separates the functions. At most, strategists get reports that have been filtered and scrubbed (what analysts pejoratively refer to as “idiot lights“), effectively neutered and incapable of generating real insight.
Those with access to raw information often don’t have the experience and overarching visibility to ask the right questions and generate insight. Conversely, the executives – the ones counted on to lead the company – do have the experience and visibility, but without access to the data, they don’t know which questions to ask, and so are left with answers to questions that may or may not be the right ones. It’s like asking a general to storm a hill, or a grunt to manage the battlefield. Neither is equipped for the task.
There’s a recent, very public and very expensive example of how failure to dig into the details by a CEO led to a strategy which, in a matter of weeks, bled billions of dollars from JP Morgan’s coffers. As recounted in The Wall Street Journal:
On April 30, associates who were gathered in a conference room handed Mr. Dimon summaries and analyses of the losses. But there were no details about the trades themselves. “I want to see the positions!” he barked, throwing down the papers, according to the attendees. “Now! I want to see everything!” When Mr. Dimon saw the numbers, these people say, he couldn’t breathe.
Dimon’s failure wasn’t that he didn’t have a system in place to analyze the data, or an executive team setting strategy. It’s that he and his strategists didn’t insist on raw, unfiltered and unsummarized data. His failure was not getting into the detail of what his team was doing, not lending his significant experience and expertise. If he had, it’s conceivable that JP Morgan would be billions of dollars richer than it is today. As Michael Schrage argues, “There’s a reason why great chefs visit the farms and markets that source their restaurants: The raw ingredients are critical to success.”
Of course, leaders can’t spend all of their time in the detail. In What Got You Here Won’t Get You There, Goldsmith and Reiter make this point explicitly. Indeed, people get promoted because of their ability to execute operationally, but are then implicitly admonished to cross the divide separating thinking from doing, to become visionary leaders. Yet in Great By Choice, Jim Collins finds that successful leaders aren’t especially bold, visionary, or innovative. Instead, “They observed what worked (data), figured out why it worked (analysis), and built upon proven foundations (strategy).” A somewhat boring approach, perhaps, but effective.
Strategy isn’t easy, but it’s not rocket science either. You have to understand your market, your customers, your direct and indirect competitors, and the intricacies of the systems in which you operate. You must use your analytical skills to ferret out key insights. And these insights must then be tied to strategies.
For a broader perspective on the strategy journey from beginning to end, see this recent McKinsey article.
Thoughts/questions? Ping me on Twitter (@JeremyArnone)
Historically, companies have driven earnings growth via robust demand, first domestically and then internationally. As worldwide economic growth has decelerated the past 10 years, companies have increasingly relied on cost-cutting programs to buoy earnings. However, with much of the easiest cost cutting already occurred (we can hope), many companies are unsure where next to find an earnings boost.
When it comes to ways to drive earnings growth, pricing always takes a back seat to higher volume (demand) and reducing variable costs (such as me or you). This despite the fact that a 1% increase in price leads to an average 8% increase in operating profit, 50% higher than a similar decrease in cost, and 300% higher than a 1% increase in volume.
On the other hand, a decrease in price has the exact same effect on earnings. For example, a 5% fall in price would require a nearly 20% increase in volume to make up the decrease in earnings. Whether because of “market conditions,” a Sales team “closing the sale,” or an attempt to spur volume, it’s almost impossible to increase demand sufficiently to justify significant price cuts.
So why does pricing not get the respect (and fear) it deserves? I think there are several reasons. Because most companies don’t understand the power of pricing, it’s not prioritized. In addition, pricing is hard; few companies have the knowledge and experience to tackle it effectively. Plus, many companies have a “gut feel” that raising prices is bad for their long-term health, and isn’t a customer-friendly approach. And lastly, driving growth via pricing just isn’t as sexy as entering new markets and attracting new customers. “Board, our strategy this year is to raise our prices by 3%. Questions?”
To see how this might work in action, I’d like to share the growth challenges confronted by a large B2C merchant. The data is disguised to ensure confidentiality.
The company is looking to improve customer acquisition. Management has preliminary discussions about lowering prices, increasing shipping discounts, and spending more on marketing. With the main selling season just 6 months away, the company needs to make a decision quickly. What should it do?
We started by running a series of pricing tests, to understand the impact on share, sales, and margin of different price points. Here’s what we found:
This analysis showed that, contrary to the team’s assumptions, the price which would drive the greatest sales was not the same price that would drive the highest share. In fact, the price difference was almost 20%. And the margin-maximizing price point was nearly 40% higher!
This analysis also showed a major problem. While the company’s advertised price was at the high end of the range, their margin performance was closer to the low price. Why? Because while the company was using the higher price in its marketing and sales collateral, it was offering a series of promotions and discounts to close the sale. In other words, they were getting the (lower) share of a high price and the (lower) margin of a low price, the worst possible combination.
Our recommendation was to reverse this relationship, to advertise the lower price and then work to increase the price during the conversion process. This would increase the volume at the top of the conversion funnel and, if managed well, increase the final price paid without a significant impact on conversion.
We also recommended a segmentation strategy which better identified prospect and customer segments. We saw very little variation in the price paid across the customer file, which can indicate an inefficient matching of needs and willingness to pay.
Finally, we suggested a more consistent use of value-add offerings. There were a variety of internal and external products and services which could complement the existing product to improve conversion, net price, and customer satisfaction.
Through the use of web analytics and the customer database, a customer segmentation project was initiated. Based on existing behavior and purchase histories (standard RFM augmented with clickstream, demographic, and survey data), a number of high-level segments were created. The use of discounts on the site and with the Sales team was reduced, while advertised prices were lowered closer to the share-maximizing level. Key parts of the website – with a focus on the order process – were changed to improve the check out process, reducing the number of steps required to complete an order while also adding in upsell and cross-sell opportunities where appropriate. This had a significant impact on the net price paid, which we see below, and yielded significant increases in market share, sales, and earnings.
In the overall marketing mix, price is the most important item that can affect a company’s profitability. How to set prices and measure their impact on a company’s business model, however, is less clear. Too many times, the focus of pricing is related to short-term competition or internal cost structure. To develop an effective pricing strategy, it’s important to integrate meaningful customer input based on company and competitive offerings, in order to answer the following types of questions.
- Is our goal market share, revenue, or profitability, and do we know the optimal price for each?
- What is the value we provide to customers, and does our pricing reflect this value?
- What do we know about our customers and can they be segmented based on willingness to pay?
- How do we leverage non-product components to increase the value (and price) of the product?
Management must create an environment that encourages marketing, product, and finance to develop the necessary inputs and to work together to develop the optimum strategies. This is no easy task, but the benefits of a comprehensive pricing strategy compared to on-going reactive pricing can be tremendous.
I’m new to the book review field, but my impression is that the review should encourage the person to actually read the book. If true, the books I’ve read most recently seem especially poor choices for possible reviews. As Jenny can attest, my book reading habits illustrate an interesting masochistic (why won’t this book ever end?!) amnesia (wait a minute, I do like 700-page biographies of a bank). Of course, with baby #2 due shortly, I can say the same of her.
So I was left to peruse my bookshelves and came across Straight Man, a wonderful novel by Richard Russo. Best known for his Pullitzer winning novel, Empire Falls, in Straight Man Russo presents us with a novel equal parts tongue-in-cheek comedy and complex personal commentary, the offspring from a late-night rendezvous between Portnoy’s Complaint and Confederacy of Dunces. Within the first 3 pages I was laughing out loud, repeatedly and uncontrollably.
Our protagonist is William Henry Devereaux, Jr., the interim and reluctant chairman of the English department of West Central Pennsylvania University, a second-rate school in the middle of nowhere. In the span of a few days, Devereaux will have his nose mangled by an angry poet, imagine his faithful wife is having an affair with his dean, wonder if a curvaceous adjunct is trying to seduce or kill him with peach pits, urge a student to “always understate necrophilia,” and publicly threaten to execute a duck (actually a goose) a day until his department is funded. All this while coming to terms with his brilliant but morally bankrupt father, the dereliction of his youthful promise, and the ominous failure of certain vital body functions.
Straight Man is an amazing read and very well written. It’s a hilarious expose on the foibles of academia, in particular the red tape and infighting among typical institutional organizations, where “the higher the degree of fighting, the less there is to fight for.” Yet it transcends mere critique, requiring and facilitating self-reflection. It shows the desperation that comes with the failure to follow the early arc of a life’s potential and promise, the searing truths about life’s missed opportunities. Encapsulating this failure, many can relate to Russo’s comment that, “We will make it. Why this fact should be so discouraging is what I’d like to know.” But while the book asks sometimes uncomfortable questions, it’s compassionate in softening the blow of answers we don’t like, of the recognition that perhaps it’s the questions and assumptions that are flawed, not our lives.
As he did in Nobody’s Fool, Russo proves a master of depicting the fraught, unvoiced currents that run between parents and children, husbands and wives, friends and colleagues. In his intelligence, humor, and ability to merge sorrow and farce into a seamless fabric, Richard Russo stands out as a writer of surpassing insight and humanity.
I found myself, at the end of this richly funny book, pondering the nature of comedy and the uses to which we put it. It struck me that the tragic-comic is a kind of default setting of drama, because as flawed humans we can only stand so much tragedy before we short-circuit into irony or farce. But that makes humor a way of deadening pain, of undercutting it’s power. No other author is able to effortlessly straddle the line between heartbreak and hilarity. Perhaps Russo’s greatest gift is to show that we need less a sense of responsibility and more a sense of humor. In Russo’s world, the tonic for heartache is lightheartedness.
Jenny and I took our moms to Italy several years ago. My favorite part of the trip was the glorious countryside of Tuscany, where we stayed just outside magnificent Montepulciano, a short hop from Florence down the A1. In the background you might just be able to make out the rustic bed and breakfast where we stayed.
While I can’t make it to Tuscany on a moments notice, I can, thankfully, recreate at least one thing – the cuisine. It’s one of my favorite ways to spend a lazy Sunday afternoon. Open a bottle (or two) of wine and congregate in the kitchen while I make one of my favorite dishes – spaghetti and meatballs. The tastes and aromas bring back memories of our trip. This recipe, borrowed from America’s Test Kitchen, with just a few of my own modifications, is fast, easy, and best of all, delicious.
We start with the wine. Our favorite is one of the remarkable reds from Chateauneuf du Pape (southern France). Sadly, despite our best efforts to be disciplined, we finished the last of those months ago. If you do get the chance to stock up while there, you can take back 6 per person, and save yourself $70 a bottle. For today, any red in the $15 – $25 range should do. Today’s is a Malbec, conveniently left from a previous dinner.
What separates this recipe from others I’ve tried is the meatballs. The biggest questions with meatballs are: How do keep them in one piece while remaining tender, what are they made of, and how do you cook them? Meatballs are tricky little devils. Make them too soft and they fall apart in the sauce (many of my Ragus started as meatballs). Give them structure (usually with bread crumbs) and they lose some moisture and tenderness. The solution is replacing bread crumbs with high-quality white bread, which helps add stability while maintaining the right texture. Another dilemma is what meat to use. I’ve tried ground pork, turkey, and beef, but the flavor was always bland. Then Jenny suggested hot Italian sausage (pork or turkey), mixed evenly with ground beef. The result is incredible flavor. Lastly, the cooking method. Frying on the stove is very messy and the results are inconsistent. This recipe eliminates those issues by first baking the meatballs before they’re put in the sauce.
There are 3 components to the recipe: The onion mixture, the marinara, and the meatballs. For folks in a hurry, a store-bought sauce is acceptable, with just a couple of embellishments, which I’ll cover below.
We’ll start with the onion mixture. This will be used in both the sauce and the meatballs. Heat the oil in a large Dutch oven (I prefer Le Creuset for the even heat conduction), medium high until the oil shimmers. Add the minced onion, stirring occasionally until golden, 10-15 minutes. Stir in the garlic, oregano, and pepper flakes until fragrant, about 30 seconds. Transfer half the mixture to a large bowl and set aside. Use a food processor to save time and tears.
Next is the marinara. Add the tomato paste to the remaining onion mixture in the pot and cook until fragrant, about 1 minute. Add the wine and cook until thickened slightly, about 2 minutes. Stir in the water and tomatoes and simmer over low heat until the sauce isn’t watery, about 45 minutes. Stir in the cheese and basil and season with salt and sugar to taste. The recipe calls for Parmesan in the sauce, I’ve found it unnecessary.
For the meatballs, heat the oven to 475 degrees. Cut the mozzarella into quarter-inch cubes, about 50 will do. Mash the bread and milk in the bowl with the reserved onion mixture. Add the sausage, beef, Parmesan, eggs, garlic, and salt and mash to combine. As you begin to form the meatballs, insert 3-4 of the mozzarella cubes into the center and close the meatball around it (you should have about 16 meatballs). Place the meatballs on an oiled and rimmed baking sheet, and bake until well browned, about 18 minutes. Transfer the meatballs to the pot with sauce and simmer for 15 minutes.
Overall this takes an hour or so, from start to digging in. The food processor can save you 5-10 minutes, depending on how quickly you can chop. Replacing the marinara with a store-bought version saves another 5-10 minutes. This last time, I substituted 3 jars of my favorite sauce and just included the basil, and onion mixture. The sauce is enhanced by adding the wine, but personally I prefer to drink it. As for the cheese you insert in the meatballs, get creative, almost any soft cheese will do. I’m going to try Brie next time.
- 1/4 cup olive oil.
- 3 onions, minced.
- 8 garlic cloves, minced.
- 1 tbs dried oregano.
- 3/4 tsp red pepper flakes.
- 1 (6-oz) can tomato paste.
- 1 cup dry red wine.
- 1 cup water.
- 4 (28-oz) cans crushed tomatoes.
- 1/2 cup Parmesan cheese, grated.
- 1/4 cup chopped fresh basil.
- salt and sugar to taste.
- 4 slices white bread, torn into pieces.
- 3/4 cup milk.
- 1 1/2 lbs hot Italian sausage.
- 1 1/2 lbs lean ground chuck (85%)
- 1 cup Parmesan cheese, grated.
- 2 large eggs, lightly beaten.
- 2 garlic cloves, minced.
- 1 1/2 tsp salt.
The analytics revolution sweeping across many organizations has yet to be fully incorporated into Sales organizations. Despite recent progress, having tools like Salesforce.com and Google Analytics is simply insufficient. Far too few organizations are combining proven Sales approaches with a true analytical mindset to ask and answer the right questions.
We have seen 3 waves of analytics in Sales: the late 1980s, the late 90’s with Siebel Systems, and more recently, with Salesforce.com and similar tools. Surveys show widespread dissatisfaction with CRM implementations, and Big Data tools like Salesforce.com are not well utilized or even understood. Despite this, executives are encouraged to invest just a little bit more – Big Data goodness is just around the corner.
Clearly there’s a major disconnect between Big Data promises and the reality in most Sales organizations today. Before investing more resources, senior executives should make sure they’re on the right path, by taking the following steps:
- Use segmentation to identify customer traits correlated with their KPIs.
- Prioritize segments based on the incremental impact from sales.
- Tailor KPIs (and salespeople’s incentives) for each segment.
To see how this might work in action, let’s explore a recent engagement where a leading enterprise confronted this situation. The data is disguised to protect confidentiality.
The company has seen impressive growth based on a model of marketing driving leads and sales turning leads into customers. With growth slowing, it is considering significant investments in marketing and sales, but is concerned about the impact on profitability. What should it do?
We started with a deep dive into the analytics, correlating 3 primary KPIs (conversion, average revenue per user (ARPU), and LTV) with 17 variables contained at the user level within Salesforce.com and proprietary databases. We used this segmentation to calculate expected values on each KPI based on the type of user. A sample of these values – conversion rates – is listed below.
While interesting, this analysis begged the question of where the sales team should focus. To find out, we broke each segment into a control and a test group. The control group received the standard outbound email and phone contacts from the sales team. The test group received no outbound contacts from the sales team – essentially Sales was turned off. The difference in performance is listed below.
There were several interesting insights. The first was an eye opener: The sales team’s impact on conversion wasn’t 20% but only 5%; surprisingly, 15% of customers in the test group converted without contact from Sales. About half the leads were from Broadcast media, very unqualified, but still took 60% of the sales team’s time. Leads from online marketing channels had a very high conversion rate when contacted by sales, but saw a more than 50% decrease when not contacted. And the most active leads – using the product most frequently – actually converted worse when they were contacted by the sales team!
The last step was to move beyond conversion as the sole KPI, focusing on LTV for each segment. For segments with very low conversion, we moved further up the funnel, testing micro-conversion events (such as a whitepaper download or attending a webinar) and allowing users, with minimal direct guidance, to move down the funnel at their own pace. For segments with already high conversion, we focused lower in the funnel, exploring ways to increase ARPU (via upsells and cross-sells) or decrease future churn (via onboarding).
A scoring model was automated within Salesforce.com, with a recommended content and contact strategy put in place for each segment. The least qualified leads were assigned to an auto-responder campaign, and outbound contact from the sales team was significantly reduced. This freed up time for the team to focus on other opportunities, including retention, ARPU, and outbound prospecting. It also saved more than $1M by demonstrating an expanded sales team was unnecessary. Meanwhile, marketing shifted their mix from broadcast to online marketing channels, increasing ROAS by 120%.
Many companies are reluctant to tinker with their approach to sales – even minor inefficiencies can jeopardize revenue. Plus, incorporating new ways of thinking requires coordination across the entire organization, from sales, marketing, analytics, support, and finance – and the consistent support and direction from the top. Much easier said than done.
However, substituting analytics for gut instinct and basic CRM reporting helps take the guessing game out of important investment decisions. Using test-and-control techniques popularized in the direct response world can show the true impact of the sales team and better prioritize their focus and objectives. Executives need to understand what’s going on within the sales organization, starting with some basic questions around analytic competencies and capabilities. Rather than invest in systems, tools, and training, many companies would be better off hiring a couple of very inquisitive, analytical problem solvers, and provide them cover to ask all sorts of interesting and (potentially) uncomfortable questions. The end results will very likely be faster, cheaper, and better than any outsourced or automated solution.
Few books can combine the eminent readability of a pulp fiction thriller with the penetrating insight of a biography, the precision of biology, the encompassing breadth of history, and the compassion of a cancer clinician. Like a master alchemist, Siddhartha Mukherjee combines these to produce a work of distilled magnificence – The Emperor of All Maladies, a biography of cancer.
I was a somewhat reluctant reader, wondering if a topic as macabre and frightening as cancer would make a good read. I wouldn’t, for instance, find a biography of car crashes or parachute failures to be especially interesting. The difference is that Mukherjee is able to identify an implacable, ever-resourceful protagonist, an anti-hero, and then recount how we’ve been engaged in a 5,000-year struggle to understand and establish supremacy over our own bodies. From Egyptian hieroglyphics circa 1600 BC (describing a breast cancer and the chilling prognosis: “None”), to the almost tragically comedic “insights” of ancient Greece, from nineteenth century recipients of crude radiation and chemotherapy, to the many false leads of the first half of the twentieth century, to the past 20 years of comprehension and progress.
From a strategy perspective, what I found fascinating was the contrast between the top-down approach to curing cancer vs. the bottom-up approach, which focused on the internal goings-on of the cell. In the fight against cancer, we see that a blanket spending of billions of dollars had almost no impact on long-term survivability (between 1971 – 1990), but that the science (and prognosis) dramatically improved when researchers started from the ground up, exploring at a cellular level the link between cancer and genes. Many companies create strategy in the Boardroom with limited understanding of the appropriateness of the strategies given conditions “on the ground.” Conversely, companies that patiently inform their strategies with careful analysis are better prepared, with a road map for success.
But the soul of The Emperor of All Maladies is the author’s recognition that all of the progress and discovery and development come at the cost of human suffering, that the biography of cancer is composed of the mini-biographies of every patient. “A patient, long before he becomes the subject of medical scrutiny, is, at first, simply a storyteller, a narrator of suffering – a traveler who has visited the kingdom of ill.”
Mukherjee doesn’t promise a cure, and alternates between guarded optimism and resignation. For every patient who sees sustainable remission, there are others with seemingly identical conditions who fail to respond, for whom palliative care is the best prescription. The reality is that Cancer may always be with us -the Greek word onkos means “mass” or “burden.” As Mukherjee writes, “Cancer is indeed the load built into our genome, the leaden counterweight to our aspirations for immortality.”
But onkos comes from the ancient Indo-European nek, meaning to carry the burden: the spirit “so inextricably human, to outwit, to outlive and survive.” Mukherjee has now seen many patients voyage into the night. “But surely,” he writes, “it was the most sublime moment of my clinical life to have watched that voyage in reverse, to encounter men and women returning from that strange country— to see them so very close, clambering back.”
While there isn’t yet (and may never be) a happy ending in our fight against cancer, the past 30 years have seen improvements that dwarf what we’d seen in the previous 5,000 years. We haven’t beaten cancer, but we’re on more equal footing everyday, and it’s now as worried about us as we are about it.
“GIANTS OF WALL STREET, IN FIERCE BATTLE FOR MASTERY, PRECIPITATE CRASH THAT BRINGS RUIN TO HORDE OF PYGMIES.” (New York Herald, 1901)
“I owe the public nothing!” (JP Morgan, 1901, after bankrupting thousands to protect a monopoly.)
“We can have a democracy or we can have great wealth in the hands of a comparative few, but we cannot have both.” (Justice Louis Brandeis)
“If the American people ever allow private banks to control the issue of their currency…the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their fathers conquered.” (Thomas Jefferson)
This is a post about our free market system. It’s not a post against the free market – that market enabled me to become reasonably successful despite very humble beginnings in a Montana trailer park. However, like many Americans, I feel that something beyond the normal business cycle is wrong with our society today, that hard work, dedication, and talent are no longer enough to live the American Dream. The homeless on seemingly every street corner are a daily reminder that there are millions of people in similarly desperate situations. I rejoice in the happiness that my daughter has brought into my life, but cry when I envisage her as 1 of every 6 children in our country today – impoverished, with little hope or future. There is nothing worse than hopelessness in a country founded on hopes and dreams.
There are different ways to measure the success or failure of an economic system. I’m going to use wealth inequality because I believe that there’s enough evidence to support this as a prime contributor to our economic and cultural dislocation today. I know that some will disagree, including several close friends and relatives. They believe that recent economic, political, and legal trends, as reactions to what others see as social wrongs, signify an all-out assault on the American way of life, an attempt to replace the interest of the individual with the interests of the State. I don’t mean to demean their perspective – in fact, I will do my best to address and incorporate it, as it is based on a fear I share: That we risk a loss of personal and economic freedom to an extent rarely seen in the history of our Grand Experiment.
Most Americans believe in the founding principles of this country – freedom from economic and political tyranny. The founders, as political refugees, understood that the concentration of wealth, taken to an extreme, could lead to vast political power and render republican rule impotent. Were the Founders alive today – where 10% of the people control 80% of the wealth – they might wonder what their Revolution accomplished. Certainly George Washington would reconsider a winter spent at Valley Forge.
Enough data exists so that we can make several arguments against the inequality of wealth that exists in the U.S. today. The first and most obvious argument is that the allocation of wealth is undeserved, that there’s a
rigged mechanism whereby the winners decide who wins. The ongoing debacle that passes for our Banking system makes this point clear (see here, here, here, here, here, here, here). It has been persuasively argued, and several studies appear to show, that such concentration of wealth leaves the overall economy worse off. (see here, here, here). And then there’s this: Extreme inequality of wealth inexorably leads to the loss of personal and economic freedom for everyone.
There’s a seemingly potent counter-argument to this skewing of income and wealth. To some, these inequalities are unfortunate but natural outcomes between those who work hard and those who do not, those who are extraordinarily talented vs. those who are not, those with perhaps a bit of good luck vs. those who never catch a break. Oftentimes, Adam Smith’s invisible hand is referenced as an impartial arbiter of success, as the best way to maximize economic utility in a fair and unbiased way. But few economists (or households) consider Adam Smith particularly relevant 3+ centuries later, and certainly not in a rigged game.
Regardless of how we got here, even if this skewing of wealth is somehow justified, the consequence is a loss of freedom for all of us. A seminal book on the danger to freedom of concentrated economic power was Friedrich Hayek’s, The Road to Serfdom. Hayek’s insight was that the centralization of economic power into the hands of elites (of any political persuasion) leads to a political and economic dependence hardly distinguishable from slavery. Hayek saw that a loss of economic freedom leads to a loss of personal and political freedom, as individuals become reliant on and subservient to the state. Importantly, Hayek didn’t distinguish between “good centralization” and “bad centralization.”
Hayek argued that centralized planning is inherently undemocratic because it enables a small minority to impose its will on the people. What gives the minorities this power is the disproportionate share of wealth they control – wealth that directly translates into coercive power. To the defenders of the free market, Hayek’s warning about the dangers of collectivization (appropriation of private property) rings true, and helps explain their visceral reaction to taxes of all kinds. However, what they fail to appreciate is that Hayek’s warning is applicable to every type of concentrated economic planning, whether the politicians themselves do the planning for political ends or if they’re beholden to financial oligarchs with profit motives. Hayek’s view was that by its very nature, centralization was repression by (or through) the state over the individual.
Let’s look at a recent consequence of wealth inequality – the Affordable Care Act of 2010. To some of my friends, this law is a nearly unprecedented reach by the state into the economic freedom of the people. And I’m personally uncomfortable with the precedent set by the individual mandate. Yet I believe the ground from which this law sprung was made fertile by distorted free market principles, a symptom of and response to a much deeper malady, rather than the malady itself. We start with the vast transfer of income from those who desperately need it to those who don’t.
But this is just the beginning of the story. We add in skyrocketing medical costs from the insurance, medical, legal, and pharmaceutical industries – taking more money out of the average American’s pocket and transferring it to the top of the pyramid via wages or investment income. The cost situation is further exacerbated by a decades-long fight against any restrictions on tobacco or junk food – waged in the name of individual/corporate freedom – that leads to epidemics in cancer and obesity-related diseases. Lastly, the reduction in the safety net further reduced accessibility to increasingly needed health care. The confluence of all of these factors led to a humanitarian and fiscal crisis from which sprung the Affordable Care Act.
It’s important to our story, and of no small irony to note that the healthcare law passed only with the support of the Insurance industry. That this law was opposed by so many of the fervent free market advocates is telling. Someone with deeper pockets got what they wanted – guaranteed, consistent profits. A careful reader of Hayek would be unsurprised – even if you think your interests matter most, there’s always someone with deeper pockets whose interests will trump yours. In a true Democracy, a bigger checkbook wouldn’t impact legislative outcome. The fact that it so clearly does today shows just how far we’ve strayed from our Founding ideals, and why all of us – not just the poor or middle class – should be worried about increasing economic inequality.
The seeming paradox of how a large majority is ignored in a democracy is of course explained by the outsized impact of money. Studies have shown that politicians respond directly to whomever is writing them the biggest check (regardless of party; both Democratic and Republican politicians ignore the voter except during campaigns). If we can’t remove money’s influence from politics (and Citizens United guarantees that), then we need to adapt to that reality, play by those rules. I think that can be done in several ways, which I’ll explore in a subsequent post.
It’s this last metric – Churn – that is almost universally considered the most important metric to improve (see David Skok’s excellent analysis here). To demonstrate that churn is, in some situations, perhaps not the right place to start when looking to improve business results, I’ll review the following:
- The LTV associated with improving each metric.
- The impact of time on when benefits are realized.
- The relative improvements you can expect on each metric.
- Other factors to consider.
To make the comparison easier, I’m going to start with David’s churn number, while estimating ARPU and conversion. For us, that means churn at 5%, ARPU at $50, and conversion at 15%.
Let’s start off by assuming we can improve each KPI by the 50% that David uses for churn improvements (from 5% to 2.5%). This means ARPU increases from $50 to $75, while conversion goes from 15% to 22.5%. If we look at the LTV impact of each change, we see the following:
So far so good. On an individual basis, reducing churn by 50% has the same impact as improving both ARPU and conversion by 50%. But a lifetime is a long time to wait, though. In this example, let’s plot the impact of each metric on a monthly basis.
While the overall impact of churn is the largest, you have to be patient. Based on these assumptions, you have to wait between 3 and 4 years before the impact from churn exceeds the impact from increasing ARPU and Conversion. For instance, after two years, you’d have received a 250% higher return from ARPU/Conversion than you would from Churn.
Up until now, we’ve assumed that we can impact each KPI by a given amount. We should relax this assumption for two reasons:
- Every company will be performing differently on a relative basis, influencing which KPI represents their lowest-hanging fruit.
- KPIs earlier in the customer life-cycle tend to be easier to impact. In general, this means that conversion > ARPU > churn.
So let’s see what happens when we adjust each KPI, taking into account the relative ease with which we can do this (hypothetically). Let’s improve conversion by 40%, ARPU by 30%, and churn by 20%.
Every company must establish baselines for their KPIs in order to understand the likely impact of optimization programs. It may be realistic to improve churn even more than ARPU and conversion; it just depends on your (relative) starting point. For relatively well-managed companies, reducing churn (or improving retention) is less simple (and more expensive) than generally understood. I’ve seen great companies hammer away at churn/retention numbers for months, even years, without making a dent, once the easy improvements were made.
There are additional factors that should be understood before embarking on a churn/retention improvement pogrom. Here are just a few:
- Significant costs. These might be direct costs – salespeople, customer support, your product team. They can also be opportunity costs – for example, every dollar spent on reducing churn is a dollar that could have been spent on the immediate benefits of customer acquisition.
- Number of customers. I’ve seen fixed cost components of churn/retention programs average 30%. As the size of the customer base increases, these costs are spread over a greater number of customers, improving unit economics.
- Acquisition economics. Your willingness to invest in churn/retention improvements depends in part on your costs to acquire new customers. Generally speaking, as your acquisition costs increase (and/or as market growth slows), retaining existing customers becomes more important.
- Stay/go impact. How much impact do you have on the customer’s stay/go decision? If you have a relatively low impact on that decision (e.g., if your customers are small and often go out of business), churn/retention strategies may not work for you – focus instead on improving your other KPIs.
- Lag factors. How long it takes to see significant impact on your metrics is an important consideration. Conversion testing can yield results in days/weeks; ARPU generally takes months. Churn/retention strategies can take years to get right / reach full impact. Make sure you build these ramp up times into your decision process.
This analysis attempts to show that the usual recommendation of focusing on churn as the most important KPI is overly broad. A combination of general and company-specific factors need to be accounted for prior to deciding upon which metrics to focus.
This analysis assumes that a company focuses on one KPI at a time. While it’s possible to focus on multiple KPIs concurrently, in my experience this typically leads to sub-optimization for all KPIs, especially for smaller companies with less experience and more limited room for error.
For a company unsure where to start, I’d suggest the following steps:
- Accurately measure your current and historical KPIs.
- Compare your KPIs to industry averages, establishing a baseline.
- Estimate direct & opportunity costs associated with KPI optimization programs.
- Model out the expected impact from each program and prioritize accordingly.
Written in reaction to an excellent post from Umair Haque.
Earlier today I read about a study which concluded that there are significant differences between how the wealthy and non-wealthy view the world. http://t.co/66N9aay At the risk of over-generalizing, in general the rich are more selfish and less empathetic than those less well off. I thought of that tonight as I read your excellent article.
The reality is that within many developed countries, income inequality has never been greater. While this by itself is both economically and morally repugnant to many of us, what sets our era apart from those that came before is what activities are driving this disparity. In the early 20th century, someone like Henry Ford was hundreds of times more wealthy than the average worker, yet it was undeniable that the products (and processes) that Ford introduced had a profound and positive impact on society in general and the working class in particular (wages increased by a factor of 10 for Ford’s employees). I believe that few of us would begrudge an innovator reaping their just reward in such a case.
Contrast that with the activities driving the income disparity today. With increasingly rare exceptions, it is sycophantic corporate boards lavishing tens of millions of dollars on their CEOs, regardless of the value that CEO adds (and often despite the damage the CEO has caused). It is private equity and large financial institutions gambling hundreds of billions of dollars on exotic financial instruments that have no proven economic or social value. It is high-frequency traders who make money by using lightning-fast computer programs to take money from traders using slower computers. Nearly all of these activities are, AT BEST, zero-sum; that is, someone wins and someone loses, but no value is created (1-1=0). Not only that, but many of these activities are negative-sum (1-1-10=-10); due to leverage, these activities are essentially making bets with other people’s money, with the potential to bring down entire economies and devastate millions of families. And how is this carnage penalized? Well, by mortgaging our future to make these people whole, by using monetary policy (QE1, QE2) to artificially inflate the equity markets, largely benefiting the people who least need a helping hand.
I grew up poor – in fact we spent several years on welfare. Years later, a close relative (just down the hall in our trailer in fact), had the good fortune to marry into money. I’d love to say that I started getting emails and phone calls requesting donations to worthy causes. Instead, just last year, she joined the Tea Party. Someone who 15 years ago was wholly reliant on the taxes of others now scorns those less well off, as if somehow they have chosen a ‘lifestyle’ and should be made to suffer for it. While this irony is apparently lost on her, it’s something I think about constantly. Human dignity is too precious to sacrifice to outdated economic theories, selfishness, and political incivility.