Transcript The Science of Success

The Science of Success
The Economics Chapters
Chapters five, six and seven
Knowledge Processes
Chapter 5
Echoing Hayek
Market economies are successful, in large part,
because they are superior at creating useful
knowledge. The main mechanisms of this
knowledge generation are market signals from
trade—prices, profit and loss, and free
speech. (SoS, p 99)
“Knowledge fuels prosperity but signaling and
guiding resources to higher-valued uses.” p.
101
A basic observation about how markets work.
(And exactly how does this happen?)
“A company must draw on the knowledge
dispersed among its employees.” (ft 4)
(Cites Hayek)
(Not “The Use of Knowledge in Society,” but a
related paper.)
Measuring things
“It is tempting to measure things that are easy
to measure; instead we should measure things
that matter, even when it is tempting to do
so.”
(Looking for the car keys under the lamp post.)
In a section citing Porter:
“Generally, a business person should attempt to
be a price seeker rather than a price taker.”
“This is best done by discovering new ways of
creating of creating value that are difficult to
imitate.” p. 107
Price will lie between cost and value.
(not a quote, but the gist of this this discussion)
Marginal Analysis
(Enough said, but let’s do it anyway.)
“Marginal analysis entails weighing the costs
and benefits of a change.”
“Marginal analysis looks at the benefits of costs
and benefits associated with a specific change
rather than the average or the whole.”
First, optimize, then do marginal
analysis
• “When considering an expansion, it is wrong
to conclude that because we already have
excess people, we don’t need to include the
expense of adding any. The analysis should be
done with the excess people removed from
the base case and added to the extent
required in the expansion case.”
• Interesting, difficult.
Benchmarking
• Ok, this isn’t really economics, but it is worth
mentioning.
• Southwest airlines studied NASCAR pit crews.
(Again, not really economics)
Back to work, opportunity cost
“The true cost of any activity is the highestvalued activity forgone.”
Again, basic economics, but it goes on…
“[P]rofit can be increased by eliminating some
profitable, value-adding activities when doing
so enables a business to capture higher valued
opportunities.”
This really has little to do with our
theme, but
“Don’t measure yourself by what you have
accomplished, but rather by what you should
have accomplished with your ability.”
p. 110
John Wooden, UCLA basketball coach
(The quote is related, loosely, to opportunity cost)
Nice opportunity cost example
Koch Material Company had an asphalt plant that
was profitable. However, a sales representative
becomes aware that a company was looking for a
location for a casino. He considered that even
though the plant was “consistently profitable,”
the land would be more valuable as a casino site
than as an asphalt plant.
(It’s now a casino. The asphalt plant was relocated.)
Profit Centers
Pages 110 – 112. Will be a nice introduction to
the transfer price discussion.
“Profit centers can be created wherever there
are identifiable products, market prices,
customers, suppliers and assets such that
profit statements can be prepared.”
Essential to the M form enterprise
Pioneered at DuPont and General Motors, profit
centers allowed accountability for the
separate divisions.
Chapter 6. Decision Rights
“Markets maximize benefits [when they are]
supported by externally enforced property
right rules that prohibit taking without giving
in return.”
-- Vernon Smith (ft 3)
“Some Economics and Politics of Globalization,”
Speech given at North Carolina State University, March 2, 2005.
(This was the first Pope lecture)
In this chapter….
there is a discussion of the general role of
property rights in the economy. Property
rights create powerful incentives for people to
act to create wealth.
In the absence of secure property rights, all
investments are insecure. The worker cannot
be sure that she will receive the value of her
work. We see this in play in many of the third
world economies.
Then this theme is brought to the
business
“At Koch industries we use decision rights to
attempt to replicate the beneficial roles of
property rights in society. Decision rights can
be thought of as property rights in the
organization. We create decision rights by
making sure that employees have clearly
defined roles, responsibilities and authorities.”
“Decision rights should reflect an employee’s
demonstrated comparative advantages.
On Local and General Knowledge
Those with local knowledge are often in a better
position to solve the problem at hand. The
ideas and creative energy of all employees
should be leveraged…
Continuing
• “Some decisions, if made at the local level,
can be unprofitable because a broader
perspective is required”
• “The mindless application of either
approach—universally centralized or
completely decentralized is not the answer.”
Chapter 7 Incentives
“At Koch, we use incentives to attempt to align
the interests of each Koch employee with the
interests of both the company and society.”
P 139
Pilgrims and Convict Ships
In 1620, the Pilgrims’ property was held in
common. … Everyone worked for the
collective, with equal rewards to equal
rewards to all, no matter how much a person
contributed. After two and a half terrible
years…”
Parcels of land were given to families. Things got
better.
(Reported by William Bradford, Governor)
Convicts to Australia
Initially, captains were compensated by the number
of convicts put on the ships. Mortality rates were
high. The incentives were to pack as many men as
possible on to the ships and to feed them as little
as possible. Mortality rates were high.
Basing compensation on the number who got off
the boats in Australia reduced mortality and
improved the health of the convicts that arrived.
Outside agents
Common practice is to pay agents a percentage
of total sales.
Koch pays a higher commission rate, but on
margins (price less opportunity costs). This
practice induces the agents to focus on profits,
rather than total sales.
Ranching
• Recognizing that people don’t go into ranching
for money but for lifestyle, of which a big part
is working with their families, the policy of not
letting family members work on the ranch was
changed. Further, houses were built on the
ranch for each family.”
• “The ranch immediately attracted a far
superior work force.”
One more thing
“At Koch Industries, we don’t reward roles.”
Dropping back to introduce transfer
pricing
p. 110
“Transferring products using a cost based system
leads to faulty profit signals and bad decisions.
Sometimes, restricting our business units to
buying internally can be just as wasteful.
These profit-distorting practices are especially
wasteful when they are used to prop up a
struggling business or plant.”