There is no reason to be upset with BofA for its new debit-card fees.

The ATM Debit-card fee is transparent and easy to understand.  This is far preferable to the spate of fees (such as overdraft insurance charges) that were opaque and confounding.  If Bank of America wants to charge for a service, they should be free to do so. 

Will the private market step in?

Conforming loan limits in San Berardino and Riverside Counties in California will drop from $500,000 to $417,000 tomorrow; in LA and Orange Counties it will drop from $729,750 to $625,500. 

So we have a natural experiment in "crowding in."  Will the private lending sector fill the gaps?

Austerity is a problem, but so is fear

Paul Krugman this morning argues that fear of fear is phony.  He is almost certainly correct that fear is not the number one problem at the moment--if I had to pick a number one issue, it would be austerity measures at the state and local levels of government.  Tracy Gordon of Brookings has a nice picture:

 Cuts in state and local government jobs (police officers, school teachers, firefighters, DMV workers) are putting a drag on employment growth.  Moreover, this picture understates the problem, because total compensation to many state and local workers has been cut.

But I do think fear is part of the problem, at least in one sector of the economy.  It seems to me that there are business opportunities in lending that are going unanswered.  The pendulum for underwriting has swung so far to caution that according to the Flow of Funds Accounts, net lending declined in the second quart of 2011.  More specifically, net bank lending dropped by $181 billion on an annualized basis in the first quarter and by $129 billion in the second quarter.  Net lending is the difference between volume of new loans and volume of repayment of old loans. I do find it plausible that one of the sources of the tight lending environment is a fear of regulators.

One more point.  if it weren't for lending by the monetary authority, net lending in the second quarter would have fallen by $860 billion on an annualized basis.

My friend (and co-author) Andy Reschovsky wins Steve Gold award

It was nice to read about it this morning:

University of Wisconsin–Madison economist Andrew Reschovsky will be honored in November with the 2011 Steve Gold Award, which recognizes a person who has made a significant contribution to public financial management in the field of intergovernmental relations and state and local finance.

The Association for Public Policy Analysis and Management, the National Conference of State Legislatures and the National Tax Association give the award each year in memory of Steve Gold, an active member of all three organizations whose career and life tragically were shortened by illness.
"I knew Steve Gold, which makes receiving this award even more meaningful," says Reschovsky, a professor of public affairs and applied economics in UW–Madison's La Follette School of Public Affairs. "As a public finance economist, Steve believed his role was to communicate to policymakers about research and analysis. His emphasis on the link between scholarship and practice and on policy-oriented work on public finance has very much influenced my career."

Amazon vs. Apple? No, it's Amazon and Apple vs. Everyone Else

To me, there's something magnificent about a well-executed product strategy.  Features and price and marketing all come together to delight a particular type of customer, and everyone wins.  The developer gets to sell a lot of products, and the users get something that improves their lives.

In the tablet market right now we have the privilege of watching two companies do great strategy, Apple and Amazon.  The press wants to label the Kindle Fire an iPad killer, but really it's the first sensible iPad counterpoint, a tablet device with its own unique design center and business model.  I don't think either one's going to kill the other, but I think together they're likely to chop up almost every other company that gets in their way.  In particular, that means Microsoft, RIM, and Google.

Let me start by talking about the new Kindle line, and then its likely impact on the market.


Two tablet paradigms

When Apple entered the tablet market, it asked "what can we do to redefine computing for tablets?"  It re-thought the user interface, application model, and an endless set of other details to create a unique new computing experience.  Apple has been rewarded with explosive sales growth.

With the Kindle line, Amazon asked a different question: "What can we do to redefine content distribution?"  The answer led it to a tablet computer, but one with very different hardware specs, user experience, and a vastly different business model.  None of the Kindles can match the iPad feature for feature (link), but they're not intended to.  At $499 and up, the iPad is a serious investment for most people, a lifestyle statement.  At $199 and down, the Kindles are impulse buys, the sort of thing people will get under Christmas trees or just buy for themselves because it looks neat and why the heck not?

Apple makes money from the sale of the iPad and its accessories, with a bit more coming from applications and content.  Given the breath-taking pricing for the Kindle line, Amazon will probably lose money on the hardware, or at best break even.  Its main profit will have to come from the sale of ebooks and movies and all sorts of other media products, plus some apps.  Those revenues may take years to fully develop, so Amazon is playing a very long game.  That's why I see Kindle as a strategy rather than just a product.  The company is betting that by subsidizing the Kindle now, it can dominate electronic media distribution for the indefinite future.

To keep iPad successful, Apple will need to continue to add wonderful new features to it, constantly refreshing the "magical" experience.  It will also continue to drive it into markets where tablet computing can make a big difference.  Apple is already making a huge push in education; some people tell me Apple has almost completely refocused its education salesforce on selling iPad to schools rather than Macs.  And there are plenty of reports of iPads moving into other verticals like aviation.

I'm sure the Kindle Fire will also show up in schools, but at heart the Kindle line is a Volkspad, priced to be the tablet thing that everyone eventually gets for basic content access.  Already about 40% of tablet owners also own e-readers according to Pew Research (link), and I expect that percentage to increase. 

Over time we might see Apple and Amazon compete more directly; it all depends on how much Apple is willing to subsidize hardware to get long-term revenue from content.  There is also potential for product line conflicts -- if Apple makes a lower-priced iPad, it might cannibalize iPhone sales.  In the past Apple has tried to keep its product lines separated in price, and it hasn't used the subsidy model.  This is a very interesting test for Apple's new CEO Tim Cook, and I'm glad Steve Jobs is still on the scene to advise him.

But in the meantime, it's very likely that iPad and Kindle will coexist nicely in the market.  The losers, I think, will be everyone else trying to play in the tablet space.


Hammer and Anvil

Companies trying to sell tablets against Apple were already suffering from slow sales.  Now instead of just being pounded by the iPad hammer, they've been undercut by the Kindle anvil.  For most of them, there's no place to go.  It's very hard for me to picture how somebody like Samsung is going to get market traction with its current tablet line, and I think the RIM PlayBook, due to its size, is going to suffer against Kindle Fire.  Between slow sales of its current phones and now the PlayBook's dwindling prospects, I hope RIM has been very very careful about managing its inventory of parts and finished devices.  Otherwise it could end up with a massive inventory writedown in a couple of quarters.

I will be very interested to see what Barnes & Noble does next with its Nook Color tablet.  Nook Color is similar in many ways to Kindle Fire, but B&N was reluctant to add a lot of Android apps because it was afraid people might buy it as a tablet rather than an e-reader.  Amazon appears to have overcome this fear, and there's a danger that B&N may have let its opportunity for leadership slip away.  On the other hand, if the next Nook Color has better features than Kindle Fire, Amazon's announcement might validate B&N's product and help it sell.

And then there's Microsoft, which has a beautiful-looking new Windows 8 tablet interface coming maybe late next year.  I'm excited, I hope it'll be wonderful, but I'm starting to wonder if any customers will still be available by the time it ships.

There is still plenty of room in the market for competing tablets, but they'll need to be aimed at different usages than the iPad and Kindle.  The biggest opportunity is for a stylus-equipped business productivity tool, an info pad (link).  But none of the major hardware companies are working on that; they seem to prefer to bash their brains out competing directly with the iPad.

You're not the licensee Droid is looking for.  Google's reaction to Kindle Fire speaks volumes about its goals for Android.  Kindle Fire is based on Android, and will run Android applications.  Android has been struggling in the tablet space, so you'd expect that Google would be delighted to have Amazon on the Android bandwagon.  But you'd be wrong.  Let's look at the press release Google issued today to welcome Amazon to the Android family.  Wait a minute, there is no press release.  Okay, so let's look on the Google blog.  Nothing at all.  Maybe a tweet from Andy Rubin?  Dead silence.

The problem is that Amazon is using Android as just an OS, not using the Google-branded services and application store that Google layers on top of the OS (link).  Although Google touted the openness of Android when it was first launched, the reality is that Google is using it as a Trojan horse to force its services onto hardware.  What Amazon did with Android is very threatening to Google, and so you're not likely to hear a lot of supportive words from them.

Silken dreams.  Speaking of threats to Google, we should discuss Amazon's new Silk browser.  It supposedly integrates Amazon Web Services with the browser to produce a faster, more efficient browsing experience on Kindle Fire.  Given the inefficiencies of web browsing over the wireless networks, this is potentially a compelling innovation that also might make it possible for future Amazon tablets to browse over 3G networks using less bandwidth than competing devices.  That might lock in a structural cost advantage for Amazon's tablets.

Kindle Fire today is a WiFi only device, but I'd be very surprised if we didn't see a 3G version sometime in 2012.

Silk potentially gives Amazon a very powerful position (link).  I can picture a couple of ways it could be used to disrupt the mobile market.  First, Amazon could tie the browser to its own content services and distribute it to other hardware vendors.  Basically, it could try to make Silk the content layer on Android that Google wants to be.  This could be a good business move for Amazon, since it's not making money from the hardware anyway.

Google would hate this passionately, but with the company already under antitrust scrutiny, it would have to respond very carefully. 

Amazon's other play could be to expand Silk into an enhanced platform for mobile web apps.  I've been waiting for someone to make web apps work properly on mobile, and many smart people have been getting more and more depressed about the lack of leadership in mobile web APIs (link).  Amazon has the expertise and the incentive to fill that gap.  The question is whether it wants to. I think it should, I hope it will.  If it does, Silk could become the platform for the next great generation of applications, giving Amazon enormous power in the computing market.

This will be a fun space to watch. Apple and Google will both feel pressure to respond to Silk to prevent Amazon from getting a decisive lead in mobile web apps.  Maybe just the threat of Silk will be enough to finally drive some innovation in the mobile web platform.

I may be indulging in wishful thinking, but there's a possibility that ten years from now we'll look back on Silk as the single most important thing in today's announcement.

Or not.  It depends on what Amazon's agenda is, and they're not telling.

Slouching toward Bethlehem.  One revolution I'm sure is coming is the remaking of the print publishing industry.  As I've said before (link), once about 20% of the reading public has electronic devices, an established author can make more money bypassing print and selling direct through e-readers.  I think the new Kindle line, and especially the entry-level Kindles at $99 and below, will finally push us past the 20% threshold.  It will take a couple of years to play out, but this will force the long-awaited restructuring, or destruction, of the traditional book publishing industry.

(Note:  I wrote this before I read John Gruber's take on the new Kindles.  He and I are thinking along similar lines. link )

Boston Fed President Eric Rosengren on the need to facilitate refinances (h/t Kurt Paulsen)

He says at a meeting in Stockholm:

There are several proposals that attempt to facilitate refinancing for homeowners who have been negatively impacted by the drop in housing prices. These proposals do face hurdles, including how to address private mortgage insurance and second liens. However, a program that made it possible for many homeowners to refinance, even if they were upside down, would likely provide significant reductions in mortgage payments to individuals who are likely to have a relatively high propensity to consume. Clearly getting more money into the hands of homeowners who would spend it could help to fuel GDP growth. This would reduce one of the impediments to a more significant effect from the monetary policy actions taken to date.

I hasten to add that there is already a government program to allow underwater borrowers to refinance, the Home Affordable Refinance Program (HARP). This program allows underwater borrowers with Fannie Mae or Freddie Mac loans to refinance at lower rates. Unfortunately, the program has helped fewer borrowers than was originally hoped. Fed Governor Betsy Duke outlined some of the potential reasons why, in the talk I mentioned earlier. They include loan-level price adjustments (LLPAs) that raise interest rates for many borrowers and thereby reduce the benefit of refinancing; originator worries about “buybacks” forced on them by Fannie Mae and Freddie Mac; junior lien-holder resistance to re-subordinating their loans; and mortgage insurance policies.

The Federal Housing Finance Agency (FHFA) is now investigating whether there are ways to enhance the program to benefit more borrowers.[Footnote 15] As this work proceeds, I hope the FHFA considers dropping or reducing LLPAs in cases when a GSE loan is refinanced into another GSE loan. Such a refinance actually reduces the GSE’s credit risk (they already guarantee the existing mortgage and the homeowner will be able to take advantage of lower rates, freeing up cash flow).

Am I posting this because I agree with it?  Yes. 

Hard Choices

Los Angeles (and other large cities) have food deserts--places with limited access to fresh, healthful, relatively inexpensive food.  Low-income people living in food deserts are at a particular disadvantage, because they can't afford cars, and therefore often do not have access to supermarkets. A common hypothesis is that poor kids eat unhealthy food because they don't have access to healthy food.  (I think this is only partially true--kids also eat unhealthy food because they like it.  For that matter, I still love McDonald's fries, I just try to limit my intake, and am in part able to because I have access to better alternatives).

Tesco's Fresh and Easy, a chain that develops and operates small grocery stores that feature fresh fruit and vegetables at reasonable prices, has decided on a business strategy of locating in food deserts.  This is potentially a great thing for kids who live in these places (especially if Fresh and Easy can figure out how to take WIC vouchers).  But this begs the question of how they are able to sustain such a business model.  Two answers present themselves--they are a non-union shop, and they rely heavily on automation.  Specifically, Fresh and Easy features self check-out, and so the store doesn't have to hire checkers.   Self check-out also makes it hard for Fresh and Easy to accept paper certificates, such as WIC vouchers, as payment.

So the cost of Fresh and Easy is that it may drive down wages for grocery workers a bit, and it may reduce employment for grocery workers.  The benefit is that it gives low-income children access to reasonably priced, good quality, fresh foods.  My personal social welfare function says to me that feeding kids inexpensively and well dominates most other considerations, but let's not pretend that there isn't a trade-off.

Michio Kaku on CERN's Challenge to Relativity

In this morning's WSJ:

Reputations may rise and fall. But in the end, this is a victory for science. No theory is carved in stone. Science is merciless when it comes to testing all theories over and over, at any time, in any place. Unlike religion or politics, science is ultimately decided by experiments, done repeatedly in every form. There are no sacred cows. In science, 100 authorities count for nothing. Experiment counts for everything.

A reminder: Ronald Reagan raised capital gains taxes

The Tax Reform Act of 1986 actually did two things that required the affluent to pay higher taxes: it raised the effective tax rate on long-term capital gains from 20 to 28 percent, and it eliminated the ability to write passive losses against ordinary income.  This meant that after 1986, Warren Buffett's taxes would have been at least as high as his secretary's.  

Read Taylor Branch's Atlantic Piece on the NCAA

Let me pull out two paragraphs from the powerful story:

Educators are in thrall to their athletic departments because of these television riches and because they respect the political furies that can burst from a locker room. “There’s fear,” Friday told me when I visited him on the University of North Carolina campus in Chapel Hill last fall. As we spoke, two giant construction cranes towered nearby over the university’s Kenan Stadium, working on the latest $77 million renovation. (The University of Michigan spent almost four times that much to expand its Big House.) Friday insisted that for the networks, paying huge sums to universities was a bargain. “We do every little thing for them,” he said. “We furnish the theater, the actors, the lights, the music, and the audience for a drama measured neatly in time slots. They bring the camera and turn it on.” Friday, a weathered idealist at 91, laments the control universities have ceded in pursuit of this money. If television wants to broadcast football from here on a Thursday night, he said, “we shut down the university at 3 o’clock to accommodate the crowds.” He longed for a campus identity more centered in an academic mission.

and

“Scholarship athletes are already paid,” declared the Knight Commission members, “in the most meaningful way possible: with a free education.” This evasion by prominent educators severed my last reluctant, emotional tie with imposed amateurism. I found it worse than self-serving. It echoes masters who once claimed that heavenly salvation would outweigh earthly injustice to slaves. In the era when our college sports first arose, colonial powers were turning the whole world upside down to define their own interests as all-inclusive and benevolent. Just so, the NCAA calls it heinous exploitation to pay college athletes a fair portion of what they earn.

I love college athletics (I am thrilled that I have gotten to attend three Rose Bowls in which Wisconsin played) and admire many college athletes.  I not only envy their athletic prowess, I am amazed at the varsity athlete who can manage a B average in a difficult major while playing a sport.

But the NCAA system gives these athletes a raw deal.  Among other things, the system makes it difficult for athletes in revenue generating sports to get a real college experience--practice and games can leave students too tired to focus on class (yes, I know some athletes have no interest in class to begin with, but in my experience they are a distinct minority).  If the "pay" is supposed to be an education, the least we as colleges and universities can do is make sure athletes get one.

Allowing underwater borrowers to refinance could improve investors' Sharpe Ratio

Consider borrowers with 6 percent 30-year mortgages that are 20 percent underwater.  Assume that the probability that any one borrower will default in any one month is .2 percent, and that the cost of default to the lender conditional on default is 50 percent.  Assume that at the end of five years, any remaining long balance is paid off).  A security containing such mortgages will have an IRR of 4.83 percent (I am happy to share the spreadsheet for the details.

Now let us convert the borrowers into people with 4 percent mortgages with 20 year terms.  The payment from such mortgages will be essentially the same as before, and the mortgage balance will be paid off more quickly.  The good news for investors is that this lowers the probability of default; the bad news is that it reduces the yield before default.  Assuming default probabilities in any one month go down to .1 percent, the IRR for investors goes down to 3.45 percent.  This seems like a bad deal for investors, except that they will have more certainty about their cash flows; the standard deviation of their investment falls.  Because default is binomial, we can calculate that the variance of returns will be p*(expected loss)*(1-p*expected loss).  The variance of not refinancing is thus .0099 and of refinancing is .004975, which translate into standard deviations of .1 and .07.  Because the riskless rate is currrently zero, when we substitute into the Sharpe formula, we find

Sharpe no refinance = .048/.1; Sharpe refinance = .0345/.07. 

This is about .5 in both cases, suggesting that investors are getting the same risk adjusted return whether refinancing becomes easy of not, assuming the assumptions are correct.  I am not saying they are; I am saying that in making policy we need to think about these sorts of implications.

Testimony to Senate Banking Committee on the Need for Mortgage Guarantees

I testified yesterday.

If the Walt Disney Company ran LA Metro...

People would pay $80 a day to leave their cars in a garage, and then walk from one mode of rail transit to another.  And the rail trips would leave you where you started.

Jim Follain has a proposal for empirical macro

He writes:

First, let’s do more research to help reduce the uncertainty regarding the fiscal situation we face and the new, modern and more complex economy in which we live. This step will involve de-emphasizing a number of metrics underlying macroeconomics built around national totals, such as national income, GDP and the aggregate unemployment rate. Instead, we are wise to take a more geographically granular view of our economy that measures regional, state and local economic activity and adapts policies specific to these areas. Focusing upon the national aggregate or the national average masks the extraordinary variation among markets in this country and, indeed, can even make it harder to identify seriously stressful events until it’s too late. This is difficult to do, but c’est la vie.

CAPABILITY & COMPETENCE ADVANCEMENT AGENDA (C2A2)

MODERN DAY CORPORATIONS SHOULD HAVE A STRUCTURED CAPABILITY & COMPETENCE DEVELOPMENT PROCESS IN PLACE TO ACHIEVE LONG-TERM SUCCESS! PRESENTING, THE THEORY OF IT ALL – A BENCHMARK MODEL THAT ORGANISATIONS CAN IMPLEMENT OFF-THE-RACK FOR DEVELOPING CAPABILITIES AND COMPETENCIES

Look around – and you’ll easily find a plethora of visionless CEOs arbitrarily deciding which business areas should a company enter and which it should leave, without giving a glimmer of thought to whether their organisations have the wherewithal to succeed in chosen battlefield. The astoundingly mammoth list of failed M&As is evidence of the same. More evidence is provided by the speed with which CEOs are being eased out of their jobs – from Yahoo to Google to Tiger Airways to Wipro to RIM, from new-age to traditional industries, companies and CEOs seem to be deciding on new businesses based more on the “fools dare where...” ideology than basing the same on a logical and structured capability and competence advancement agenda. I usually write what my readers term ‘light stuff’ – easy on the eyes and amusing on the brain – and would have used this column to simply berate those organisations that don’t have structured plans to develop competencies and would have praised those that did. But I realized that even for an organisation that in all sincerity wants to set in motion a long term plan that could match its capabilities and vision, there practically exists no ‘readymade’ model that one could implement straight off the board to document one’s competencies. Worse, there’s no telling which competence fits where and is how important for future growth!

Guess what, for a change, I decided to ditch the ‘light stuff’ trademark and to go ahead and benchmark the methodology that is followed by the best in class to match vision with strengths, goals with skills, objectives with focused training – I call it the C2A2 model; in other words, the ‘Capabilities and Competencies Advancement Agenda’! Of course, the ‘C2A2’ term might seem pure limerick at its best, meant to invoke ‘term recall’ in the minds of the reader. But irrespective of the play of the term, the fact is that implementing such a competence development agenda in your organisation – whatever you call it, as long you have a process that does it – might just save your firm from getting decimated in the near future.


C2A2: AN IMPERATIVE FOR IMPLEMENTING STRATEGIC INTENTIONS

An imperative reason for corporations to take up the C2A2 model is the fact that immediately, the top management within the organisation is forced – or encouraged – to match their irreverent business vision (which may have been earlier propagated more due to their ego) with the competencies that are documented within the organisation. In other words, call it what you may, but even if you have documents floating around in various business of your organisation that have mapped out various strengths and weaknesses of those businesses, you’re well started already. But wait, there’s much more left – and that’s where I hit you with the jargon.

‘CAPABILITY MODULATION’ IN C2A2: KNOW YOUR HARDCAPS Vs. SOFTCAPS

Capabilities within any organisation should be visibly perceived in two basic forms, namely HardCaps and SoftCaps. Hard capabilities, or HardCaps, show themselves in the forms of visible ‘hard’ items that can be seen. For example, machinery, cash, personnel, number of patents et al, are HardCaps. Soft capabilities, or SoftCaps, show themselves up in the form of ‘soft’ items that cannot be necessarily seen, rather can be perceived. The backbone of any company’s strategic architecture is made up of the combination of HardCaps & SoftCaps. HardCaps can be quantified. But Hard Capabilities are ruled by Soft Capabilities and this is where the problem arises. It is much difficult to maintain and understand SoftCaps. Knowledge management, process manuals, ISO et al, are all attempts by any organisation to maintain a Hard interface on Soft Capabilities. The corollary is that SoftCaps are most difficult for competitors to replicate and hence can become the basis for extremely long sustainable competitive advantages. But a corporation cannot succeed on Soft- Caps alone. There has to be a most practicable combination of Soft Capabilities and Hard Capabilities for any company to succeed.

So how does one understand which ‘Caps’ is more important? And which less? And how does one know which capability does one need to develop and which to destroy? Differentiating your capabilities using the Structural Capabilities Architecture is one solution that provides the answers.

THE STRUCTURAL CAPABILITIES ARCHITECTURE

Structural Capabilities within any organisation belong to four categories. Doorway, Elemental, Enrichment and Power Leadership Capabilities. Once you have categorised each and every capability under these heads, you would automatically understand which ones you need to maintain, develop and which ones you need to leave go.

DOORWAY CAPABILITIES: These are essential capacities which allow entry of the organisation into targeted businesses/markets/ industries by dissolving entry barriers. These capabilities could relate to any of the functional areas (marketing, human resources, manufacturing, finance, research & development, legal, advertising et al). For example, any corporation wishing to enter the business of manufacturing aircraft needs to have all-encompassing financial capabilities, technology backup with respect to personnel, plant & machinery, necessary government licences, patent clarifications et al. Similarly, every industry has a set of Doorway Capabilities (Porter slantingly refers to these as Entry Barriers), which one has to obtain ‘before’ entering an industry. The simple corollary which most CEOs forget: if you don’t have Doorway Capabilities, it makes quite less sense to enter a new industry, however attractive it might be. Ergo, first document what Doorway Capabilities are required to enter an industry, then acquire those capabilities, and subsequently enter.

ELEMENTAL CAPABILITIES: These are capacities that, after an organisation has procured the Doorway Capabilities, sustain any organisation’s functioning on a day-to-day basis. When Barista took leadership of the narrow market of café sales through Barista stores all over, competitors were more moved by the glamour of it all, rather than the pure profit dynamics. Also-ran competitors did not realise that coffee parlours were not a source of industry leadership, but were rather only a source of industry survival and continuance (Elemental) capabilities. Duncans (a G. P. Goenka group company) went into setting up Barista style tea parlours in various East Indian territories with the collaboration of retail outlets like Pantaloon (Café Bollywood). At the same time, Café Coffee Day was bent on targeting the highest potential markets by opening up coffee parlours all over India. Even though Nestle also has Café Nescafe outlets all across relevant markets, Nestlé is the leader in the overall coffee segment (with HUL following in at second rank) not because of Café Nescafe coffee parlours, but thoroughly because of the focus on converting traditional supply chain channels (institutional sales, vending machines, retail sales et al) into ‘Enrichment capabilities’ (definition on next page). Nestle & HUL have clearly realised that in this industry, the maximum sales growth can occur only through leadership in traditional channels, rather than through fashionable outlets.


But wait, there are two groups of Elemental Capabilities – Pure & Derived.

Derived Elemental Capabilities are those that are continuations & combinations of improved Doorway Capabilities. For example, for an automobile manufacturer, having a plant is a Doorway Capability, but continuing production in the plant is an Elemental Capability derived from already existing Doorway Capabilities like the plant, personnel, electricity availability etc. The fact that Maruti Suzuki India Limited’s plant in Manesar (Gurgaon), rolls out the maximum number of vehicles per day (1200 units, as of September 6, 2011) and has been attaining similar benchmarks for the past 14 years (since it started) is a brilliant example of excelling at attaining derived elemental capabilities. Setting up marketing channels are invaluable Doorway Capabilities for retail corporations to start operations; maintaining these marketing channels using a combination of Doorway Capabilities like sales personnel, dealer network, and transportation et al, is a Derived Elemental Capability. Globally, Walmart is an example of this.

The other group of Elemental Capabilities is known as Pure Elemental Capabilities. These are capabilities that have not been derived from Doorway Capabilities but have been developed or acquired anew. Having detailed customer query handling processes, in spite of not being Doorway Capabilities, are essential for almost all airlines and computer selling organisations for able day-to-day customer relationship management, thus becoming Pure Elemental Capabilities that should be acquired & developed by any computer organisation. Virgin Atlantic’s customer relationship management programme, being currently handled by loyalty marketing specialists ICLP (which also works with airline group Star Alliance and for several carriers like Cathay Pacific, Air New Zealand and Qatar Airways) is an example.

ENRICHMENT CAPABILITIES: Any capability that provides the basis for growth over and above the current standards of the organisation is known as an Enrichment Capability. Enrichment Capabilities are not about gaining leadership in the industry, neither are they about obtaining competitive advantage. Rather they are about gaining absolute growth in areas that are critical to the organisation. Jet Airways entered the Indian market in May 1993, and has since then, carried millions of passengers. Since the start of its operation, Jet was clinically involved with a radical focus on improvement of structural capabilities. It continuously attempted to upgrade the most critical structural capability, namely the aircraft fleet. In 2003, Jet Airways started with an operational fleet of 34 Boeing 737s and 8 ATR72-500 aircraft. Since then the airline has earned a reputation for “constantly maintaining its average fleet age below 10 years”, which is characterised by frequent phasing out of aircraft that exceed 10 years of age. As of May 2011, the average age of the airline’s fleet stood at just 5.4 years – the lowest in the industry! Today, the airline’s total fleet of 97 aircraft consists of 12 A330s, 55 B737s, 10 B777s and 20 ATR72s. Aircraft are nothing but Enrichment Capabilities for Jet, as growth of the airline increases with the number of aircraft acquired by Jet, ceterus paribus. In fact, today, despite not being at the top in terms of the number of aircraft in their fleet, Jet Airways has the largest market share of 25.5% (June 2011) and is the only profitable FSC (with a positive bottomline of Rs.96.9 million during FY2010-11) in the domestic market.


But wait. Even Enrichment Capabilities can be pure or derived.

The capabilities that have been derived from Elemental Capabilities are known as Derived Enrichment Capabilities.

For example, a food services organisation might believe after research and inference that improvement of the marketing channel reach might result in improvement of its market share. In this case, the organisation would attempt to Derive Enrichment Capabilities from the already existing Elemental Capabilities by combining factors like PR campaigns, advertising et al. The food services organisation might replicate this combination of its Elemental Capabilities in expanding marketing channels to other geographic regions, thus providing the much needed growth. For an automobile manufacturer, having a plant is a Doorway Capability, continuing production in the plant is an Elemental Capability, but improving production process efficiencies in order to be more cost effective are Derived Enrichment Capabilities. The other group of Enrichment Capabilities is known as Pure Enrichment Capabilities. These are capabilities that have not been derived from previous Capabilities but have been developed or acquired anew. Capability processes covering PR, market scanning & research, training & development, technology & capital asset acquisitions, research & development are all examples of capabilities that can take the form of Pure Enrichment Capabilities if directly acquired or taken over from the external environment. Brand takeovers, joint ventures, plant acquisitions, marketing channel purchases are all examples of Pure Enrichment Capabilities.

POWER LEADERSHIP CAPABILITIES (OR COMPETENCIES): Capabilities that provide the basis for gaining leadership and sustainable competitive advantages in various industries and markets – those that give you Power Brands too – are known as Power Leadership Capabilities or Competencies. This set is what a company should strive to maintain.

For example, becoming the lowest cost manufacturer in any industry could be a direct result of a previous Enrichment capability of cost effective manufacturing becoming extremely superior to those of competitors. Do not forget that this ‘cost effective manufacturing’ must have been obtained after combining various Elemental Capabilities like relevant training of personnel, process improvements & IT systems integration being refined to the highest degree and thus becoming a reason for industry leadership (see chart on previous page for progression). But this can be bought in one straight shot too!

Yes, Power Leadership Capabilities can also be obtained without necessarily goingthrough the progression of organic development of capabilities. M&As are typical examples of how companies attempt in one go to gain Power Leadership Capabilities external to the organisation by taking over targeted companies that have critical and strategically important assets, products, brands, structures and processes. But given the ever-present risk within M&As, it’s better (but not necessary) if Power Leadership Capabilities are developed organically within the organisation.

What I’ve attempted in this massively theoretical editorial is to tell you – the CEO – that the first step to becoming a world class organistion setting superlative benchmarks, is documenting a plan to know, maintain and develop your capabilities and competencies. And if you had no idea how to prepare that document, just blindly implement what I’ve presented here – and keep sending me the royalty.

Ten-Year Treasury Below 2 percent!

If I am reading this graph correctly, we are at a 130 year record:

Those bond vigilantes sure are being vengeful.  And how about that S&P downgrade?

The good news graph of the day, though, comes from the Fed:

This is the average financial obligation ratio, which is debt service plus rent over disposable income.  Lower interest rates do seem to be helping, although it would be useful to know what has happened to the median, as opposed to average, household.  I refinanced my mortgage earlier this year, and it was great, and meant my financial obligation ratio fell by ten percent or so. But underwater borrowers who can't refinance (or households whose income fell enough to precent qualification for a new mortgage) may be worse off than before.  It is hence possible that while the average has improved, the median has not.

Where are the Medicis when you need them?

Richard White's Railroaded: The Transcontinentals and the Making of Modern America, is a wonderful book.  In it he shows how the railroad barons were crooks and swindlers who suckled on the federal teat every bit as much as the deposed yet still wealthy CEOs of failed Wall Street and mortgage firms.

But at least the Huntingtons (well, Collis' nephew Henry, anyway) left us with the Huntington Library and Gardens, an institution that by itself makes a trip to Pasadena worthwhile.  And Leland Stanford left us with, well, Stanford.  Angelo?  Dick?  We're waiting.

Realtors should love school spending

In the most recent Wisconsin gubernatorial election, Realtors and homebuilders were the leading campaign contributors to Scott Walker. As governor, Walker has shown hostility toward public education in general and school teachers in particular.  If one were to analyze what ails Wisconsin, public education would not rise to the top of the list, because Wisconsin has among the highest high school graduation rates in the country (or conversely. among the lowest drop-out rates), along with strong SAT and ACT scores.  Milwaukee public schools are another matter, but somehow I do not think the school children of Milwaukee are among the top of Governor Walker's concerns.

Beyond all this, however, it puzzles me as to why real estate people would support someone hostile to public education.  There is a very long literature that shows that spending on schools produces higher property values, particularly in the suburbs that are the places where Realtors and homebuilders make most of their money.  Lisa Barrow and Cecilia Rouse:

In this paper we use a 'market-based' approach to examine whether increased school expenditures are valued by potential residents and whether the current level of public school provision is inefficient. We do so by employing an instrumental variables strategy to estimate the effect of state education aid on residential property values. We find evidence that, on net, additional state aid is valued by potential residents and that school districts do not appear to overspend on education. We also find that school districts may overspend in areas in which residents are poor or less educated, in large districts, and in districts with higher shares of rental property. One interpretation of these results is that increased competition has the potential to reduce overspending on public schools in some areas.

A money quote from the NBER digest on the paper:

… A $1.00 increase in per pupil state aid increases aggregate per pupil housing values by about $20.00, indicating that potential residents value education expenditure."


The Barrow and Rouse paper are not alone in their findings: starting with Wally Oates' seminal 1969 paper through Hilber and Mayer's recent work, the empirical literature finds that school expenditures produce higher property values.


Wisconsin's economy has real problems, among which is a startling poor culture of entrepeneurship: if one looks at venture capital, it ranks very poorly.  As such, the children that it educates well leave for other states to find opportunity (despite the stellar performance of its schools, its adult labor force is below average in share of workers with a college degree).  But to attack one of the things the state does well--public education--makes no sense.   And for Realtors to abet an attack that diminishes their own earning power makes even less sense.

Happy Birthday, Business Computing

September 5, 2011

On this date sixty years ago, September 5 1951, the world's first business computing program was first tested on the world's first business computer, the Lyons Electronic Office (link).

LEO was inspired by wartime computers that calculated things like artillery aiming tables for the military.  Lyons was a massive restaurant chain in the UK, and realized that the new digital computers could simplify its human-driven accounting operations.  So it built its own computer, consisting of 21 racks with 6,000 vacuum tubes and occupying about 5,000 square feet.  The company's first use of LEO was to calculate the cost of all the baked goods produced by its 12 bakeries (link).

From that humble beginning...wait, that wasn't a humble beginning at all, it was a very cool beginning.  The first use of a business computer was to solve a real-world problem faster and more accurately than people could do it on their own.  That's exactly what you're supposed to do with computers.  LEO was quickly adapted to other tasks, where it achieved impressive results.  For example, it cut the time needed to calculate an employee paycheck from eight minutes to 1.5 seconds.

It's hard to believe that many people believed for years that computers didn't increase business productivity (link).

From that very auspicious start grew most of the computing industry we know today (link).  So take a moment to contemplate that dinner roll or slice of pie you eat today, and say a quiet thank-you to David Caminer, John Pinkerton (link), and the other pioneers who got it all started sixty years ago today.



More about Lyons
More about LEO

A point I wish I had made to NPR

I just finished taping an interview with Robert Siegel on finding our way out of the housing crisis.  I agreed with Elizabeth Duke about the need to blow out second liens, and with the Hubbard-Mayer-Gross plan to allow current underwater borrowers to refinance easily.

My contribution was that we needed to perform a kind of triage--that places that had massive house price declines and have very high unemployment (i.e., Miami, Las Vegas, Fresno) should get debt relief, lest it take forever for them to recover.  What I didn't say (and I wish I had) is that one way or another, many loans in these places will fail, because it will be nearly impossible for borrowers to get above water.  We might as well take the pain of the write-offs now, rather than have zombie-loans hanging around.