Only slightly bent

I’ve long had the opinion that the financial markets are far from rational, and that the media, companies & market participants themselves dealing with them as rational – and, worse, rationalizing every strange market movement – is nothing short of insane. I haven’t had much fact-based research to back this opinion up, however, which is why I was interested in reading Justin Fox’s The Myth of the Rational Market: A history of risk, reward, and delusion on Wall Street.

The title tells quite succinctly what the book is about – it chronicles the creation and dismantling of the rational market theory from the very beginning. While reading up on the history of financial theories and how they were created was interesting and certainly useful per se it, to me personally, made for somewhat boring reading for the first 150 pages or so. Despite not exactly being a gripping page-turner, the first half of the book does provide a fascinating quick history of capitalism, the evolving view on profit & risk and, among other things, how the now-ubiquitous “shareholder value” came to mean anything.

One interesting aspect that I hadn’t fully digested earlier was that despite the view otherwise, one cannot really get paid for taking a risk, because risk is a measurable quantity that could be insured against; profit came when you proceed in the face of uncertainty. It may sound like a trivial difference, but the implications run deep.

During the course of reading the book, a few things become abundantly clear and with plenty of evidence to back the claims up. First, the markets are not rational or efficient. While this shouldn’t really come as a shock to anyone, for some reason the vast majority of (surprise!) finance professionals still act as if it is. The problem with utilizing this knowledge? No one person is rational either, so good luck in trying to beat the market. Second, the remarkably – for the lack of a better word – strange world of analysts, with all the expectations to beat the estimates and the resulting whisper estimates, “The Number” etc is revealed. Third, practically no actively investing funds does any better than the market on average – a find which any analyst, who supposedly trust mathematics, should find somewhat disturbing; already back in the 60s:

The scholarly consensus that nobody on Wall Street knew what he was doing began to harden. “Many academics have concluded that the value of investment advice is virtually zero,” Burton Malkiel and a Princeton colleague wrote in 1968.

Probably the most interesting part of the book is the anatomy of several market crashes and how they came to be. What’s most amazing are the rationalizations that some offer to explain the quirks and crashes away in order to keep holding on to the fatally wounded theories; this is from a chapter dealing with the 1987 crash:

“The appropriate response to the October performance of the market is applause“, Gene Fama declared. Fama’s reasoning was that an inefficient market would have been one in which the price decline occurred slowly. The rapid adjustment (a.k.a. crash) was evidence of how quickly the market processed new information. Left unanswered was what exactly that new information was. If your belief in efficient markets was strong enough, you didn’t need to know. The omniscient market had been able to sense something that, even after the fact, individual scholars and investors were unable to pin down.

At the end, some sobering conclusions are drawn. While fixing the market is probably too big a task to accomplish in short order, there is something companies can do, and something society needs to ponder:

It means that managers of a publicly traded company should insulate themselves and their employees from day-to-day or even month-to-month stock price fluctuations.
[..]
The biggest and hardest questions have to do with what sort of role we as a society give financial markets. For the past three decades the answer, backed by the theories of the rational market, has been to give markets an ever larger role – shoving aside other institutions such as governments and corporations. Now, though, we seem to have arrived at a turning point. It’s not just that the rational market theories have fallen apart. Financial markets have fallen apart, too.

All in all a very useful and interesting book that provides a lot of history and background to the nature of the market and how it works. Like I said, I found the first part somewhat boring reading, but overall the book was excellent. I would’ve hoped for some more coverage on the GFC, but then again the GFC as a tool against the rational market theory is a bit like shooting fish in a barrel so that might’ve been too easy.. The Myth of the Rational Market also gives a good background to many familiar names and as such provides much better context for understanding where Greenspan, Samuelson, Summers, Buffett, Minsky, Keynes, et al come from and what they’re all about.

Oh, and did I get the proof I was looking for that markets indeed are not rational? Yes. But, notably, I also learned that they’re not completely insane either and there actually can be some useful information embedded in the market figures.

One of the recent annoying trends in the mobile business domain has been the attitude towards apps. Most of the media extols apps as the next big thing, the gold rush everyone must get at now or miss billions of dollars of revenue – and your standard sources of industry opinions and forecasters like Gartner don’t exactly help calm things down by parading the figures and showing off impressive growth charts.

Then some people realize that oh dear, most apps don’t make any money! The whole paid app craze must be a mistake!

This backlash, though popping up occasionally earlier, was propelled to the “masses” by Tomi Ahonen’s post here and followed by reactions and other observations here, here, here and in many other places.

Suddenly a whole storm of comments for and against apps and the “app economy” ensued. And I’m left thinking what’s with all the commotion? It is, of course, an indisputable fact that most apps don’t make a lot of money for their creators. What I don’t get is exactly why this is a surprise to anyone.

Why would apps be any different from other, crudely similarly structured industries? I.e. industries where creators of various sizes are vying for the same market with vastly varying resources, creating products with quality and appeal ranging from total crap to great? Take, for example, the music industry; of the 100,000 albums released last year, 17,000 only sold 1 copy; more than 81,000 albums sold under 100 copies. The vast majority didn’t make any money.

Book publishing is similar; the average book sells less than 500 copies, with the hits badly distorting the average. In 2004, 950,000 titles out of the 1.2 million tracked by Nielsen Bookscan sold fewer than 99 copies.

A few big hits, small reasonably profitable middle ground, long tail of disappointments. Sounds a lot like the app economy to me.

A tough market? Of course, any competitive market is.

But somehow surprising industry dynamics? Hardly.

And definitely not worth losing your sleep over either way; if you think apps will magically save your business case, reset your expectations to something resembling reality. If you think they’re a fad that don’t deserve to exist, you are almost saying books and music are in the same category – and yet it’s highly likely you happily consume both. Both sides of the polarized debate should just get a grip, take a step back and reflect on it a bit.

Ever since the iPhone launched some years ago and ended up being, by most measures, a big success, I feel the tech press has been getting increasingly mean. And I don’t like it one bit. These days not a day goes by without someone reporting of an “iPhone-killer” device emerging.

What’s with all the negativity? Is Steve Jobs such a polarizing personality that all the hatred surfaced just because of him?

Alas, no. It turns out the iPhone is not the only thing other devices are out to kill, at least according to the press. Google for any even remotely popular mobile device + “killer” and you’ll end up with a depressing amount of articles. From the remarkable 2.5 million “iPad killer” items to half a million “iPhone killer” articles and pages to the tens of thousands of “Nexus One killer” items to thousands of rants about a “Droid killer”, it seems the industry is in a flat-out war. From Blackberries to Nokias, it’s kill this and kill that.

And it’s not just the press either. It’s the individuals also – so-called Apple fanboys who are seemingly blind to all criticism directed at Apple products have been joined by similar extremism from proponents of other platforms and manufacturers. As a result, it’s getting increasingly difficult to have a civilized, objective conversation about something as simple as mobile phones – that does not bode well when you think about the need for having such conversations about topics of far bigger significance.

One problem with this is that business is not, contrary to the popular analogue, war. The technology press shouldn’t be out there going from one “killer” device to another without really having even elementary understanding of the product positioning and other basics. For example, the upcoming Nokia N8 has been called the company’s “iPhone killer” in many, many publications. Except a quick glance at the portfolio strategy and pricing will reveal the devices are targeted at very different segments. The iPhone is meticulously positioned at the very top of the smartphone range (and priced accordingly), something where Nokia has explicitly said it will have MeeGo devices – on the other hand Symbian, which N8 is running, is about “democratizing the smartphone”. Second, the pricing? The SRP of the N8 is roughly half of the iPhone 3GS’s. They are hardly vying for the same user base – which is not to say individuals wouldn’t perhaps pit the two against each other and decide to get one or the other, but in general the N8 is not positioned as the “iPhone killer” the vast majority of the press sees it to be.

The iPhone does not need to be killed. It simply hasn’t deserved it – it or Apple hasn’t committed any mortal sins against anyone. Very few devices deserve to be “killed” and most of the time, the market takes care of their early demise just fine by refusing the adopt the monstrosities. If and when a clearly superior devices come out, the older models will be eased out, simple as that. And with most modern equipment designed to self-destruct soon after the warranty expires, fast rotation of the mobile devices is, unfortunately, guaranteed for the time being.

But unfortunately it’s not just about the killing either; the “killer” devices are just a symptom of a common lack of basic analysis and fact-checking which seems to be too much to expect from the press these days. That is a loss to all of us, and will lead us down a path even more dangerous than ignorance – one of misinformation accepted as truth.

When in the US, e-commerce was pure bliss already ten years ago. Stuff was cheap, came to your door fast and reliably and the whole shopping experience was just good. In Finland, to understate a little, things were not so good. Relatively few companies had (or have) an online store and the prices were in line with the brick-and-mortar stores, i.e. absurdly high. Especially the shipping costs (largely thanks to the Itella-monopoly, no doubt) were just insane. Some improvement has happened in recent years, but there’s still a long way to go.

Anyhow, I was expecting Australia to fall somewhere between Finland and US in terms of online commerce. And most of the times it does, but at times the experience is even worse than in Finland – a big disappointment. First, relatively few companies are online here. There is increasing, but still low, awareness of how to do e-commerce properly (let alone m-commerce, let’s not even go there). Second, shipping, while cheaper than in Finland, takes surprisingly long even from “nearby”. Third, by coincidence or not, it was an Australian online merchant who happened to be the first one to ever lose my credit card details which forced me to get new cards after fraud attempts.

Now, years ago e-commerce really took off with books first, so here is a case study from yesterday about getting a book. I wanted to buy this book. By nature, I first checked Amazon US: $25 AUD plus $17 AUD for expedited international shipping, so $42 AUD total and I could expect to get the book in about 10 days. That doesn’t sound too bad for a big, 750+ pages, hardcover book.

What about the local competition? First up, Borders: sticker shock of $89.95 AUD and a delivery time of 10-12 days. Angus & Robertson was in the same ballpark. Only Dymocks was significantly cheaper at $55 AUD, but still more expensive than Amazon. None of the Australian vendors charged explicit shipping costs, but the high initial price and shipping times of 10-12 days explain why that is so. As a comparison, the book would have cost about $50 AUD including shipping if bought (with)in Finland with a delivery time of 5-15 days (annoyingly wide scale).

Let’s take a look at the figures again:

Remember that Borders, Dymocks and Angus & Robertson are all local, Australian companies and the Amazon US order is shipping from literally the other side of the planet just for me. If one bought more than one book, the figures would be even more favorable for Amazon.

Whenever an individual can import goods from halfway across the planet, while paying for individual express air cargo, for up to 50% less than the domestic companies are charging, some aspect(s) of competition and/or efficient markets are clearly missing.

I enjoy a good management book as much as the next person – oh, wait, probably a bit more as I actually do enjoy reading them. Anyway, it shouldn’t come as a surprise that they often promise a whole deal more than they can deliver, so I was happy to see The Economist taking a stab at the gurus a few weeks ago in the article The three habits of highly irritating management gurus.

Here’s one rather fundamental error in the guru literature:

Henderson et al put it even more bluntly in their HBR article:

Just goes to show that prediction is difficult – especially of the future. So considering the data the books are based on is more or less invalid, what good are these disparaged books by the gurus? In my experience, they do provide good alternative viewpoints into problems and help in taking a little bit of a different perspective to things. They help in generating some internal diversity in thinking and that’s always a good thing. And note that I say diversity; changing your viewpoint to align perfectly with the touted system in any given book is not diversity, it’s just altering the tunnel vision to a different version. Don’t use the guru books to merely change your way of thinking from one way to another – use them to broaden your thinking.

I also suggest you give the books’ authors as much money as their books are worth when compared to the promises they make, and borrow them from a library instead of buying. Other than just a few gems, it’s highly unlikely you’ll ever want to return to the books after reading them once. And if you and a hundred other people use the library book, the gurus get an appropriately small revenue slice for each read.

For a more detailed look at the topic, check out these resources:

• Andrew Henderson’s page at the University of Texas
• Deloitte: The persistence project
• Harvard Business Review: Are “Great” Companies Just Lucky? by by Michael E. Raynor, Mumtaz Ahmed, and Andrew D. Henderson
• .. and if you haven’t seen The System by Derren Brown, watch it here. It’s quite long and in multiple parts but very good. And don’t read the comments before you’ve seen it all.

This is a cross-post with my contribution at genmobilec.org

This might seem like a stupid question – after all, if you’re hooked on for example Twitter, your service is being run by Twitter. Right?

Wrong. It is in fact likely that the service is running on the benevolence and patience of venture capitalists and other investors who believe that somehow, someday, it will be profitable. Because right now, more often than not, Internet services aren’t profitable business.

Facebook was for long a loss-making enterprise; and they made some significant losses. It is only now that they might be reaching the break-even point. Twitter on the other hand is expecting their first revenue (i.e. any money coming in at all) this quarter. Of course, since most of these companies aren’t public, it’s difficult to know exactly their financials. However, it’s still a safe bet to say most are not even breaking even.

Now, turn the attention to mobile operators, who have been accustomed to very reliable sources of revenue (voice calls). They are now having to venture into uncertain territory in order to continue on the growth path and try to fight against the somewhat inevitable commoditization of their business.

In one sense, operators have had it too easy. SMS has in just 10 years become one of the most incredible money-printing machines any industry has seen. With SMS, the operators enjoy what can only be described as excellent (or absurd, depending on your point of view) margins. And the enabling equipment is a bargain; SMSCs often have RoI times measured in hours or days. Premium SMS has, on the other hand, enabled many successful mobile services despite the operator margins.

But there are limits to growth in SMS and voice calls, so operators are looking to data to capture that growth. It’s easy in theory – just get people to sign up for $10 or $20 or $30 per month data package and voilá, your ARPU is suddenly back on the growth track. In practise, however, it’s not so easy – mainly because people are often difficult in the sense that they need a reason to spend their hard-earned money So the operators must be able to give a compelling reason for customers to sign up for a data package.

One interesting thing many operators are doing when searching for that reason, is turning to third party services. What’s more, they are turning to the above mentioned unprofitable Internet and mobile Internet services. Over the past few months, I’ve seen entire advertising campaigns by operators such as Elisa in Finland and Three in Australia that were focused on promoting just one service – Facebook, and mobile access to it. Riding on the popularity of Facebook, the operators want to sell you data plans and even devices.

This presents another interesting aspect; people have come to expect that Internet services are free. People have also come to expect that mobile services are not free, that you have to pay ludicrous amounts for simple things such as ringtones. But what happens when these worlds collide in the form of mobile Internet?

The jury is still out on this one, but really it all boils down to a simple question: what would you be willing to pay for?

Because contrary to what some people like to think, advertising will be unable to support all the services it’s now envisioned to support – at least in its current form. So how about Facebook or Twitter at $5/month? Would you subscribe?