Good news coming out of Washington! Apparently there is no inflation and things aren't costing more.
What? Does anyone in Washington purchase their own food, gasoline or healthcare? I forgot - those expenses are covered by lobbyists.
On a serious note, the CPI is down about 1.3% compared to a year ago, meaning that goods or services that cost you $10 a year ago now cost about $9.87. So what's the real story?
Behavior finance and economics suggests that most consumers feel pain more vividly than they feel joy. Basically, we like to avoid losing money more than we like making the same amount of money, even though 'old school' economics teaches us that consumers seek to maximize their pleasure, or 'utility.'
Former Wimbledon champion and tennis great Ivan Lendl perhaps said it best when he was quoted saying "I hate losing more than I like winning." Remember, this is coming from a guy who used to win all the time.
We drive around searching for gas that is $2.72 per gallon instead of $2.75, but won't cross the street for cheaper gas that's $2.08 instead of $2.11. Why? It's a better bargain in the second scenario, after all.
The applications for the economy are far-reaching. We see gas prices going up, but forget that they are down 30% from a year ago. That doesn't offset the 29% increase in prices of fuel over the past six months. We have short term memory, and the figures seem to support behavioral theory. Consider the following (yes, I'm keeping the math simple because it's early and my brain isn't working too well yet)
Assume that gas a year ago cost $3.00 per gallon. A 30% drop in fuel would mean that gas costs $2.10. WOW! That's signficiant. Oops. Now gas goes up 29%, resulting in a new cost of $2.71. Yikes! That hurts, even though it's still less than the original starting point of $3.00.
The same calculations can be applied to the stock market. Assume your retirement plan had $50,000 a year ago and the market lost 25%. You'd be down to $37,500. It takes a 35% gain this year to get back to square one. Sadly, this is what's been going on with investments the past two years, creating opposition to something called the wealth-effect. In short, if consumers feel wealthy (good returns on their 401k, appreciating values on their homes, lower unemployment figures, etc.) they are more likely to spend. There hasn't been much good news or even 'paper returns' to allow consumers to feel wealthy - even a nice return in the market the past six months.
To further support this 'behavioral stuff,' as my wife calls it, consider an even-money bet. Let's say I flip a coin and we bet $1. If it comes up heads, I win $1 from you. If it comes up tails, you win $1 from me. Easy enough? We know that most people would take the bet. What if I won two straight times? Three times in a row? How about four or five?
What if I make the bet $10 per flip, or even $50? At what point do you jump off and act out of 'fear' rather than rationality? We allow the dollar amount to skew our ability to judge. Don't worry, I'm guilty of this too. Studies have shown that when the bet goes to $100 per flip, most folks would demand payment of $160 if they win. I'm not about to take the other side of that bet anytime soon, by the way.
See what I mean? We're easily tricked by math and to be frank, it stinks. I fall for it all the time and I study this junk!
So sit back, relax and take consolation in the fact that you are paying less for things today than you were a year ago while you're driving around looking for the cheapest gas station around.
Showing posts with label behavior. Show all posts
Showing posts with label behavior. Show all posts
Tuesday, October 27, 2009
Saturday, September 12, 2009
Takin' care of business
Have you hit the skids yet? After all, the kids are back at school, school buses are clogging up the highways and nights are getting longer. Sometimes just for kicks my wife and I will hang out on the porch when it gets dark early and pretend that it's still summer. It's not, of course, but pretending is fun.
Pretending is not fun, however, when a business is at risk of making game-changing mistakes.
A business owner recently called me and asked for my evaluation of their current cashflows so I rolled up my sleeves and dug into some antiquated spreadsheets about customers, an unaudited profit and loss statement and an unaudited balance sheet. If those three things sound sorta, you know, casual, it's because they are. In short, it's like keeping your checkbook balance on a paper napkin or a grocery receipt.
Regardless, I did my best and came to the conclusion that only about 30% of the business promised to him by his customers actually resulted in a sale, yet the staff had to go through about 80% of the promised business. They were spending a ton of time working on potential sales that would never transpire, as history showed that the customer-base failed to deliver most of the time. Of course, there were a few notable exceptions, which I pointed out in my moderately formal report back to the client. The staff was frustrated because they felt like they were working too hard and too long. And they were correct. Unfortunately the company was not profiting from their efforts.
Upon delivering the report, I followed-up with a phone call and a lengthy discussion in order to point out some significant cost saving measures. The culmination of the call came when I suggested something radical - eliminating over half of his customers and focusing on the remaining customers that could deliver promised sales on a fairly regular basis. A final suggestion was to perhaps remove one or more of the positions that served the customers since there would be far fewer potential sales to screen in order to get to an actual sale.
To say I was pleased with my findings, both quantitative and qualitative, would be an understatement.
"Christian, I see your point but I'm thinking of adding staff so that we can hit the break-even point," was his response.
(Crickets chirping here, please.)
"Chris, are you there?"
It's as if my hard data and suggestions weren't even heard or acknowledged, and in fact, I was living in opposite world. I had suggested firing clients and staff, focusing on the core business and streamlining things - not taking on additional payroll, headaches and a bigger nut to crack.
Pretending is not a good option if you are a business owner. In fact, it's not a good option for anyone (unless you are a girl pretending to be a fairy princess or a kid that wants to throw the winning touchdown pass in the Super Bowl.)
But we all pretend, don't we? We pretend that a relationship that has been horrible for twenty years is going to change, or that a job we hate will change once the economy turns around or perhaps a child/loved one that has been a hell-raiser will finally come around.
In relationships we call this 'vested,' or in poker we call it 'pot-committed.' In short it means that emotionally it's too hard to remove ourselves and it seems the only logical thing to to is see it through the (already known)outcome.
As a business owner, it's imperative to never become enamored with an idea that stops working or your 'baby.' Focus on the bottom line and once it goes to red, get out immediately.
GM, Chrysler, National Record Mart, Asbestos, Polaroid One Shots, typewriters and carbon copies were all great ideas too. Now they are all either firmly planted along the landing strip of business progress or approaching quickly. Sometimes (most times) technology impedes our ability to keep doing the same thing and make the same profits. The runway is covered with failed landing attempts.
Recognize when the business changes and prepare to make drastic changes to meet the challenge, or prepare to close shop. Those are the only alternatives in business, and in life, actually.
I have a friend that says "if I have to kiss a frog, I kiss the frog and move on."
I urge each of you to find the frogs remaining in your life, kiss them goodbye and move on. Only princesses get to kiss frogs and have them turn into a Prince.
Pretending is not fun, however, when a business is at risk of making game-changing mistakes.
A business owner recently called me and asked for my evaluation of their current cashflows so I rolled up my sleeves and dug into some antiquated spreadsheets about customers, an unaudited profit and loss statement and an unaudited balance sheet. If those three things sound sorta, you know, casual, it's because they are. In short, it's like keeping your checkbook balance on a paper napkin or a grocery receipt.
Regardless, I did my best and came to the conclusion that only about 30% of the business promised to him by his customers actually resulted in a sale, yet the staff had to go through about 80% of the promised business. They were spending a ton of time working on potential sales that would never transpire, as history showed that the customer-base failed to deliver most of the time. Of course, there were a few notable exceptions, which I pointed out in my moderately formal report back to the client. The staff was frustrated because they felt like they were working too hard and too long. And they were correct. Unfortunately the company was not profiting from their efforts.
Upon delivering the report, I followed-up with a phone call and a lengthy discussion in order to point out some significant cost saving measures. The culmination of the call came when I suggested something radical - eliminating over half of his customers and focusing on the remaining customers that could deliver promised sales on a fairly regular basis. A final suggestion was to perhaps remove one or more of the positions that served the customers since there would be far fewer potential sales to screen in order to get to an actual sale.
To say I was pleased with my findings, both quantitative and qualitative, would be an understatement.
"Christian, I see your point but I'm thinking of adding staff so that we can hit the break-even point," was his response.
(Crickets chirping here, please.)
"Chris, are you there?"
It's as if my hard data and suggestions weren't even heard or acknowledged, and in fact, I was living in opposite world. I had suggested firing clients and staff, focusing on the core business and streamlining things - not taking on additional payroll, headaches and a bigger nut to crack.
Pretending is not a good option if you are a business owner. In fact, it's not a good option for anyone (unless you are a girl pretending to be a fairy princess or a kid that wants to throw the winning touchdown pass in the Super Bowl.)
But we all pretend, don't we? We pretend that a relationship that has been horrible for twenty years is going to change, or that a job we hate will change once the economy turns around or perhaps a child/loved one that has been a hell-raiser will finally come around.
In relationships we call this 'vested,' or in poker we call it 'pot-committed.' In short it means that emotionally it's too hard to remove ourselves and it seems the only logical thing to to is see it through the (already known)outcome.
As a business owner, it's imperative to never become enamored with an idea that stops working or your 'baby.' Focus on the bottom line and once it goes to red, get out immediately.
GM, Chrysler, National Record Mart, Asbestos, Polaroid One Shots, typewriters and carbon copies were all great ideas too. Now they are all either firmly planted along the landing strip of business progress or approaching quickly. Sometimes (most times) technology impedes our ability to keep doing the same thing and make the same profits. The runway is covered with failed landing attempts.
Recognize when the business changes and prepare to make drastic changes to meet the challenge, or prepare to close shop. Those are the only alternatives in business, and in life, actually.
I have a friend that says "if I have to kiss a frog, I kiss the frog and move on."
I urge each of you to find the frogs remaining in your life, kiss them goodbye and move on. Only princesses get to kiss frogs and have them turn into a Prince.
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