Thursday, February 28, 2008

An Economist Measures the Fear of Letting Go

Here is a fascinating report from the International Herald Tribune:

‘Predictably Irrational’: Keeping (too many) options open

MIT economist Dan Ariely’s new book Predictably Irrational identifies various patterns of behavior in which people — not just a few people, but basically everyone — can’t endure the discomfort of making a rational decision. The article focuses mainly on one experiment based on a video game with three doors. Players wasted effort and lost out on points — which in the experiment translated to real money — just trying to keep all the doors open.

I believe this is the same pattern I see in people who keep too many possessions — clothes they have no reason to wear, movies they don’t want to watch, food that no one wants to eat, and so on. The resulting clutter comes with costs that are hard to ignore, yet somehow people do ignore the cost of clutter and focus instead on the value of the possessions, even when that value is entirely imaginary.

Sunday, February 24, 2008

Castro’s Quiet Exit

For half a century, there were people who talked about ways to get Fidel Castro out of office. There were plans for invasion, civil war, and assassination. Today, Castro is quietly retiring from his various positions as leader of Cuba. It is better that it happens this way.

It’s easy to say now that the people who thought war was necessary to unseat Castro were mistaken. Cuba never did become a disaster zone under Castro, nor did it become an ongoing threat to its neighbors. Its economy may have progressed at a painfully slow pace, but it never crumbled.

It is easy to criticize the Cuban government’s management of the country in recent decades, yet whatever faults they had were not so costly as to justify a war. Patience has its price, but the price of war is much greater. With the benefit of hindsight, if you imagined a war undertaken in Cuba just to hasten this day by a few years, you would say, “For what?”

No one knows what will happen next in Cuba, and the people who want a more effective government for that country are not satisfied with the mere departure of its longtime leader. I imagine that some are saying that now would be an opportune time for the war they have been waiting for. Yet uncertainty and impatience does not add any weight to the case for war. If there were a war, the aftermath would be more uncertain and could easily take longer to clean up than the current situation. Those who are foolish enough or desperate enough to seek the aid of the god of war never know what their reward will be.

Wednesday, February 20, 2008

Sharper Image Bankrupt As Consumers Turn Cautious

Sharper Image’s surprise bankruptcy filing yesterday seems to be the result of the same trends in consumer spending that emerged elsewhere around November and December. Consumers are cautious and trying especially hard to spend wisely and purchase things that have clear practical value. We saw this, for example, in the sudden shift toward gift cards after Black Friday, then in the fact that consumers have been unusually slow to spend the gift cards they received in December. Now Sharper Image faces a “severe liquidity crisis,” in the words of its CFO, meaning it finds itself with way too much inventory and not nearly enough cash.

I have to guess that Sharper Image overextended itself for the holiday season, perhaps relying on the economic reports during the early fall that said the economic slowdown did not seem to be affecting luxury goods at all. By December, luxury goods were tanking, and the bloated markups that made Sharper Image profitable in the past were driving customers away. In the end, holiday sales could not bring in enough money to pay the bills.

If this scenario is correct, then Sharper Image’s troubles are a classic boom-and-bust story. People in a hurry to get ahead of the competition (“boom”) go too far in the wrong direction and are forced to come to a sudden stop (“bust”). In this case, it seems Sharper Image was betting too heavily on gimmicky image-boosting products (well, that’s their name, after all) in a time of uncertainty that led consumers to look for practicality instead.

Reports from two other retailers are consistent with this picture of consumer sentiment.

Wal-Mart reported a nice gain in revenue for the fourth quarter — a gain that came right after the retail giant gave up on a two-year campaign to raise its prices. Wal-Mart’s move back to lower prices came at just the right time to catch up with consumers’ move in that direction, and the higher profit shows that it was the right decision.

Lillian Vernon, a painfully unattractive gift catalog that got by for years on its homey style and low prices, has also filed for bankruptcy. Lillian Vernon today is featuring ceramic Easter baskets and fake-rose mailbox decorations, and items like these are a tough sell, despite their low prices, when consumers turn cautious.

Sunday, February 10, 2008

After eBay, Online Sellers Hope the Auction Format Is Still Alive

EBay, a name that was once synonymous with online auctions, has taken further steps to shed its auction business with dramatic fee increases that seem designed to give an advantage to its largest sellers. The 15 percent discount for most large established eBay sellers is enough to make it impossible for a new seller to compete. And even for the most successful sellers, the handwriting is on the wall: they have to convert to the store format or risk being marginalized and eventually eliminated from the site.

Some sellers are planning a boycott of eBay next week, but others are just leaving for greener pastures. Stories in and CNNMoney describe a mass exodus from eBay to other auction sites — a process that actually began when Yahoo shut down its auction site last year. These are online auction sites that some sellers are moving to:

Each of the competing sites has at least one key advantage that eBay could never match, should it decide to return to the online auction business. Some of the sites have no seller fees, a much lower cost structure, support for swapping, flat monthly fees, Google Checkout support, etc. And after this month they’ll have another advantage that eBay won’t be able to match: shoppers who like the online auction format. After eBay pulls the plug on its auction search interface, which apparently it is ready to do any day now, auction fans will still be able to find the online auction experience on these other sites.

Saturday, February 9, 2008

Don’t Put Your Retirement Savings in One Bank!

Many people assume U.S. bank deposits are safe because they’re FDIC-insured. That is true up to a point, but more people than ever are going beyond that point and I’m afraid that not everyone understands the risks involved.

FDIC insurance for any one bank is limited to a maximum of $100,000 per account owner. That means if your bank goes under and you have less than $100,000 in all your accounts combined, the FDIC will make sure you get your money. If you have your IRA in a bank, it is insured separately up to $250,000. That’s a lot of money, and more than most of us have in the bank on any given day. But it is not nearly enough to live on for the rest of your life, so when you put your retirement savings in the bank, you need to think about it differently than the checking account you use to pay your bills. It is worth the trouble to make sure your life savings is insured.

Bank failures are rare — at least they have been in the United States during the 75 years since the FDIC was created. The mere presence of insurance makes bank failures unlikely because people don’t have to panic at the thought of the bank running out of cash.

Yet banks continue to fail. Two weeks ago, Douglass National Bank in Kansas City, Missouri, was shut down. Read the news about banks, and you may come away with the impression that bank managers are not the brightest people you will ever meet. You can’t count on your fingers the number of large corporations that have had multibillion dollar lines of credit from multiple banks for months after they were effectively bankrupt. Or look at Bank of America, already in distressing financial condition itself because of bad loans, spending an enormous sum last month to buy a failed lender that was thought to have the largest concentration of bad loans in the world. It’s important to remember that there are thousands and thousands of banks, and it’s mainly the banks that get themselves into trouble that get in the news. But as long as banking executives make bad decisions, there will be banks that fail. And in 2008, with the global financial system in crisis, it’s fair to expect that more than one or two banks in the United States will go under.

But you don’t have to lose any money from a bank failure. It’s really very simple to have all your bank deposits fully insured by the FDIC. Put them in more than one bank, making sure that each bank is on the FDIC’s list. This can be as simple as going into five, ten, or fifteen banks, if you have that much money to put in the bank, and buying a $100,000 certificate of deposit at each one.

Everyone should have at least two banks — it lets you continue spending money in the event that the bank has a problem. For most of us, it’s enough to have a checking account at one bank and a credit card issued by another bank. But when your savings start to spill over the $100,000 mark, and it’s money you can’t afford to lose, it’s time to move some of it to a second bank.

Friday, February 8, 2008

For Chrysler, Consolidation Makes Sense

Chrysler says it plans to cut the number of models it makes by half. It also plans to shrink its dealer network somewhat. These moves make a lot of sense.

What Chrysler is doing is consolidating. Consolidation is a way of reducing the amount of work that needs to be done by taking away some of the zones of responsibility.

When you hear about consolidation you might think of one company buying another, but that is just one scenario that can lead to consolidation. A company I was working for a few years ago did a different kind of consolidation when they replaced their telephone and computer networks with a single digital network. This saved them work in the long run by giving them just one network of wires to maintain, instead of two. While they were at it, they replaced six fax machines with just one.

Consolidating the fax machines made a lot of sense because faxing is not as important as it used to be. This company kept six fax machines busy back when fax was the primary way to send documents from one place to another. Now that they can send or receive any document by e-mail, fax is used only for unusual special cases, and their one remaining fax machine is silent most of the time.

Decline and consolidation naturally go together. When something becomes less important, you almost automatically look for ways to simplify it by having fewer things to deal with. Let’s say you go from eating breakfast cereal every day to eating it about once a week — that’s a kind of decline. It only makes sense to go from having four different kinds of cereal on the shelf to having just one. That’s consolidation. In this scenario, you don’t want to have to work so hard on breakfast cereal anymore because it is no longer such a prominent part of your life.

It is a principle of economics that you will see consolidation in declining industries. There are so many fewer companies in computer manufacturing and banking than there were a few years ago because these are declining industries. It is not that these industries are declining in importance, but technological advances have dramatically reduced the total amount of work that needs to be done to keep track of the money and make computers for everyone. Where there is less work to be done, there is less money to be made, hence the need to cut costs by consolidating.

The automobile industry, in a similar way, is no less important than it was in the past, but it is also declining because of technology. Cars last longer so there isn’t the need to make quite so many of them. But the side of the industry that Chrysler finds itself in — heavy cars that burn liquid fuel — may decline rapidly over the coming decade. Chrysler was bought out by private investors a year ago and plans to be around for a long time to come. It has to reduce its investment in its current product line so it can start making the new-generation cars that buyers will shortly come to expect.

The first step in that direction is the one Chrysler just announced. Many of the models they offer are so similar to each other that the average customer needs help telling them apart. This creates confusion among buyers and extra work for the sales staff, and that is reason enough to cut back. But it also creates extra costs along the entire process of selling cars, from engineering to advertising. These are costs that Chrysler and its dealers can save by making only models that are clearly distinct from each other.

The cuts in the dealer network are another kind of consolidation Chrysler wants to try. As U.S. consumer demand for cars declines, it would probably be impossible for Chrysler to prop up as many dealers as it has now.

Going forward, Chrysler and the other large auto makers have to be able to compete with the new car companies that make just one, two, or three models of cars. They need to cut their own costs so they are in line with those of their competitors. Chrysler is moving so quickly in part because it is now a privately held company. Unlike a public company, they cannot afford to stand their ground and lose money for years while hoping things get better. If they fail to make a profit, it is their own money they are losing. Chrysler had already started cutting costs and streamlining its operations when it was owned by Daimler but, to borrow a line from a movie, this time it’s personal.

Wednesday, February 6, 2008

The General Election Season Starts Today

Late last year when we learned that half of U.S. states would be holding primary elections on February 5, observers assumed that the major parties would select a nominee by the end of that evening, and the general election season would begin February 6, today. It did not happen quite that way, but the general election campaign is beginning anyway.

The Republican party may as well start rallying around John McCain because no other candidate seems to match the breadth of his appeal. Mitt Romney appeals to the conservative branch of the party, but there are no longer enough of them voting to win a primary in any state, so it is hard to picture Romney winning any more states than he has won already. Mike Huckabee is seen as likeable among evangelical Christian voters in the South, but he would be hard pressed to extend that appeal to the east and west coasts where most voters live. And so, it scarcely matters whether McCain gets to his party’s convention with enough votes to win a nomination, or a few less. It would be hard to put forward any other candidate for the Republican nomination with a straight face.

In the Democratic party, the votes so far are so evenly split between Hillary Clinton and Barack Obama that it is now virtually impossible for either to lock up the nomination before the convention. At this point, Clinton could win every remaining state and still not have the votes to win, and the same can be said for Obama. To win the nomination, either candidate will need the support of the party officials who also get a few votes at the convention. And what will the party officials be looking for in a candidate? More than anything else, they will be looking for a candidate who can win the general election — a candidate who can beat McCain in November.

And so, although the nomination is still far from decided, neither Clinton nor Obama can afford to spend much time campaigning against each other. Instead, they have to start campaigning against McCain. And in fact, we observed that shift in tone late last week.

And so it is effectively a general election campaign from here forward. McCain might seem to have a disadvantage in that he is running against two candidates of the other party, but his bigger disadvantage is that Democratic primary voters have sometimes seemed to outnumber Republicans by two to one this year. He’ll need to start now to try to find a way to make people feel good about the Republican party again.

Tuesday, February 5, 2008

10 Small Ways to Take On More Responsibility

In my last post I wrote about the possibility of getting a better deal if you make it a practice to take on more responsibility for what goes on in your life, particularly in your economic exchanges with others. If this is hard to do, it’s because you’ve gotten so used to relying on others to take care of things for you that you’re no longer conscious of how often you do it. Here I’ve provided a list of small exercises that can make you more conscious of situations in which you leave it to others to make things work out — and of what it means to personally make sure things work out well. This is not anything like a comprehensive list. I’ve intentionally picked examples that are very different from each other to get you thinking about the range of possibilities here.

  1. Read the ingredients of a food item — something you have or something you are thinking about buying. Don’t just read the list, understand what all the words are. You can look up most food ingredients in Wikipedia.
  2. Make a backup copy of software or music you downloaded. Then keep it somewhere safe.
  3. Pick a product you buy regularly and look for an alternative source for it. Try to find a substitute that is more convenient, less expensive, or better in some way.
  4. Pick something you own and calculate how much you pay in rent for the space it occupies (or how much you would pay if you rented the space). Calculate the cost of keeping the item over its expected life span and compare that amount to the original purchase price.
  5. Buy an item and pay with exact change.
  6. Spend 20 minutes shopping for cars online, comparing both used and new cars, and try to decide what kind of car you would buy tomorrow if your car broke down and couldn’t be repaired. This information should also give you an idea of the maximum amount it would make sense to spend to repair your current car. You never know when a car might break down, so knowing in advance what your replacement threshold is can let you face repair questions with more confidence.
  7. If you recently bought a new book release and read it, see if you can think of a friend who you might lend your copy to so they can read it while it’s still new. You can do this with music and movies too. Conversely, if you are thinking about buying a new book, movie, etc., consider whether a friend might be happy to lend it to you — or whether it might make sense to get on the waiting list to borrow it from the library.
  8. If you go to eat at a restaurant, take along a small food container and use it to take home any leftover food at the end of the meal.
  9. Try a different web browser for a day — not the one you usually use, and not one that came with your computer or operating system. You’ll appreciate the difference between choosing software for yourself and having the marketing department of a big company choose it for you.
  10. Learn the steps to a dance and be prepared to show them to your friends.