A Proposal to Managing Partners

The following article was originally published in October 1997, in the Total Quality Client Service Newsletter, published by Harcourt Brace.

Remember, time is money

–Benjamin Franklin: Advice to a Young Tradesman, 1748

Dear Colleagues,

When we see the advocates of alternative pricing boldly disseminating their doctrine, and maintaining that the right to value price is included in the basic human freedoms, we may quite properly feel serious concern about the fate of our profession; for what use will the American consumer put their hands and their minds when they live under a system of alternative pricing?

The professional organizations that you have honored with your confidence have been obliged to concern themselves with so grave a situation––that is, the death of hourly billing––and have sought in their wisdom to discover a means of protection that might be substituted for the present one, which seems endangered.

I propose that you forbid all of your firm’s associates to use their right hands.

Fellow colleagues, do not do me the injustice of thinking that I have lightly adopted a measure that at first sight may seem bizarre. Deep study of the hourly billing system has revealed to us this syllogism, upon which the whole of it is based:

  • Time is money.
  • The more hours one works, the richer one is.
  • The more difficulties one has to overcome, the more hours one works.
  • Ergo, the more difficulties one has to overcome, the richer one is.

What, in fact, is hourly billing, if not an ingenious application of this line of reasoning.  What, you may ask, is the purpose of forbidding the use of the right hand? As for the efficacy of the measure, it is incontestable. It is difficult, much more difficult than people think, to do with the left hand what one is accustomed to doing with the right. You will be convinced of this if you will deign to put my system to the test in performing some act that is familiar to you, such as, for instance, the dialing of the telephone. We can, therefore, flatter ourselves on opening to CPAs everywhere an unlimited number of job––and billing––opportunities.

Once the associates in every branch of your firm are restricted to the use of their left hands alone, imagine the immense number of billable hours that will be needed to meet the present demand for your firm’s services! So prodigious a demand for billable hours cannot fail to bring about a considerable rise in firm profits, and pauperism will disappear from the firm as if by magic.
As soon as all firms adopt my proposal, as soon as all right hands are either cut off or tied down, things will change. Twenty times, thirty times as many assistants, staff, managers and partners will not suffice to meet the national demand for CPAs. Yes, we may picture a touching scene of prosperity in the CPA profession. Such bustling about! Such activity! Such a rise in all billable hours!

Each tax return will busy a hundred fingers instead of ten. No young CPA will any longer be idle, and we have no need to indicate to your perspicacity the moral consequences of this great revolution. Not only will more young CPAs be employed, but each of them will earn more, for all of them together will be unable to satisfy the demand; and if competition reappears (such as from American Express Tax and Business Services), it will not be a threat because we, alone, will have the competitive advantage of, at least, twice the number of billable hours per professional.

You see, dear colleagues, my proposal is not only in accord with the economic tradition of hourly billing, but is essentially moral and democratic as well. In order to appreciate its consequences, let us assume that is has been put into effect, and, transporting ourselves in imagination into the future, let us imagine that the system has been in operation for twenty years. Nonbillable hours have been banished from all CPA firms; steady billable hours have brought affluence, harmony, contentment, and morality to every CPA firm; low realization rates, write-downs and low profits per partner are things of the past.

The left hand being very clumsy to work with, jobs are superabundant, and the pay is above-market. Everything has been organized on this basis; consequently, CPA firms are thronged with willing associates. Is it not true that if at such a time utopian dreamers were suddenly to appear, demanding freedom for the right hand, they would throw the profession into a panic? Is it not true that this supposed reform would upset everyone’s life? Hence, my system must be good, since it cannot be destroyed without causing suffering.

And yet I have a gloomy foreboding that one day there will be formed a CPA firm that may allow its associates to use their right hands. I have the feeling that we can already hear the advocates of freedom for the right hand. Therefore, it will not be inappropriate for the proponents of left-hand CPAs to intermingle a few threats, among their fine theories––such as time is money––to these radical both-hand CPA advocates.

“What! You wish to substitute the billable hours of the right hand for that of the left, and thus force down, if not entirely abolish, time, the sole and most important road to success and wealth? And this at a time when increased competition is already imposing painful sacrifices upon CPAs, causing them to worry about their futures, and making them more readily disposed to listen to bad advice and to abandon the wise course of conduct to which they have hitherto adhered!”

I am confident that, armed with such cogent reasoning, if it comes to a battle, the left hand will emerge the victor. If that fails, however, we’ll need appropriate regulations, to be enforced by the rule of law––promulgated by the various state’s board of accountancy––and backed up with severely harsh punishments meted out to those CPAs who refuse to use only their left hands.

Nevertheless, I do not intend to conceal from my fellow colleagues that there is one respect in which my project is vulnerable. We may be told that in twenty years all left hands will be as skillful as right hands are now, and it will then no longer be possible to count on left-handedness to increase the number of billable hours, jobs, income and profits, in CPA firms across the country.

My reply to this is that, according to learned doctors, the left side of the human body has a natural weakness that is completely reassuring for the future of CPA’s prosperity. If, then, fellow colleagues, you consent to abide by this proposal, a great principal will be established: All wealth stems from the intensity of labor.

It will be easy for us to extend and vary its applications. We shall ordain, for example, that it shall no longer be permissible to work except with the foot. Men and women have even been know to write without using either hands or feet. You see, fellow colleagues, that we shall not be lacking in means of increasing the number of billable hours in your firms. As a last resort, we should take recourse to the limitless possibilities of amputation.

Finally, fellow colleagues, if this proposal were not intended for publication, I should call your attention to the great influence that all measures of the kind I am proposing to you are likely to confer upon men and women in positions of power. But this is a matter that I prefer to reserve for a private audience.

Author’s Note Adopted from Economic Sophisms, by Frederic Bastiat (1801-1850),  Second Series, Chapter 16, “The Right Hand and the Left,” (New York: The Foundation for Economic Education, Inc., 1996).

May 15, 2015 Show Notes: Public Choice Theory

Winston Churchill said,

Democracy is the worst form of government, except all those other forms that have been tried from time to time.

Public Choice Theory describes the extension of analysis to the political alternatives to markets. Many commentators talk about “market failure,” but far fewer ever mention government failure. Public choice theory sheds light on how government employees face incentives as much as employees in the private markets, and how these incentives can create bad policies, costly regulations, and other negative consequences.

Identify a problem to be “solved” by government. But there are no solutions, only tradeoffs.

Nobel laureate James Buchanan and Gordon Tullock, founders Public Choice Economics, insisted:

Any formula for government intervention that ignores political realities is unscientific.

Gordon Tullock wrote that public choice was “politics without romance.”

Economists are often blamed for having a religious faith in markets, but no one has pointed out more market failures than economists.

We underestimate how well markets work and over-estimate how well democracy works.

Four Insights from Public Choice Economics

1. Special-interest-group effect (concentrated benefits, diffused costs)

  • Sugar program cost each American $9.24 yet it raised each sugar grower’s annual income by an average of $617,000 in 2012

2. Rational ignorance—your vote won’t determine election

  • Put more time into developing your job skills, or a major purchase then into an election. You’ll only get small amount of benefits, or pay small amount of costs

3. Rent-seeking—lobbyists wasteful to society, redistribution transfers slices of the pie, does nothing to increase pie

4. Bundling effect—Example: shopping supermarket

  • Imagine having to pick between two shopping carts pre-filled with food. You could look, put not move items from one cart to the other
  • Outside observers cannot know that you chose that Cart A despite its offering of diapers and dog food rather than because of them
  • We can say nothing about the majority’s preferences for any individual policy
  • So politicians don’t know why they won (or why opponents lost)

The Myth of the Rational Voter by Bryan Caplan

Why are voters predictably irrational?

H.L. Mencken: “Democracy is a pathetic belief in the collective wisdom of individual ignorance.”

Voters are asked to do brain surgery and they can’t pass basic anatomy.

Democracy is a relatively inferior way of making decisions: marriage, career, state to live, home to buy, etc.

Most voters are worse than ignorant, they are irrational, according to Caplan. He claims democracy fails because it does what voters want—a built-in externality.

Wisdom of the crowds doesn’t work with voting because of systematic errors

Most voters have four biases:

  1. Antimarket bias––tendency to underestimate the benefits of the market mechanism
  1. Antiforeign bias––a tendency to underestimate the economic benefits of interaction with foreigners
  • Incessant worry about the “trade deficit”
  • Ideological purity is free! Severe biases can’t exist in betting or prediction markets, but can in voters
  1. Make-work bias––a tendency to underestimate the economic benefits of conserving labor
  • China excavating land with shovels; Milton friedman asks, why not tractors? Need jobs. Oh, then use spoons
  • We wouldn’t think this way in our household, where we love labor saving devices
  • You don’t worry how to spend the hours you save buying a washing machine
  • Saving labor is progress and responsible for our ever-increasing standard of living!
  • Illusion that employment, not production, is the measure of prosperity
  1. Pessimistic bias––a tendency to overestimate the severity of economic problems and underestimate the recent past, present, and future performance of the economy.
  • Pessimism sells: Club of Rome, peak oil, Malthus, etc.
  • As you do better, your children have to do even better, optimism declines

Analogy between voting and shopping flawed. You don’t “buy” policies with votes.

Democracy let’s people with severe biases continue to participate at no extra cost.

If people are rational consumers and irrational voters, it’s a good idea to rely more on markets and less on politics.

Other Books and Resources

An unhealthy Alliance video

May 8, 2015 Show Notes: Interview with Dan Ariely

Ed and I were honored to have the opportunity to speak with Dan Ariely, James B. Duke Professor of Psychology & Behavioral Economics at Duke University, and New York Times best-selling author of four books.

Dan has had a major influence on the thinking of both of us in economic matters, especially in the areas of pricing, decision making, and choice architecture.

We asked Dan

  • Burning Man, which he tries to attend every year. He explains it’s a “gift economy,” not a barter economy.
  • Whether or not he was comfortable with the term “behavioral economics,” given that Austrian economist Ludwig von Mises argued that animals behave, but humans act (with a purpose or objective in mind), and they also learn. Dan uses the term “Judgment and Decision Making (JDM) in his first book, Predictably Irrational.
  • David Friedman says economists assume rationality because it’s useful and can predict human behavior about 50% of the time. Dan disputes the 50% figure, and explains why we need to explain failure points and mistakes in human decision making.
  • The “placebo effect” (Latin for “I shall please”). The term originally explained 14th century sham mourners. People get a larger placebo effect when the price of a pill was communicated to be higher than average.
  • Do the questions on the hospital in-take forms influence a patient’s ability to get well quicker?
  • The Economist subscription example Dan uses in his book and TED talk, with two and three choices, respectively. Is the “decoy” (or “dominated”) option manipulative?
  • Does Dan believe in the Subjective Theory of Value? He does say that value will never be perfectly objective, but we can do better at measuring it than we do now.
  • The backwards bicycle video. Dan hadn’t seen it, but discusses the power of habits and how hard they are to change.
  • In The Upside of Irrationality, Dan writes about the concept of “Hedonic adaption”: we humans adapt far more quickly than we think.
  • He also wrote in that book that “the market for single people is the most egregious market failure in Western society.” How has Internet dating has influenced this failure? Dan explains since it’s based on searchable and quantifiable aspects of people (height, income, etc.) it may not be very predictable of compatibility, like trying to understand how a cookie will taste by reading the ingredients. Humans are not algorithms.
  • Now that you’ve studied all of this irrationality, are you more rational? He focuses on habits, traps, and tries to establish rules (e.g., no eating bread).
  • In The Honest Truth About Dishonesty Dan explains “the fudge factor”: people’s ability to cheat, up to a point where they can still feel good about their own sense of integrity. He discussed how signing your tax return first would reduce cheating, and gave empirical evidence of how this worked with odometer mileage declarations for auto insurance (people declared 15% more miles when signing the form first).
  • His latest book, due out May 19th, Irrationally Yours, based on his popular Wall Street Journal advice column, and a new movie on dishonesty coming out May 22.

We highly recommend all of Dan’s books, blog, advice column and research.

Dan’s Books

May 1, 2015 Show Notes: Best Business Books

Thousands of business books are published each year. Some are worthless, others have merit, fewer still have lasting value, but a handful possess the ability to transform your business (and possibly, your life).

Yet with today’s busy and demanding schedules, do you feel you don’t devote enough time to reading and absorbing new ideas? Then this show is for you. Ed and Ron will explore the best business books ever written, selecting their favorite all-time business books.

Ed and Ron discussed four of their all-time favorite business books. Stay tuned for further shows in this series where we will share more of our favorites.

Minding the Store, Stanley Marcus, 1974

Ron believes Stanley Marcus is the true grandfather of the customer service revolution. This is the single best book ever written on customer service, and the autobiography of a remarkable man who had a remarkable life.

“There is never a good sale for Neiman Marcus unless it’s a good buy for the customer.” Herbert Marcus, 1926, to Stanley Marcus on his first day working at the store.

Neiman Marcus (NM) was established (September 8, 1907) as a result of the bad judgment of its founders, Herbert Marcus, his younger sister, Carrie Marcus Neiman, and her husband, Al Neiman.

They established a sales promotion business in Atlanta, GA, and received two offers to sell out, one for $25,000 and the other for an exclusive franchise for the state of Missouri or Kansas for a relatively new product called Coca-Cola.

Stanley Marcus’s innovations:

  • First weekly fashion shows/bridal fashion shows
  • His and Her Xmas Gifts
  • Christmas Catalog
  • Fortnight (themes) to overcome October bus lag!
  • Personalized gift wrapping

Stanley took over store in 1950, after death of his father.

Women’s Wear Daily hung “the melancholy Plato of retailing” label on him.

People liked what they didn’t find at NM. Stanley wrote:

It’s up to management to decide, not whether the article will sell, but whether it should be sold.

Another excellent book on Marcus is Stanley Marcus: The Relentless Reign of a Merchant Prince, by Thomas E. Alexander.

Stanley wrote four books during his lifetime but this one of the only ones I’ve seen written about him by an insider, Thomas E. Alexander, who met Stanley in 1965 and served nearly 20 years as his Executive Vice President of Marketing.

This was an incredibly demanding job, since Marcus was the consummate marketer, and many previous men failed at in this role.

Alexander gives you an insider’s view of the famous Neiman Marcus Fortnights, a Dallas institution until they were discontinued in 1986.

Many of the pictures come from the Stanley Marcus Collection at South Methodist University, DeGolyer Library.

You’ll read about the first out-of-state store in Bal Harbour, Florida, opened in January 1971, and also the controversy of the San Francisco store opening at Union Square. Herb Caen was an incredible critic of Neiman Marcus opening there, and the irony was that Stanely Marcus was farther to the left than Caen ever dreamed of being.

One very amusing anecdote about Marcus are the two things that exceeded his expectations, which were very high. One was Sophia Loren, and the other was the Bohemian Grove in San Francisco.

Another is the story of Marcus’s falling out with the world famous architect, Frank Lloyd Wright. Upon hiring another architect and Wright seeing his drawings, sends Marcus a letter and under his signature writes, “Looks to me like you dropped big money to pick up small change.”

In the final chapter, “Saying Goodbye,” Alexander tells of Marcus, age 95, reflecting: “Without change, there is no challenge, and without challenge there is only the status quo but no progress.” Wise words.

Other books by Stanley Marcus

The Halo Effect…and the Eight Other Business Delusions That Deceive Managers, Phil Rosenzweig

Ed’s Summary:

  • Tom Peters gets destroyed.
  • Jim Collins gets destroyed.

Halo Effect: the tendency to look at a company’s overall performance and make attributions about its culture, leadership, value, and more.

Business books: scientific rigor or storytelling?

Do business questions lend to scientific investigations? Rosenzweig says, in many instances, yes. He believes there’s no need to veer between extremes: humanities and science.

We have no satisfactory theory of effective leadership that is independent of performance

Does strong financial performance creates employee satisfaction, or vice versa?

We yearn to find out how we can avoid the seemingly inevitable fate of decline and death.

Nothing recedes like success.

The book really debunks the work of Jim Collins, especially his book Good to Great.

Physics envy: we can predict the movement of planets, so why not the performance of companies?

Collins book offered a picture of business somewhere between Norman Rockwell and Mister Rogers

Profit Beyond Measure: Extraordinary Results through Attention to Work and People, H. Thomas Johnson and Anders Broms, 2000

In 1987, as mentioned before, H. Thomas Johnson and Robert S. Kaplan published Relevance Lost: The Rise and Fall of Management Accounting, which was named in 1997 one of the 14 most influential management books to appear in the first 75 years of Harvard Business Review’s history.

The book is credited with launching the activity-based costing revolution. Yet, these two thinkers have gone down very different paths since then: Kaplan going on to pioneering work in the field of performance measurement, creating the Balanced Scorecard, and Johnson moving on to what he calls “management by means.”

In fact, they are now feuding with each other, and have not spoken in years.

Johnson’s book Profit Beyond Measure is a seminal work, although not yet fully developed. And while I have severe misgivings about some of his environmental rants in the book, when he profiles Toyota and Scania—the latter now owned by Volvo—as two manufacturers that do not have a standard cost accounting system, he is on firm ground.

It is hard to argue with results, and Toyota is one of the most respected companies in the world, and has produced one of the highest-quality products at the lowest cost in the industry for years, dating back to 1926 when it started as a weaving machinery manufacturer.

As Glenn Uminger, a financial controller at Toyota Motor Manufacturing-Kentucky (TMM-K)—which Johnson studies in depth in his book—since 1988, says, “TMM-K has never had a standard cost system to track operating costs, and we probably never will.”

So how do they do it? How can a manufacturing company run without a standard cost accounting system? Toyota understands price drives costs, not the other way around. Here is how Johnson explains it in his book, Profit Beyond Measure:

None of these comments is meant to imply that Toyota does not have accounting and production planning information systems. Of course it does. Toyota has a comprehensive array of information systems, accounting and otherwise, with which to plan, in advance of operations, and to report results of operations after the fact. But information from such systems is not allowed to influence operational decisions.

Toyota management discharges its responsibility for costs not by taking arbitrary steps to manipulate operations, but largely in the vehicle planning stage. During the design stage, long before the first penny has been committed to making a vehicle, Toyota has always placed enormous importance on setting and achieving cost targets. To do so, over the years Toyota has developed a famous technique for target costing. Simply stated, target cost is the maximum cost the company can afford to incur to produce and sell a vehicle and still earn a required profit at the price customers are expected to pay.

Johnson goes on to explain his theory that Toyota operates under “management by means” rather than “management by results.” It is an interesting viewpoint because it views the organization as a living system, based on interdependent relationships, and those are nearly impossible to quantify.

He notes Dr. Edward Deming’s observation that over 97 percent of the events that affect a company’s results are not measurable, while less than 3 percent of what influences final results can be measured:

Because cost and profit are not objects, but are properties that emerge from relationships, quantitative measures can only describe them, they cannot explain them. Quantitative measures, unlike art, music, or the stories and myths that humans fashion with words, cannot convey understanding of the multidimensional patterns that shape the relationships from which results, such as cost and profit, emerge in a living system.

If Andrew Carnegie said, “Watch the costs and the profits will take care of themselves,” Johnson is saying, “Nurture the means. The results will take care of themselves.” Kaplan would say, “Measure the result and the means will take care of themselves,” and I say, “Watch your value, and the profits will take care of themselves.”

Turning to One Another: Simple Conversations to Restore Hope to the Future, Margaret Wheatly, 2009

Ed shared the ten questions from this book:

  • Do I feel a vocation to be fully human?
  • What is my faith in the future?
  • What do I believe about others?
  • What am I willing to notice about my world?
  • When have I experienced good listening?
  • Am I willing to reclaim time to think?
  • What is the relationship I want with the earth?
  • What is my unique contribution to the whole?
  • When have I experienced working for the common good?
  • When do I experience the sacred?

April 24, 2015 Show Notes: Free-Rider Friday

Welcome to “Free-Rider Friday.” Most of our shows are “topic” driven, where we dive deep into one subject. Free-Rider Fridays are designed to be “event” driven—whatever issues are in the news that we (or you) find worthy of commentary.

In economics, free riding means reaping the benefits from the actions of others and consequently refusing to bear the full costs of those actions. This means Ed and Ron will free ride off of the news, and each other, with no advanced knowledge of the events either will bring up.

You can also comment on Twitter at #ASKTSOE.

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Ed’s Topic – More on the “one-percent”

The top 1% of income earners in the USA pay nearly 40% of federal income taxes. You can see another breakdown here, based on 2012 IRS data, from the Tax Foundation.

Ron’s Topic – Net Neutrality Regulation Update

Ajit Pi (pronounced “Ah-JEET Pi”), FCC Commissioner, was interviewed in the April Rush Limbaugh Newsletter (no link available). Here’s some of what he said:

The FCC is wielding a regulatory sledgehammer to pound down a nail that simply doesn’t exist.

Innovators, engineers, and technologists have decided how the Internet works—but now it’s going to be regulators, politicians, and lawyers.

He also mentioned how Netflix’s CFO said: “We didn’t really like Title II. We would have preferred a non-regulated solution.”

Allegations Netflix (1/3 of all traffic at peak) purposefully sends traffic on worse roads; refused open video standards to intentionally worsen the experience of users to gin up support for net neutrality regulation.

There’s no regulation of content contained in the 400 pages, which is good news. But Mr. Pi says it’s possible.

The “Universal Service Fee” (USF) now applies to broadband, not just voice. So expect to see this on your broadband bill.

Mr. Pi believes these regulations will help big companies at the expense of smaller ones—less competition, less choice, etc.

Ed’s Topic – AppleWatch

The Apple Watch pre-sold 2.3 million units. We discussed the blog post by pricing consultant and author Rafi Mohammed, who grades Apple an A for ambition, but a D in pricing strategy. Here’s why:

Problems

  1. Upgrades
  2. No carrier subsidies
  3. Price range too wide ($349 to $17,000)

Should have

  1. Narrow price range $249-$2000
  2. Offer a monthly payment plan
  3. Trade-in program
  4. Bundle watch with iPhone

It remains to be seen if the most profitable company on the planet really launched with a sub-optimal pricing strategy.

This is wonderful thing about enterprise: all value is subjective, and subject to the test of the market—that is, the preferences of individuals.

Ron’s Topic – Peter Drucker and 2020

An HBR blog post by Rick Wartzman, “What Peter Drucker Knew About 2020,” was discussed.

Here’s the article on the company that introduced a $70,000 minimum wage for its 120 employees.

Ed’s Topic – Learn Liberty and the TIP Story

Many great educational videos on economics, different schools of thought of classical liberalism, etc., at LearnLiberty.org.

Ron would also recommend Milton Friedman’s “Free to Choose” TV series, both the original 1980 series as well the updated series done in for 1990.

You can watch both for free at freetochoose.tv, along with other excellent content.

Ed also asked Ron about the TIP Clause used in some professional firms when they are delivering extraordinary value.

Here’s the story, as told in Ron’s Book, Implementing Value Pricing: A Radical Business Model for Professional Firms:

In 1997, Tim was the managing partner of top accounting firm, and his best, long-term customer (of 20 years) had come to him wanting to sell his $250 million closely held business. He told Tim (and I am paraphrasing here), “You’ve been my CPA for 20 years and I trust you with my life. It is time for me to sell my business and enjoy my golden years. Here is what I want you to do:

  • Update our business valuation to maximize the sales price.
  • Fly with me anywhere we have to go to meet with potential buyers.
  • Be actively involved at every stage of the sales negotiation.
  • Perform the due diligence, along with the attorneys, of the qualified buyers.
  • Work with the attorneys on the sales contract to make sure my interests are protected.
  • Perform tax planning and structure the deal in such a manner as to maximize my wealth retention.”

Obviously, this was a very sophisticated customer and it is true Tim had no idea, at the outset of this engagement, how long it would take to close the deal, and how much firm capacity (his and his team members) it would require. But he did know more than an average salesman would know, which is one of the enormous advantages professionals possess when it comes to pricing the customer, not the service. He knew the customer’s business was well niched, profitable, and growing. This would indicate a very high probability of success.

He also knew this customer was an audit customer of the firm’s and therefore he would not be able to charge a contingency price based upon a financial outcome (such as a percentage of the sales price, or of any tax savings), since that would impair independence, which is illegal for an auditor.

When I asked Tim how he priced this engagement, he proudly proclaimed that every hour charged to this project was at his highest consulting rate of $400 per hour, indicating, right from the start, Tim knew there was more value on this project than he would ever be able to pad on a timesheet.

He further explained how he had updated the business valuation, negotiated with two buyers, and did all of the other tasks requested by the customer. As a result of Tim’s work, the customer received (and saved in taxes) an additional $15,000,000, and acknowledged Tim was directly responsible for this outcome. In Tim’s own words, the customer was “elated.”

Tim then told how he priced the engagement. He reviewed all of the hours from the work-in-progress time and billing system, believed it did not adequately reflect the value he provided, and marked it up an additional 25 percent over the $400 hourly rate. He then sent out an invoice for $38,000, which the customer promptly—and happily—paid.

He believed he was value pricing. He was not—he was value guessing, since the customer had absolutely no input into the price up front, and only a customer can determine value.

When I asked Tim what he thought the customer would have paid if he had utilized a TIP clause (also referred to as the retrospective price, or success price), such as the following:

In the event that we are able to satisfy your needs in a timely and professional manner, you have agreed to review the situation and decide whether, in the sole discretion of XYZ [company], some additional payment to ABC [CPAs] is appropriate in view of your overall satisfaction with the services rendered by ABC.

The TIP is being based on the “overall satisfaction with the services rendered,” and not any financial contingency, which is the origin of the acronym TIP—to insure performance. This TIP clause would be discussed with the customer before any work began. If needed, you could put a minimum price on the engagement (such as $40,000) to cover immediate firm capacity.

But in this case, given the 20-year relationship with the customer, even a price solely determined by a TIP would have been acceptable, since the customer was not likely to take advantage of Tim after the services he rendered and the long-term relationship they had.

In answer to my question, Tim said his customer would most likely have paid him $500,000, a sum I believe to this day is below the real number—but at least better than the $38,000 he finally charged. Nevertheless, since Tim knows the customer better than I do, let us take his number as correct.

I informed Tim he had made the Ultimate Accounting Entry:

Debit Credit
Experience $462,000
Cash $462,000

Tim was providing extraordinary value to this customer yet his cost-plus pricing theory prevented him from capturing a fair portion of it. Are we not ruled by our theories? This is why it is imperative to extinguish the cost-plus mentality from your firm.

No one in any seminar I have shared this story with believed Tim would have received less than $38,000 for his services on this engagement. In effect, Tim paid a reverse risk premium—he was assured he would not go below his hourly rate, but in return he gave up the added value the customer already believed he had created. This is not a risk worth taking if you want to maximize your firm’s profitability.

The deleterious effects of this are deeper than just being deprived the value from the work you provided on any one engagement. The problem lies at the very core of a firm’s measurement system and points out how it does not offer the opportunity to learn from lost pricing opportunities, or pricing mistakes.

In his inimitable way, Yogi Berra explains this situation with his quip, “We made too many wrong mistakes.”

When it comes to pricing, the wisdom from Yogi is profound. Tim made the wrong mistake, and here is why: He will not learn anything from it because the firm’s primary assessment is billable hours—once again the billable hour is the incorrect measuring device for value. When the partners review the realization report on this engagement, they will see 125 percent, which is excellent when you consider most firms realize between 50 and 95 percent overall on each hour.

Most likely, Tim will get nothing but accolades and praise from his fellow partners. No one will ask where the $462,000 is because the billable hour metrics do not have a way to capture that type of information, which is precisely why pricing is more of an art than a science.

This is an excellent example of a wrong mistake for another reason: Tim (or the firm) will not learn anything from this lost pricing opportunity. The $462,000 simply vanishes into thin air (or, more precisely, the consumer surplus remains on the customer’s income statement).

No knowledge was gained by the firm on how to price the next similar engagement in accordance with value—it will simply perpetuate the same mistake, over and over. Being a more accurate activity-based cost-accountant, or even excellent project manager, would also not have helped Tim to capture the value.

This is not meant to imply with value pricing you will never make mistakes. You certainly will. The difference is they will be the right mistakes, because with value pricing, as opposed to cost-plus pricing, you are forced to receive input from the customer as to your value, and have in place pricing strategies that will capture more of that value (like the TIP clause).

If you engage in After Action Reviews (AARs), which perform value assessments on each engagement, and elicit feedback from your customers, you will learn from your mistakes and become better at pricing in the future.

Most feedback firms receive on pricing is negative: “Your price was too high.” Or it is ambivalent: “Your price was just right.” No customer ever discloses how much money your firm left on the table. Since humans emerged from the cave and began to barter, it is the customer’s job to do everything in their power to push down prices. There is nothing new about this, and it should not surprise any executive. Your firm’s job, however, is to push back. The only effective way to accomplish this is by emphasizing value.

Ron was also interviewed for an article on the TIP clause, which you can read here.

April 17, 2015 Show Notes: We’re All Consultants Now!

Ed discussed how we are all consultants now. This material is based on Peter Block’s seminal book, Flawless Consulting.

Consulting Definitions

A consultant is a person in a position to have some influence over an individual, group, or organization, but who has no direct power to make changes or implement programs.

A surrogate manager is a person in a position who acts on behalf or in place of a manager. If you are being asked to “complete this report,” “design this system,” or “figure out what to do,” you are in the position of surrogate manager.

Consultants and surrogate managers are two distinct roles. You cannot be both because that would be a contradiction. It is irrational.

Consulting Assumptions

Whenever performing in a consulting role, it is important that the consultant must be clear about one’s own basic beliefs. Our own behaviors must be consistent with what we recommend.

It makes sense to spend some time thinking about what your personal beliefs are about what makes for good management and leadership. To this end, presented below are three assumptions about consulting for the purposes of our dialogue.

Problem solving requires valid data. This data not only includes objective or hard data, but personal or soft data. Hard data are not only computer system data, but other hard facts such as events or situations. Soft data are also facts, but relate to the personal feelings of those involved. If people feel that they have not been trained effectively on a new system, then this is a fact, even if we have a sign-off sheet saying they were trained. Throwing away this data because it is soft, puts actual problem solving in peril.

Effective decision making requires free choice. If a decision is to be truly implemented, the people involved in carrying out the decision must feel that they were a part of the decision. When they do not feel a part of the decision, they have a tendency to get defensive. If “no” is not a choice, than it is not really a decision.

Effective implementation requires customer commitment. If a customer is not fully committed to the implementation of a decision, it will fail. Support is not enough, commitment is required. In order to gain commitment, people need to clearly see the benefit this will have for them.

Consulting Levels: The FORD Model

Customers desire consultants to work on many different levels within an engagement. Often times the desired consultant level is not effectively communicated by both parties.

It is critical to the success of any engagement that both the consultant and the customer are clear about the desired level. These levels are:

  • Findings
  • Options
  • Recommendations
  • Decision

See Ed’s blog post on the FORD Model.

Chris Marston’s Concentric Circles blog post.

Consulting Goals

Along with consulting assumptions, a consultant should have some basic goals. These goals may not always be attained, but they should indicate your preference. Like assumptions, presented below are three goals for this material.

To establish a collaborative relationship. Collaboration is proven to be the most effective way to maximize both the consultant and customer’s resources. Secondarily, it provides a model for the customer to see and use to solve problems in the future.

To solve problems so they stay solved. Many consultants act in a way so as to fix the immediate problem. This is what has given consulting a bad connotation. Solving problems so they stay solved is a key differentiator. Teaching customers to solve problems on their own in the future requires a higher level of skill.

To ensure attention is given to both the technical problem and the relationship. Most organizations pay attention only to their technical problems. Consultants are in a unique position that allows them to see the people and process issues that surround the technical problem.

To develop customer commitment. As was stated earlier, without customer commitment the consultant has no chance to succeed. Therefore, the underlying goal of every action is to develop customer commitment to a solution to the problem.

To quote Peter Block:

We may cling to the fantasy that if our thinking is clear and logical, our wording eloquent, and our convictions solid, the strength of our arguments will carry the day. Clear arguments do help, but they are not enough. The customer will experience doubts and dilemmas that block commitment. Flawless Consulting, p 21.

Positive Deviance

I also asked Ed about Peter Block’s concept of “positive deviance”: Are we here to merely solve a problem, or create a new future for ourselves?”

Peter Drucker thought we should pursue opportunities, not just solve problems. Solving problems, at best, only returns us to the status quo. Executives need to spend the majority of their time—and allocate their best talent—to the opportunities of tomorrow.

Ed’s Statement of Intent

“It is my intention to help you and your organization make the best possible decision.”

Not Final Thoughts

What I love about Ed’s concept that we are consultants now is that is positions professionals at the top of Joseph Pine’s Progression of Economic Value Curve—that of transformations.

For if consulting is done right, you are transforming a person, a group, or an organization, rather than just delivering services.

This is one of the most effective strategies to de-commoditize your offerings!

April 10, 2015 Show Notes – For Good and Evil: Taxes and Civilization

There have been great and powerful men who have moved civilization, but most of the time no heroes can be found, and the world is led by scoundrels, fools, and second-stringers. Taxes, however, are ever present, often making a strong impact upon our lives—for good and evil. The prosperity as well as the decline of nations has always had a tax factor, and this we will see time and again throughout history

–Charles Adams, For Good and Evil

For Good and Evil by Charles Adams is the most comprehensive book on the history of taxation throughout civilization that I have ever read. Adams is an international tax attorney who offers a refreshing perspective on taxation, one you will not find among most practicing tax professionals.

It is a lively book that takes you from Ancient Egypt, Greece, Rome and the Middle Ages, all the way up to present day. It offers a perspective on taxation that you will not find in the current debates surrounding tax reform, and offers some very compelling alternatives and improvements to our existing system.

In order to tempt you to buy a copy of this book and read it, we offer the following tidbits of knowledge you will learn from Adams:

  • Taxpayers from the beginning of time have reacted to oppressive taxation in three ways: 1) rampant tax evasion and flight to avoid tax; 2) riots; 3) violence;
  • The first casualty of “dumb taxation” has always been liberty; the second casualty has been the wealth and strength of a nation;
  • The origins of Hanukkah are rooted in the tax struggles of the ancient Hebrews;
  • The Ancient Greeks extracted large amounts of wealth from rich private citizens through the liturgy—the voluntary alternative to progressive taxation. Enforced by tradition and strong public sentiment, most gave three to four times more than what was expected from them;
  • Plane Geometry was not invented by Euclid, but rather by ancient tax collectors determining land size for harvest taxes;
  • One of the causes of the fall of the Roman Empire was tax evasion;
  • William Tell refused to acknowledge the Austrian Hapsburgs and their gang of tax collectors. For this defiance he was ordered to shoot an apple from the head of his son with a crossbow;
  • The American Revolution was probably more the consequence of the oppressive administration of taxes than the taxes themselves. Taxation with representation has proven more expensive than taxation without representation;
  • In 1787 no citizen of the United States could vote who was not a taxpayer;
  • Was the Civil War fought over slavery or Northern Tax policy?
  • In 1816 Britons put a tax on newspapers (the “knowledge tax”), designed to curb the opposition press. The tax was levied by the page. Papers today continue to print large pages, which were initiated for tax avoidance;
  • Tax laws have taken away liberty more often than foreign invaders;

And ultimately,

  • All good tax systems tend to go bad.

As Adams Points out: “Polybius, considered the greatest historian of the ancient world, said that the best preparation for politics was the study of history in order to avoid the disasters of others.”

With respect to taxation, there have been plenty of disasters. If enough of us educate ourselves, it may be possible to avoid those historical debacles. Adams reminds us of the wisdom from past thinkers that we have foolishly forgotten.

The Lost Legacy: The Enlightenment Thinkers on Taxation

It is vain to say that enlightened statesmen will be able to adjust these clashing [tax] interests, and render them all subservient to the public good. Enlightened statesmen will not always be at the helm

–James Madison, The Federalist, No. 10, 1787-1788

It has been noted that the principal trouble with the contemporary generation is that it hasn’t read the minutes of the last meeting. With respect to tax policy, this is an understatement. The Enlightenment period (1650 to 1700) was the high watermark for tax wisdom, ethics, jurisprudence and plain common sense, according to Charles Adams in For Good and Evil.

The Enlightenment thinkers knew their history; they searched the world’s governmental systems for what worked and what didn’t, and took the best of many. With regard to taxation, they frequently spoke of the relationship between taxation and despotism and prosperity. Their primary insight was that government exists to maintain our liberty—not our prosperity.

The legacy they left us has largely been forgotten. Listen to the present tax reform debates and you will not hear the ideas and ideals of the Enlightenment thinkers, especially amongst the media and the “tax experts.” Instead, they report on any changes as if it were a sporting event—who wins and who loses, rather than what is good for the whole country.

This is tragic. It is amazing that in a society such as ours—with instantaneous access and ability to transmit information far and wide—we have forgotten the wisdom of these thinkers. It proves that information does not equate to wisdom.

Charles Adams points out:

Perhaps this is an example of the simple truth about life—what comes easy is taken lightly. Our liberty and freedoms were handed down to us by generations past that had to fight for the liberty we now enjoy. Liberty to us is an inheritance, not something we earned or achieved on our own. We take liberty lightly, and we don’t seem to realize how hard it is to get it back once it is lost.

The following is the “priceless legacy” the men of the Enlightenment passed on to us, adapted from For Good and Evil (first edition), Chapter 26.

  1. Government is at best a necessary evil

Thomas Paine in Common Sense (1776): “Government, even in its best state is but a necessary evil, in its worst state an intolerable one.”

Paine said that taxation was tyranny, and a great destroyer of liberty as well as of property and industry, and it impoverishes the people more than foreign enemies do.

  1. The imaginary wants of the state

“Baron de Montesquieu in his The Spirit of Laws (1751), a book which greatly influenced the Framers of the U.S. Constitution, explained this problem:

                  The revenues of the state are a portion of that each subject gives of his property in order to secure or to have the agreeable enjoyment of the remainder.

To fix these revenues in a proper manner, regard should be had both to the necessities of the state and those of the subject. The real wants of the people ought never to give way to the imaginary wants of the state.

Imaginary wants are those which flow from the passions, and from the weakness of the governors, from the charms of an extraordinary project, from the distempered desire of vain glory and from a certain impotency of mind incapable of withstanding the attacks of    fancy. Often has it happened that ministers of a restless disposition, have imagined that the wants of the state were those of their own little and ignoble souls.”

  1. Government should stay out of business

Adam Smith in The Wealth of Nations:

Princes, however, have frequently engaged in many other mercantile projects, and have been willing, like private persons, to mend their fortunes by becoming adventurers in the common branches of trade. They have scarce ever succeeded. The profusion with which the affairs of princes are always managed, renders it almost impossible that they should. The agents of the prince regard the wealth of their master as inexhaustible; are careless in what price they buy, are careless in what price they sell; are careless at what expense.

Two words: Post Office.

  1. Liberty carries the seed of its own destruction

          Montesquieu noted that people living in a state of liberty tend to let their guard down and tolerate great taxes, but once granted they discover they cannot take a backward step: “Liberty produces excessive taxes; the effect of excessive taxes is slavery.”

  1. Direct taxes are the badge of slavery, and indirect taxes the badge of liberty

         Again Montesquieu: “Capitation [direct taxes on the individual] is more natural to slavery; a duty on merchandise is more natural to liberty, because it has not so direct a relation to the person.”

Recall that the Supreme Court ruled the 1894 income tax unconstitutional because it was a direct tax (thus had to be apportioned amongst the states).

  1. Tax evasion is not a criminal act

            Tax evasion is the consequence of excessive taxation, it’s a “positive offense” because it’s one manufactured by the state, not worthy of being called a true crime.

Taxation means forced exaction. Taxes aren’t debts, no principle of fair value received, which is basis for legally enforceable debt.

The US Treasury Department defines a tax as: “A compulsory payment for which no specific benefit is received in return.”

A tax is owed because the government says so, nothing else is required. You can’t be put in prison for not paying your VISA bill.

  1. Liberty’s most dangerous foe: arbitrary taxation

          David Hume:

“But the most pernicious of all taxes are the arbitrary. They are commonly converted, by their management, into punishments on industry…It is surprising, therefore, to see them have place among any civilized people.” If any of the following three principles are violated, the taxation was considered arbitrary:

  1. Taxation must be with consent.
  2. Have to be apportioned among the people by a definite standard or rule.
  3. Must be equal, counter to the inclination of everyone to push their taxes off onto someone else.
  1. Common sense economics: the supply-siders

            Not a new theory at all, goes back into antiquity.

  1. The marks of a bad tax system: Adam Smith’s four points:

1. A tax was bad that required a large bureaucracy for administration.

2. A tax was bad that “may obstruct the industry of the people, and discouraged them from applying to certain branches of business which might give maintenance and employment to great multitudes. While it obliges the people to pay, it may thus diminish, or perhaps destroy, some of the funds which might enable them more easily to do so.”

3. A tax was bad that encouraged evasion. “The law, contrary to all the ordinary principles of justice, first creates the temptation, and then punishes those who yield to it.”

4. A tax is bad that puts the people through “odious examinations of the tax-gatherers, and exposes them to much unnecessary trouble, vexation, and oppression…It is in some one or other of these four different ways that taxes are frequently so much more burdensome to the people than they are beneficial to the sovereign.”

  1. What a good tax system should be: Lord Kames’s six rules:

            Lord Henry Home Kames, a scholar of that era, published his Sketches on the History of Man (1769), which analyzed tax issues and greatly influenced Adam Smith. Here are Kames’ “Rules to be observed in Taxing”:

  1. “When the opportunity for evasion exists, taxes must be moderate. It is unjust for a legislature ‘first to tempt and then to punish’ for yielding to temptation.”
  1. Taxes that are expensive to levy should be avoided.
  1. Arbitrary taxes are “disgustful to all.” The amount paid is determined by the “vague and conjectured opinion of others.”
  1. To remedy the “inequity of riches,” the poor should be relieved of any significant tax burdens.
  1. Taxes that sap the strength of a nation should be avoided. Such taxes “contradict the very nature of government, which is to protect not oppress.”
  1. Taxes that require an oath are to be avoided. Said Kames:

Perjury has dwindled into a venial transgression and scarcely held an imputation to any man’s character…Lamentable indeed has been the conduct of our legislature: instead of laws for reforming and improving morals, the imprudent multiplication of oaths [for tax enforcement] has not only spread corruption through every rank, but by annihilating the authority of the oath over conscience, has rendered it ineffectual.

The U.S. Supreme Court condemned the use of oaths for tax administration as late as 1885, Boyd v. United States, 116 U.S. 616, 631.

How many of these tests would our present-day tax system meet?

Very important question:

                        Have we squandered our inheritance?

Those who have no concern for their ancestors will have none for their descendants

–Edmund Burke

To know nothing of what happened before you were born is to remain ever a child

–Cicero

You can watch an hour long interview with Charles Adams from Booknotes here.

April 3, 2015 Show Notes: Entrepreneur Heaven: Thomas Edison, Henry Ford, Walt Disney, J.W. Marriott

They say you can’t turn back the clock and go back to the good old days. Yet this is precisely what is happening with the total quality service movement, the customer loyalty movement, CRM, and other philosophies that put the customer at the center of the business organization. Millions of dollars are being spent on consultants to relearn what was once common sense, practiced by the great entrepreneurs from the turn of the century to the mid-1950s.

This show, the first in our Entrepreneur Heaven Series, will explore the wisdom of Thomas Edison, Henry Ford, J.W. Marriott, and Walt Disney. Wisdom is timeless, and occasionally turning back the clock is the wisest course of action. Sometimes history is our best teacher.

Thomas Edison (Feb 11, 1847 – October 18, 1931)

Born in Ohio, died 1931, at 84. Scarlet fever as boy may have contributed to him being deaf.

Before age 40: invented the phonograph, electric light, and improved the motion picture camera.

World record of 1,093 patents over lifetime; first at 21; last one granted ten months before his death, and four posthumously.

Sign in Edison’s laboratory:

            Hell! There ain’t no rules around here! We are tryin’ to accomplish somep’n.

Notable Quotes

It is too much the fashion to attribute all inventions to accident, and a great deal of nonsense is talked on that score.

Asked if the age of invention was passing in 1908: “Passing? Why, it hasn’t started yet.”

He loved silent films (he was deaf), but didn’t think there was any money in talking movies. He believed talking films would never supplant silent films (“The public does not want talking movies”).

He also thought films would completely supplant books in schools.

When will you retire: “A few days before the funeral.”

There is no free lunch. 2/22/1929, Fort Myers Press

If you want to succeed, get some enemies.

Most assuredly I do believe in God. Nature and science both affirm His existence, and where the layman believes the man of science knows. 1890 [You could argue he believed in Intelligent Design]

I am at work on an invention which will enable a man in Wall Street not only to telephone to a friend near Central Park, but to actually see that friend while speaking to him…Of course, it is ridiculous to talk about seeing between New York and Paris; the rotundity of the earth, if nothing else, would render that impossible. –September 1, 1889, Levant Herald

Henry Ford on Edison: “It might be said we live in the age of Edison…in many ways, the greatest man since the world began. March 7, 1929, NYT

Henry Ford (July 30, 1863 – April 7, 1947)

Ford’s father: “Henry worries me. He doesn’t seem to settle down and I don’t know what’s going to become of him.”

William Ford died in 1905, before Ford achieved great success.

There’s no record of Ford personally meeting Hitler. But Ford was awarded the Grand Cross of the German Eagle, highest honor in Nazi Party (July 1938).

Revolutionized: $5/day, 8-hour day; five-day-week, as a tool to induce his employees and their families to better living; and profit-sharing.Yet very few employees were paid $5/hour (the average pay was $2.34/hour); efficiency experts set unachievable standards; Ford had the reputation as the worst sweatshops.

He established a “Sociological Department” to monitor his employees behavior on and off the clock. (closed in 1920, when he distanced himself from this view).

He believed in reincarnation; was raised Episcopalian; and was an anti-Semite. He bought the Dearborn Independent in 1919, which ran anti-Semitic articles, and was closed in 1927.

He didn’t believe in charity, which is interesting since the Ford Foundation has given millions. He believed charity “Lowers the self-respect of receiver and deadens the conscience of the giver.”

He had a Puritan streak, disliking jazz, consumer debt, and supported Prohibition.

Thomas Edison was his idol, and they each had a vacation home in Ft. Myers, Fl.

The Model T came only in black because paint dried faster—a case of efficiency over effectiveness. Ford said of the Model T: “The only thing wrong with that car was that people stopped buying it.”

GM started GMAC in 1919 to begin financing cars, which is what really grabbed market share from Ford, who didn’t start a financing arm until the late 1920s. Ford didn’t think people should go into debt.

He also believed in abolishing patents, since he thought they killed competition.

Notable Quotes

Visitors often ask me what the car of the future will be. I don’t know. If I did I would be making it now. Feb 1936

Business men go down with their businesses because they like the old way so well they cannot bring themselves to change. Circa 1923

[Sound business] is to provide a service. Try to run a business solely to make money and the business will die. Circa 1932

A manufacturer is not through with his customer when a sale is completed. He has then only started with his customer….If the machine does not give service, then it is better for the manufacture if he had never had an introduction, for he will have the worst of all advertisements—a dissatisfied customer. Circa 1923

Profits are merely what we think we work for…The real profit is not what the promoters get, but what the country gets. July 7, 1929 NYT

Walt Disney (Dec 5, 1901 – Dec 15, 1966)

One estimate, in 1966 alone, the year of his death, 240 million people saw a Disney movie, a weekly audience of 100 million watched a Disney television show, 80 million read a Disney book, 50 million listened to Disney records, 80 million bought Disney merchandise, 150 million read a Disney comic strip, 80 million saw a Disney educational film, and nearly 7 million visited Disneyland.

NASA acknowledged that Disney’s early drumbeating for its program was instrumental in generating public support for space exploration.

During London blitz, children’s gas masks had Mickey on them.

Disneyland was just a modern variant on the old Puritan ideal of a shining City on a Hill. “Why should I run for Mayor [of Los Angeles] when I’m already king”

The Walt Disney Family Museum, Park Presidio, San Francisco display over 900 awards for artistic work and service, including his Presidential Medal for Freedom, presented by Lyndon Johnson in 1964.

In 1955, Walt paid $4,000/acre for Disneyland property; 4 years later it was valued at $20,000/acre.

Walt’s good friend, Art Linkletter, refused to invest in Anaheim, and he figures the tour of the property with Walt cost him $3m per step!

Walt Disney World is even more dramatic (27,400 acres bought for $5m = $185/acre. Worth well over $2 million per acre today.

Realtors axiom: Location, location, location. Bunk! It can be trumped with intellectual capital.

Late 1930s, Mickey lost his tail. Thousands saved not drawing it! It was restored. Effectiveness over efficiency.

Paul Anderson, a Disney Historian at BYU lists six characteristics to describe Walt’s success:

  1. Curiosity
  2. Knowledge
  3. Experimentation
  4. Quality at all costs
  5. Control—delegate to good people
  6. Vision

Every theme park operator told him he’d go broke with Disneyland within one year. Ward Kimball, one of the famous Disney animators:

            If you want to know the real secret of Walt Disney’s success, it’s that he never tried to make money.

Ron’s favorite Disney line:

            I could never convince the financiers that Disneyland was feasible, because dreams offer too little collateral.

J. Willard Marriott (Sept 17, 1900 – Aug 13, 1985)

Started a Hot Shoppe $3,000 in 1927 (A&W Root Beer).

First hotel was Twin Bridges, Arlington, VA, Jan 1957.

In-Flight catering started by JW visiting Hot Shoppe in 1937 next to airfield, watching customers buy food for airplane flight.

Had an “employees-first philosophy. Knew human touch was all-important for guests staying away from home.

Diversified into catering, cruise ships, theme parks (1972)—got out of all of them eventually.

Rule of decision making: Listen to your heart (research & data only get you so far).

Recommend Books and Readings

Obviously, there are lot of books written on each of these men. The following are the ones Ron has particularly enjoyed, and found to be reliable as to the actual history of their lives.

The Quotable Edison, edited by Michele Wehrwein Albion

The Quotable Henry Ford, edited by Michele Wehrwein Albion

The Animated Man: A Life of Walt Disney, by Michael Barrier

Walt Disney, by Neal Gabler

How to Be Like Walt, Pat Williams

Marriott: The J. Willard Marriott Story, by Robert O’Brien

Earning My Mouse Ears, Part I, by Ron Baker

Earning My Mouse Ears, Part II, by Ron Baker

Earning My Mouse Ears, Part III, by Ron Baker

 

March 27, 2015 Show Notes: Free-Rider Friday

Welcome to “Free-Rider Friday.” Most of our shows are “topic” driven, where we dive deep into one subject. Free-Rider Fridays are designed to be “event” driven—whatever issues are in the news that we (or you) find worthy of commentary.

In economics, free riding means reaping the benefits from the actions of others and consequently refusing to bear the full costs of those actions. This means Ed and Ron will free ride off of the news, and each other, with no advanced knowledge of the events either will bring up.

You can also comment on Twitter at #ASKTSOE.

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Ed’s Topics

Ed read an email from Jay, a listener in San Antonio. Jay asked Ron when he was introduced to the big libertarian thinkers, including Ludwig von Mises.

Jay also asked Ron about Edmund Burke and natural rights, and how long Ed has been a Libertarian.

Ed discussed the Tinder Plus App, and how it’s priced.

Ed mentioned how Salesforce reacted to a proposed law in Indiana that allows businesses to discriminate against gay and lesbian couples, and also Audra McDonald’s reaction to it.

Ron’s Topics

Bob Cross, our guest on the March 13, 2015 show, told a story of how Marriott did a primitive form of Revenue Management in the 1950s. It turns out, so did my Dad in the barbershop, with respect to kids haircuts on Saturday’s, the busiest day of the week.

An article in the January 19, 2015 issue of The Economist, “When the chips are down,” about McDonald’s sales being down 4.6% year-over-year as of November 2014.

In contrast, fast-casual restaurants such as Shake Shack, Nando’s, Chipotle Mexican Grill, and Panera Bread, are up 10.5%. Four reasons are cited:

  1. Fresh food
  2. High-level customization of your order
  3. Clever pricing, some dishes same price as fast food, but better at nudging to pricier dishes and extras, get an extra 40% out of each diner’s wallet
  4. Each outlet offers a touch of distinctiveness (better before cheaper)

Other random topics

We discussed the concept of “Nudging,” and the book by Cass Sunstein and Richard Thaler, Nudge.

We also discussed an email question from listener Buyan:

Hi Ron,

I am an active listener on your books and podcasts. I currently lead an IT consulting company where we do custom development and CRM implementation projects. I have several questions on the business model which makes sense from your podcast.

  1. From a consulting company perspective, I am struggling with defining value for my customers. Most of our clients use our services for complex, integration needs of their business. Do you have some examples of how other professional service firms define value or create value ?
  2. I am now implementing the 3 price point approach which you had suggested instead of the previous one price which did not work for us. I would like to differentiate our firm with a zappos like service experience but our struggle is communicating that as a value to our clients. Are there any pointers on how that would work for an IT consulting company?

So please let me know.

Thanks,

Buyan

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March 13, 2015 Show Notes: Interview with Pricing Legend Robert G. Cross

PWP Studio photographers specialize in corporate event photography, decor, details, incentive travel, conventions, and on-location photography in Atlanta, Georgia

What a treat it was to have the chance to interview Bob Cross, an absolute legend in pricing circles, and a mentor to me since reading his book, Revenue Management: Hard-Core Tactics for Market Domination, back in 1997. It really opened up the world of Revenue Management (especially in airlines) to me, and had a profound impact on my pricing future.

I got to hear Bob speak, and then meet him, at a Professional Pricing Society Conference back in 2000. You’ll want to listen to this entire interview, as his story of how he got into pricing is fascinating.

Biography

Robert G. Cross is the Chairman and CEO of Revenue Analytics.  He is widely recognized as the foremost expert in the field of Revenue Management. Robert G. Cross guides Revenue Analytics’ strategic vision and provides a wealth of industry expertise. He is actively involved in client work, and his leadership has been instrumental in helping develop leading Revenue Management capabilities for Revenue Analytics clients, including Coca-Cola, Marriott International and InterContinental Hotels Group. Labeled the “Guru of Revenue Management” by The Wall Street Journal, Robert G. Cross, prior to Revenue Analytics, founded Talus Solutions, Inc., a company credited with creating billions of dollars in value for clients such as Delta Air Lines, Ford Motor Company and UPS. Talus was acquired by Manugistics Group, Inc. in December of 2000 for $366 million.

Delta Story

Bob explains how a chemistry major, then a lawyer, ends up in Yield Management at Delta Airlines.

Bob tells the story of how Delta was leaving $200 Million on the table by misallocating seats (selling too many discount seats too soon, thus sacrificing last-minute full-fare seats, and having planes leave ½ empty that could have been sold out with discounted seats).

Revenue management accounted for $300 million in incremental revenue gain, ½ of Delta’s turnaround gain $600 million in 1984.

Bob left Delta and started the first company entirely devoted to the art and science of Revenue Management.

Bill Marriott, Jr. Story

One of my favorite stories Bob told at his PPS speech was how Bill Marriott, Jr. did Revenue Management back in the 1950s, before sophisticated software was available.

I reminded Bob that revenue management is not new, recounting this story from my book, Pricing on Purpose:

Indeed, it may be entering its third millennium as a management technique. We are told that Joseph and Mary had to be accommodated in a stable two thousand years ago because there was no room at the inn. But perhaps the innkeeper had identified them as customers who could not afford a premium rate on a night of peak demand and had decided to hold out for better business. After all, he might have known that there were three kings in town who had yet to find accommodation.

Revenue management strategies add $150M-200M in annual revenue at Marriott.

It uses a “Revenue Opportunity Model,” which measures actual revenue against a theoretical optimal.

Revenue management has spread to Hilton, Holiday Inn, Sheraton, Disney, golf courses, sports, entertainment, operas, retailers, and it literally saved National Car Rental from bankruptcy.

Revenue Management: Hard-Core Tactics for Market Domination, 1997

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I read this book in May 1997. There are blurbs from Robert Crandall (American Airlines Yield Management pioneer), Bill Marriott, Jr., and Herb Kelleher from Southwest Airlines fame.

In the Acknowledgements, Bob talks about his late barber, Carol Meinke, who operated a one-chair Barbershop. He tries to convince her to manage supply and demand using pricing!

My father, Sam Baker, was also a barber. Saturday’s were his busiest days, and the last thing you wanted to do was turn away a working gentlemen who would pay full price, and only has weekends to get his hair cut.

So the barbers used to tell the moms bringing in kids on Saturday that the price is cheaper if they come in on Tuesday! This is revenue management in action!:

            Sell the right product to the right customer at the right time for the right price.

Excellent Articles on Pricing by Bob

Milestones in the application of analytical pricing and revenue management,” September 25, 2010

This is an excellent article if you’re interested in the history and diffusion of Yield Management, how it started in the airlines, and diffused into hotels, transportation companies, among others.

Over past few decades, revenue management has added tens of billions to net profits of hundreds of firms.

In 1991 UPS built a pricing department—Using “Target Pricing” it increased its profits in the first year by $100 million.

Fred Smith FedEx attributes 10% revenue growth and 33% profit growth to revenue management and a more “disciplined pricing approach.”

In the early 1990s, Canadian Broadcast Corporation, then ABC, NBC began revenue management to sell advertising.

Ford Motor realized cost-cutting was not the answer, and from the mid-1990s to the end of decade earned $3 Billion in additional profits thanks to better pricing.

Revenue Management’s Renaissance: A Rebirth of the Art and Science of Profitable Revenue Generation,” February 2009.

Customer-Centric pricing: The Surprising secret for profitability,” 2005.

Questions

We asked Bob if he sees a trend away from cost-plus pricing? Yes, he does.

Which industries were the best pricers? Used to be airlines, now he’d say hotels.

Which country leads the world in pricing? The United States.

Other Resources

Pricing on Purpose: Creating and Capturing Value, by Ronald J. Baker

Ron is honored to keynote at this year’s Professional Pricing Society Conference in Dallas, Texas, on May 7, 2015: “Top Ten Business Myths.”