Book Review: Models. Behaving. Badly

Emanuel Derman has written a terrific book for explaining the difference between models, theories, and intuition.

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The author grew up in Cape Town, South Africa, when apartheid was at its peak in the 1950s and 1960s, came to the US in the mid-60s, worked as a theoretical physicist, then as a “quant” at Goldman Sachs.

I can quibble with some of his political and economic views, such as the claim that the extreme left and right are equivalent, which is nonsense. I’d rather live under a Italian fascist than a communist. And his contention that capitalism is not capable of self-regulation, Wall Street overshoots in its greed, etc. Not once does he mention government failure when discussing the financial meltdown of 2008.

These quibbles aside, his dissection of the differences between a model and theory is fascinating, one that I wish I had read a lot sooner. This will be a very abbreviated review, just to summarize the major differences between theories and models, which I believe will be incredibly useful in our work.

The author’s major purpose in the book is to explain the three ways of understanding the world: theories, models, and intuition.

Humans worry about what’s ahead, and models and theories are a way of foretelling the future, and controlling it. We need theories and models because of time (the world is not stationary, and we must plan for the future).

Theories attempt to discover the principles that drive the world; they need confirmation, but no justification for their existence. They must stand on their own two feet. A theory can become a fact; it is deep; whereas a model is shallower. A theory doesn’t simplify, it becomes indistinguishable from the object itself.

We advance by mounting new theories atop previous facts. If those theories prove correct, they become facts too.

This is why the author loves what Goethe wrote in Maxims and Reflections:

The ultimate goal would be: to grasp that everything in the realm of fact is already theory.

And:

There is nothing so terrible as activity without insight.

Models stand on someone else’s feet. They are metaphors. They simplify, and can only capture partial truths, not entireties (the model is not the object; think of a model airplane vs. a real one; a model is a toy!).

Models always describe one thing relative to something else (think of the VeraSage Adaptive Capacity Model of the Boeing 777 airplane as a firm).

While theories tell you what something is, models tell you merely what something is like. Models fail and theories are never perfect (always subject to falsification). Models save mental labor—they are a little language.

A model grounded in a theory can have more power than either alone.

Intuition is more comprehensive; it unifies the subject, and plays a major role in the discovery of nature’s truths. It also requires common sense and ethical principles.

Einstein called intuition “a sympathetic understanding of experience.”

The author spent 17 years extending the Black-Scholes model, the most celebrated model in economics:

Our knowledge about the behavior of stock markets is much sparser than our knowledge about how egg whites turn fluffy. Fluids and egg protein don’t care what people think about them. Markets and stock prices do. This makes models usable but simultaneously limits their usefulness.

He states that financial modeling is not the physics of markets, which is absolutely true. This is why Austrians wanted to study human behavior first (Ludwig von Mises called it Praxeology), then work up to macroeconomic principles.

What’s interesting is his contention that

Economists for the most part have never seen a genuine theory…for people have proved difficult to theorize about. Economists falsely believe that rigor can replace fact and intuition.

Economists are said to have “physics envy,” a joke I believe this author would agree with.

He calls the Efficient Market Hypothesis a model, not a hypothesis. Austrian economists don’t subscribe to the EMH, but rather, as Rory Sutherland says, the Cool Market Hypothesis—markets just do things that are cool.

I’m not sure what the author’s opinion would be on the subjective theory of value? Is that a theory, or intuition, or both? He does write:

Value is determined by people, and people change their minds.

The movements of stock prices are more like the movements of humans than of molecules. It is irresponsible to pretend otherwise. There are no genuine theories in finance. Financial models are always metaphors.

I also love this advice:

Whenever we make a model of something involving human beings, we are trying to force the ugly stepsister’s foot into Cinderella’s pretty glass slipper. It doesn’t fit without cutting off some essential parts. You must start with models but then overlay them with common sense and experience.

And:

To confuse a model with a theory is to believe that humans obey mathematical rules, and so to invite future disaster.

Here’s a list that distinguishes the characteristics of models with theories

Models
Are made
Require a modeler
Fail
Simplify
Shallow—a little language
Partial truths
Stands on other’s feet
Metaphor—what something is like
Save mental labor
Static

Theories
Are discovered
No theorizer needed
Need confirmation
Indistinguishable from object
Deep
Entireties
Stands on its own
What something is
Subject to falsification—never perfect
Cumulative—new theories atop facts

I’m trying to figure out if The Firm of the Future is a theory or a model? Probably a model, but maybe both?

Book Review: Masters of Management

Masters of Management is the update to one of my favorite business books of all time, The Witch Doctors (TWD), first published in 1996, by Adrian Wooldridge and John Micklethwait, two editors from The Economist. If you’re a regular reader of The Economist, Wooldridge is the Schumpeter columnist. Though only Wooldrdige wrote this one, the Foreword is written by Micklethwait.

What has happened between TWD and this work? Enron and the 2008-09 financial crisis, which was partly fueled by MBA’s risk models, and financial innovations in packaging up faulty mortgages.

The industry has essentially stayed the same, though the ideas have changed. The authors wrote in TWD that the management gurus are “the unacknowledged legislators of mankind.” I’ve always thought this overblown, but no doubt the gurus do have an impact on organizational thinking. They do get to test their theories immediately, being a “live” science, unlike, say, economics.

While TWD looked at the dark side of the management consultancy industry, this work looks more at the uplifting side. The consulting industry is $300 billion a year (as of 2007), while business books alone account for $750 million in sales, and the schools of business turn out 150,000 graduate degrees every year.

In TWD, the authors laid out four charges against the industry, which I believe are as true today as they were then:

  1. The discipline is constitutionally incapable of self-criticism;
  2. It favors terminology that confuses rather than educates;
  3. It rarely rises above the level of basic common sense;
  4. It is faddish, fickle, and bedeviled by contradictions that would not be allowed in more rigorous disciplines.

Number one is the biggest change the author has noticed between TWD and this book. No doubt there have been many published books that take a harsh look at the management consulting industry, one of the best being The Management Myth, by Matthew Stewart, reviewed here.

With respect to number two, the author quotes George Orwell:

[Language] becomes ugly and inaccurate not because our thoughts are foolish, but the slovenliness of our language makes it easier for us to have foolish thoughts.

Wooldridge writes, “Management scientists have arguably done more damage to the English language than any other group of people.” Amen. Pick up a random business book and you’ll read why.

Since the ideas have changed, there are some new fads that come in for a skewering. One is Corporate Social Responsibility (CSR), which is “the tribute that capitalism everywhere pays to virtue.”

Approximately 2% of all investment in the USA are in CSR funds, and less than 1% in Europe. So much for putting your money where your mouth is.

There is chapter devoted to Peter Drucker and Tom Peters, and other prominent gurus get their mention: Michael Porter, Clayton Christensen, Henry Mintzberg, among others.

The new wave of academic and journalist gurus come in for some criticism (and praise) as well: Howard Gardner, Robert Reich, Richard Florida, Thomas Friedman, and Malcolm Gladwell.

Thomas Friedman’s (and Ted Levitt had the same theory) Flat Earth idea come in for a skewering, which is spot on. Read Milton Friedman instead.

There’s also a chapter on “frugal innovation,” which is definitely changing the pricing, supply chain dynamics, and value proposition in developing countries.

Some interesting facts are noted:

  • Only 25% of India’s engineering, and 15% of its finance and accounting, graduates are qualified to work at a multinational firm.
  • In 2010, 47% of world’s wealthy are entrepreneurs.
  • 52% of Silicon Valley startups are founded by immigrants, and 26% of those are Indians.
  • New Zealand has the highest rate of startups in the world.

The author doesn’t like 360-degree feedback, labeling it a “quasi-Leninist” policy whereby you have to listen to other people’s opinions and criticisms of you. Amen. This policy if followed today in North Korea.

An excellent example is provide of the stupidity, and perversion, of measurements:

In Stafford Hospital, between 400 and 1,200 more people died in 2005-08, more than actuarial science would have predicted because the managers were so obsessed with hitting predefined targets that they routinely neglected patients.

I have some quibbles with the book. The author says that National Review is the ultimate journalistic dead end. Really?

The government did not save the financial system from collapse—it caused the collapse.

The idea that Sarbanes-Oxley protects shareholders from malign managers is highly debatable. But even if it was true, at what cost? Diversification is a much more effective protector of shareholder interest, and it doesn’t require a top-down regulatory regime that imposes enormous and unnecessary burdens on companies.

He claims the USA underinvests in childcare, but it’s precisely because the USA doesn’t dole out as many mandated employee benefits that we have a much more dynamic and mobile labor market, more job creation, and less chronic unemployment.

He believes the USA needs more progressive taxation. This is one of the most frustrating things about reading The Economist: they’ve never met a tax that wasn’t high enough.

These quibbles aside, this is an incredibly worthwhile book. While the management consultancy industry is still immature, and allows in all sorts of self-proclaimed gurus and thought leaders, it could be argued that this is a sign of its vitality and openness to new ideas. After all, professions and academic disciplines can calcify, and reject new theories for a long time.

But this low barrier to entry also means there are an enormous amount of crackpots. Masters of Management is a useful guide in separating the wheat from the chaff. Bravo, Mr. Wooldridge!

Best Books 2011

Reading business books is tedious, as former management consultant Martin Kihn reminds us:

Business books are boring. They are bloated compendiums of half-baked ideas committed in fourth grade prose. Their purpose is to transform a commonsense concept or two into a consulting career through the catalyst of hollow jargon.

If you’re over reading business books, here are my ten favorite books from 2011, which I thoroughly enjoyed.

Steven Levitt and Stephen Dubner. Super Freakonomics.

An enhanced version of the hardback book. It does contain more information, much of it quite interesting. If you read the original hardcover, though, this one is probably not needed, but still a fun read.

William J. Bernstein. The Birth of Plenty.

I enjoyed this book immensely; it is a tour de force of history, economic growth, and the importance of institutions.

The author, a Medical Doctor, has truly done his homework. His question is simple: Why did economic growth explode when it did (1820)? Until 1820, per capita economic growth was near zero. He concludes it’s not geography, climate, exposure to microbiological agents (as Jared Diamond has argued in his books), but rather four factors:

  1. Property rights
  2. Scientific rationalism (positing and falsifying theories)
  3. Capital markets
  4. Improvements in transportation and communication

Which of the four is most important? All of them are like ingredients to a cake, all are equally important to produce a just dessert.

It’s not physical objects (materialism) that matters, but rather institutions. Yet here I believe the author doesn’t go deep enough. What about Human Capital, and not formal education, but attitudes, entrepreneurship, linguistics, and faith in the future? I think Deirdre McCloskey is closer to the answer with her book series on Bourgeois Virtues.

Also, the importance of trust in expanding the number of strangers we can deal with is critical to free markets.

And yet for all it’s virtues, there are major points where I disagree vigorously with this author.

He claims that government needs to regulate the stock market to prevent accounting scandals, fraud, and protect investors. He should read George Stigler’s work on why the SEC is ineffective.

We’ll never reach perfection, nor zero fraud, nor is riskless risk an option. He points out market failure but never discusses government failure. In the real world intentions don’t matter; results do.

He does the same with the Great Depression, without ever mentioning the recent economic research that shows the government and New Deal policies prolonged and deepened the Great Depression.

He claims that income and wealth inequality rises during periods of rapid industrialization as a few prosper at the expense of the rest of society. Yet this is zero-sum thinking, and it’s economically illiterate.

He’s a “gapologist” who believes inequality matters. But relative inequality is another word for envy. What matters is absolute poverty. I rather be poor anywhere in the world today than 200 years ago.

Nor does he seem to realize the poorest people are not the same people over time—we do have tremendous mobility in the USA and other free market economies. He’s read Thomas Sowell on history, he should read his work on income and wealth inequality.

But the only known antidote to poverty is wealth, and while this book is an exploration of how wealth is created, the author seems to revert to the socialist idea of redistribution rather than creation.

He also pulls out the old canard about CEO pay, again so what? It’s not his money, and if it is, sell your stock if you think Apple pays Steve Jobs too much.

The author states near the end that property rights are expensive to enforce. So what? This is one of major reasons we have government, so the price is worth paying.

The book rarely uses the word freedom and liberty, except in the discussion about property rights. But the author seems to be too enthusiastic to suspend these rights in his quest to close the inequality gap.

As long as you are grounded in the works of Thomas Sowell and George Gilder, read this book for a great historical tour, but ignore his conclusions for a better ordering of the universe. He’s off the mark too often.

Top Choice: Kevin Williamson. The Politically Incorrect Guide to Socialism.

This is a fantastic book! It is well written, irreverent in places, and an excellent historical tour of the failures of socialism and communism.

Kevin Williamson is an editor at National Review. He begins by defining socialism, and not as the “ownership of the means of production” but by two factors:

  1. Public provision of non-public goods; and
  2. Economic central planning.

Even a mixed economy like the USA can have pockets of socialism—public schools, Medicare, Obamacare, Social Security, etc.—just like communist/socialist countries can have pockets of free markets.

There is a learned discussion of the enormous difference between the Labor Theory of Value and the Subjective Theory of Value, and the importance of the role of prices.

Williamson devotes a chapter each to debunking the socialist paradises of India, Sweden, North Korea, and Venezuela, and one on why socialism is really bad for the environment (the ten dirtiest cities in the world are all in socialist or former socialist countries).

If you think the BP oil spill was bad, it’s nothing compared to a government run company that takes zero responsibility and pays no damages to injured parties.

I also loved how he lambasts the idea of “US energy independence,” a centrally planned socialist dream if there ever was one. Why should we be independent with respect to energy? This is the road to poverty, not wealth.

He even does an excellent job at explaining why mark-to-market accounting is so wrong, and how it contributed to the Great Recession of 2008. This is because GAAP cannot predict value into the future, but rather only record it after a transaction has taken place.

I highly recommend this work, and it makes me want to read other books in the series.

Top Choice: Guy Sorman. Economics Does Not Lie.

What’s scarcer than bird crap in a cuckoo clock? A French intellectual who champions the free market. This is an excellent book, well written and researched, on how societies create wealth and how economics leads the way.

The enemy of human development is bad economic policies. Since the 1980s, 800 million people have escaped mass poverty, especially in China and India. The book is a wonderful exploration of how wealth is created, and the author believes in the premise of explaining wealth, not poverty (which is rare in circles other than economics).

He devotes an entire chapter to Paul Romer’s New Growth Theory and the necessity of ideas. And while economists know how to create wealth and avoid poverty, they cannot guarantee prosperity for any one individual anymore than a doctor can heal every patient.

The author favors globalization, and cites the leading economic thinkers who defend it as one of the most effective ways for countries to escape poverty.

Just look at the countries that were isolated (USSR, China, India) and how they only escaped by opening up to trade. Look at the countries that remain isolated to see how the alternative works (North Korea).

The author rightly points out that the Chinese Yuan has become a scapegoat for outdated US companies, and how China’s prosperity depends on US consumers.

It never made sense to me why we fear China, India, or indeed any other country, becoming rich. If China invents the cure for cancer, aren’t we all better off even though we didn’t get the jobs?

The author devotes a section to the limits of rationality, and discusses behavioral economics. As for the argument that behavioral economics will lead to statism, he argues that this is unfair to the theory since it also accounts for the irrationality of government actors (as does Public Choice Theory).

There’s a chapter on the Asian Tigers, India, and Brazil. Another chapter explains why China’s capitalism is not a third way, but rather the result of capitalism being highly diverse and capable of handling many types of regimes—from Hitler and Pinochet to Francos.

Another chapter looks at Europe and the USA, with some very interesting insights on which is declining. Another looks at the setting sun of Japan, and another asks if the Greenhouse Effect will leave us broke? The answer is no.

The author even explains why the Kyoto protocols aren’t working in Europe; because you cannot create a market by decree.

The only disagreements I have with this author are minor: his claim that diversity in universities create better business managers is more conventional than wisdom, and his views on why insider trading laws are necessary. But these are minor quibbles.

His concluding chapter lays out a synthesis of the findings of economics into 10 propositions, a consensus, if you will, among economists:

  1. The market economy is the most efficient of all economic systems.
  2. Free trade helps economic development.
  3. Good institutions help development.
  4. The best measure of a good economy is its growth.
  5. Creative destruction is the engine of economic growth.
  6. Monetary stability, too, is necessary for growth; inflation is always harmful (this last point is debatable).
  7. Unemployment among unskilled workers is largely determined by how much labor costs (why Europe’s labor markets are so rigid—it’s expensive to fire).
  8. While the welfare state is necessary in some form, it isn’t always effective.
  9. The creation of complex financial markets, despite excesses, has brought about economic progress.
  10. Competition is usually desirable.

This is a refreshing, optimistic book. Coming from a French intellectual—in the mold of another Frenchman who understood capitalism, Jean-Francois Revel—makes it that much more pleasant. Highly recommended.

Donald Luskin and Andrew Greta. I am John Galt.

This is an innovative book, and the authors have really done their homework on Ayn Rand.

They compare the heroes and villains from her novel, Atlas Shrugged, to real-life people from today, drawing some interesting parallels, while demonstrating how prescient some of Rand’s fictional scenarios have turned into ugly reality.

Some of the heroes: Steve Jobs; Bill Gates; John Allison, of BB&T, the 12th largest bank built on Objectivism principles, and a bank that refuses to loan to developers who seize property through eminent domain; TJ Rodgers of Cypress Semiconductor and an outspoken capitalist; and the last chapter is devoted to Milton Friedman, the Champion of Liberty, even though Rand had some disagreements with his views.

The villains are also interesting: Paul Krugman—the one author, Donald Luskin, actually founded the Krugman Truth Squad blog, whose purpose was to debunk his NYT editorials with facts, evidence, and the truth; Barney Frank is exposed for his major role in the housing crisis, which is also covered in depth and brilliantly in this work; and Angelo Mozilo from Countrywide Mortgage fame for his role is sub-prime lending, illustrating the perils of moral hazard created by government entities Fannie and Freddie.

If you’re a Rand fan, you’ll enjoy the parallels to her books, as well as the chapter on Alan Greenspan (“The Sellout”), who was a Randian insider, and to this day believes in her philosophy. A good, cogent read.

Todd Buchholz. Rush.

In the spirit of The Rational Optimist, Todd Buchholz has written an uplifting book. He makes the very counterintuitive claim that happiness comes from us rushing around.

There’s no evidence that cutting out the frenzy in our lives would make us happier. In 1900, the average life expectancy was 47; today it’s fast approaching 80. Could it be that competition and stress actually extend life?

Buchholz cites a lot evidence—from all fields—that they do. He takes on the “Edenists” who believe we are all on a hedonic treadmill. But it’s not envy, greed, or keeping up with the Smith’s that keeps us rushing around. It’s the drive to improve ourselves, create, build, and earn our keep.

Why else would anyone attend college, take the Bar, or CPA exam?

This drive is encoded into our genetic nature. Aristotle believed in cultivating good habits, and the very term “second nature” recognizes we have a first, while holding out hope it can be changed.

What separates humans from animals is our ability to create for the future; indeed, Buchholz says we spend 12% of our time thinking about the future. Personal control predicts happiness much better than income.

Why aren’t you happy is the wrong question. Social scientists ask the wrong question a lot: like, what are the root causes of poverty? (rather than what creates wealth?), or why do bad things happen to good people? (why don’t bad things happen all the time?).

I also love Buchholz’s discussion on how an advanced economy relies on transactions among strangers. It’s strangers, not neighbors or a village, that creates wealth. Commerce fosters the Rule of Repeats, which turns strangers into partners (think of how your life is the hands of an airline pilot).

This is the virtue of a competitive economic system. Reputation counts:

Trusting someone we have just met—or even more astounding, trusting someone we will never see face-to-face—that is the trick to moving from mud huts to prosperity. …It requires more flexible brain patterns. We are a face-to-face species.

He also discusses the Industrial Revolution, saying perhaps it should be called the Industrious Revolution.

Also, even though GDP is a flawed measurement, happiness measurements are worse. At least GDP shows a strong correlation with longer life, higher IQs, more charity, and less crime.

Buchholz also debunks the Emotional Intelligence and self-esteem fads. He even takes on Dan Ariely’s work along with behavioral economics. Relying on young people, in contrived laboratory experiments, has major biological flaws.

But what he wants the Edenists to answer is when should we stop moving forward. 1776? 1900? If so, we wouldn’t have airplanes and polio vaccines.

Without the Twentieth century’s progress, we’d all be watching television by candlelight, according to Milton Berle.

The philosopher Kierkegaard called anxiety the dizziness of freedom. If everything is stress, then the only answer is Timothy Leary’s “turn on, tune in, drop out.”

Surely that’s not the answer. We are fine-tuned for adaptation and survival, much less so for happiness.

Yet we try, even though it’s elusive. The stress, competition, and struggle is what keeps us all going. On balance, it’s all good.

Top Choice: Thomas Sowell. The Thomas Sowell Reader.

As usual, brilliant!

Paul Johnson. Humorists.

This is the fourth book in Paul Johnson’s excellent series; the first three being Intellectuals, Creators, and Heroes (all reviewed on my Shelfari shelf).

He starts by stating that comics are probably the most valuable of the four, as the world is a “vale of tears,” and the central force that creates laughter is chaos, contemplated in safety.

As with any Johnson work, this book is full of interesting historical facts, and no one profiles historical figures better than he does.

We learn that both Karl Marx and Jeremy Bentham thought punning was beneath them, the latter calling it “an atrocity.”

Where else would you learn that Field Marshall Helmuth von Moltke, the leading nineteenth-century Prussian strategist, laughed only twice: once when told that a certain French fortress was impregnable, and once when his mother-in-law died.

Also that the catch-phrase was invented in the 18th century. His first profile is Hogarth, then Ben Franklin, who invented the one-liner in Poor Richard’s Almanac, and maybe even the term “smart aleck.”

We learn that Charles Dickens used to write a paragraph, stand up and act out the scene, including facial expressions, in a mirror. Not very efficient; but highly effective.

Reason itself is a matter of faith, which is why “poets do not go mad—but chess-players do.” See Bobby Fisher. Maybe this is how House, M.D. will meet his end?

Damon Runyon is profiled, as is, of course, W.C. Fields, who along with J. Edgar Hoover hated Eleanor Roosevelt.

Fields was full of one-liners, “Women are like elephants. I like to look at them but I don’t want to own one.” Mae West is also mentioned, along with one of her favorite jokes: “She was Snow White, but she drifted.”

Charlie Chaplin comes in for some criticism, his biggest moral failure being he never criticized communism. His most famous movie, Modern Times, was an attack on industrial capitalism, but the movie was banned in Nazi Germany and Fascist Italy.

Laurel Hardy and the Marx Brothers are included, with some great one-liners from Groucho: “I never forget a face but I’ll make an exception in your case.” “I’ve been around so long I can remember Doris Day before she became a virgin.”

The book ends on a note of pessimism on the state of humor. Johnson points out that over the last generation Political Correctness has created “hate terms” and allegations of “racism,” creating the most comprehensive system of censorship since the days of Hitler and Stalin.

He writes:

The future of humorists thus looks bleak, at the time I write this. The ordinary people like jokes, often crude ones, as George Orwell pointed out in his perceptive essay on rude seaside picture postcards.

Let’s hope that our comedians are braver than the forces of PC, for the only line drawn in humor should be whether or not the joke is funny. Would you agree, Greg Kyte?

Mark Steyn. After America.

Mark Steyn is one of my favorite writers. Not only does he provide brilliant commentary, he does it with an acerbic wit that’s a joy to read.

His column in National Review, and blog, are must-reads. His latest book is a force to be reckoned with.

Using the acronym ARMAGEDDON to arrange the book, Steyn touches on the world’s woes.

Here’s what it stands for: Addiction; Redistribution; Monopoly (i.e., government); Arteriosclerosis; Global Retreat; Engineering; Decay; Disintegration; Open Season; and Nukes Away.

Steyn offers excellent analysis of: Europe’s idiocy; cultural decline; demographic decline (the future belongs to those who show up for it); how debt is a moral issue, not an economic issue; the strangulation of the human spirit from government regulation and Nannyism (big government makes small citizens); the failure of Keynesian economics’ the self-deluding self-esteem movement; and of course, PC lunacy.

He thinks the USA’s inability to replace the World Trade Center after a decade is a shame, noting that the Empire State Building was built in 18 months during the Great Depression.

Today, you couldn’t build the Hoover Dam, and even if you did, it would be shut down for not being wheel chair accessible.

That’s not to say I agree with everything he writes. He seems to believe in “manufacturism” and the materialist fallacy, since he cites the Boeing 747, Concorde, and the Moon Landing as the era when human capability peaked (1965-1975).

This ignores Google, Apple, and a host of other advances since then.

I find Matt Ridley’s The Rational Optimist far more compelling on why our future will be better.

Steyn also seems to believe that buying a house is the surest route to wealth for most Americans. But surely human capital is far more important, which he recognizes when he chastises China for destroying so much of it.

He also uses the line “They have our souls who have our bonds.” But this is debatable. What does it mean that China buys our debt? Is that a sign of weakness or strength?

Nevertheless, you will LOL at many places in this book. Steyn is incredibly entertaining, probably more so Than PJ O’Rourke. This is well worth reading, and pondering. It will, no doubt, change your mind on a variety of issues.

Mark Kramer, et. al. The Black Book of Communism.

This is a somber, but critically important, book. It sets out to answer the question, Why?

Why did communism exterminate its enemies. Why was it bloody no matter where it was implemented? It claimed it needed to break eggs—and it did, to the tune of about 100 million deaths—to make an omelet. But there was never an omelet.

Why did it inspire other nations, whereas the French Revolution never did (all communist nations were linked by an umbilical cord to the Soviet womb)?

Why was there no Nuremberg trial, no stigma, no accounting for the massive crimes of this regime?

Why was there never a “benign” period in the evolution of communist regimes? All were bloody form the start.

The Tsarists, between 1825-1917, committed 3,932 deaths. This number was surpassed by the Bolsheviks in four months.

Communism didn’t just commit criminal acts; it was a criminal enterprise.

Whereas Nazis killed based on race and territory, communism murdered based on class.

All I could think of as I read this work was Stalin’s memorable line: “One death is a tragedy; one million is a statistic.” The death toll is almost unbelievable:

  • USSR = 20 million
  • China = 65 million
  • Vietnam = 1 million
  • North Korea = 2 million
  • Cambodia = 2 million
  • Eastern Europe = 1 million
  • Latin America = 150,000
  • Africa = 1.7 million
  • Afghanistan = 1.5 million
  • International Communist movement not in power = 10,000

This approaches 100 million deaths. By (gruesome) comparison, Nazism murdered about 25 million.

Yet the French government’s National Lottery actually used an image of Stalin and Mao in an advertising campaign. Could you imagine if some enterprise dare used Hitler or Goebbels? At least Nazis were made to account for their crimes.

The book catalogs the crimes of the USSR, from the Red Terror, Great Terror, Great Famine, collectivization and dekulakization, The Gulag, the Katyn massacre, up to Khrushchev’s Secret Speech.

In chapters, it explores communism around the world: Spain, Poland, communism and terrorism, Central and Southeast Europe, China, North Korea, Vietnam and Laos, Cambodia, Latin America, including Cuba and Nicaragua, Africa, and Afghanistan.

What also makes this book amazing is that the authors are a group of French scholars, many of whom were actually supporters of communism at one time, but now are rethinking that position.

This has not made them popular with their left-wing friends, but as they say, they have to go where the truth leads them.

I’m not sure this book answers the question as to why. Maybe there is no answer, excepts man’s unbelievable capacity for cruelty in the quest for Utopia.

No one can read this book and walk away without feeling an incredible hatred for not only a bad idea (communism) but also the ruthlessness of the people who acted in its name.

This is a heavy book, and it is a bit dated (1999), since more research is coming out everyday from the opening of archives in the former Soviet Union. However, it is one volume that chronicles, in graphic detail, the murderous regimes and should be read by anyone interested in the history of ideas.

Book Review: Baker’s Dozen Best Business Books 2011

Someone recently asked me which were the best business books I read last year. Since we here at VeraSage are inveterate readers, I’d love to know your best books from last year.

Tom Hood recently posted his, so I thought I’d share my Baker’s Dozen.

Some of these books I’ve already reviewed elsewhere, so will limit my remarks to books not previously discussed.

I’ve also noted my absolute Top Choices, so if you only read a few from this list, start with these.

Also, as always, you can access my shelf at shelfari.com for my complete library, my Top 100 Best Business Books of all time (see tag “bbb” underneath the shelf).

Business Books

Peter Drucker. Technology, Management and Society. Read full review here.

Jim Rains. Target Cost Management. Read full review here.

Top Choice: Thomas Alexander. Stanley Marcus: The Relentless Reign of a Merchant Prince.

He was called “America’s Merchant Prince,” and “the melancholy Plato of retailing.” I consider Stanley Marcus the grandfather of Total Quality Service.

Here’s a man who understood the value of each and every customer, long before CRM and Lifetime Value became management fads.

The founders of Neiman Marcus also certainly understood their “Why” (see Simon Sinek’s Start with Why).

Stanley wrote four books during his lifetime, but this is 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 in this role. Alexander obviously did something right that made Marcus keep him around that long.

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

There are many fantastic pictures and other inside stories of how Marcus conducted business, treated customers, his team, and foreign government officials. 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.

The columnist Herb Caen was an vocal 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.

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. Stanley Marcus was an amazing man, and his story is compelling on many levels. This book adds another dimension to a man who has left an indelible legacy on the culture. Well worth reading after you read Marcus’s own, Minding the Store, the best book ever written on customer service.

Robert Kanigel. The One Best Way. Read full review here.

Bob Lutz. Car Guys vs. Bean Counters. Read full review here.

Top Choice: Howard Hansen and Steven Geske. Healing Leadership. [Kindle Edition only].

I had the honor of writing the foreword to this book, but it doesn’t change the fact that this book had a profound influence of my thinking. Here is an excerpt from that foreword:

They say any writer should be able to sum up the purpose of their book on the back of a business card. I can do that for this book by using another author’s book:

The colossal misunderstanding of our time is the assumption that insight will work with people who are unmotivated to change. If you want your child, spouse, client, or boss to shape up, stay connected while changing yourself rather than trying to fix them.

As with most ideas and relationships, it is no coincidence that the above was written by Edwin H. Friedman, in his masterful book A Failure of Nerve: Leadership in the Age of the Quick Fix.

Healing Leadership takes a totally different approach, and one that is not very comfortable for those of us used to reading business books. How many books on leadership have you read where the central message is you can’t succeed at affecting change in the people you lead? That you need to get out of the business of needing others to change? The authors even admit they won’t get rich by dispensing this type of advice.

Rather than assaulting the reader with endless platitudes and checklists of “do this and don’t do that,” this book advocates a “way of being,” recognizing that leadership is an emotional process, not a mechanistic science that treats humans like machines.

You are about to explore some very profound, powerful, and simple concepts. But please don’t confuse simple with simplistic. Virtuoso bass player, accomplished pianist, bandleader, and composer Charles Mingus said: “Making the simple complicated is commonplace; making the complicated simple, awesomely simple, that’s creativity.”

Three creative concepts from Healing Leadership have permanently altered not only my worldview, but my behavior. The authors present the “Energy Management Model,” which teaches how we could have greater success in achieving our goals if we tried not so much to control time—an impossibility, as it is outside us—and instead tried to control energy—eminently possible, as it is within us.

You’ll learn the difference between episodic and chronic anxiety, along with the 10 telltale signs of someone who is chronically anxious, and what to do about it.

Finally, the concept of Emotional Triangles—what the authors call “the weather of human relationships.” This framework ties everything in the book together, while offering an enormously effective way to lower your anxiety. After reading about Emotional Triangles you’ll wish you had understood them in elementary school.

But don’t confuse simple with easy. These frameworks are very counterintuitive, and they will no doubt cause some confusion. Don’t despair. That’s a leading indicator that your understanding is deepening. You simply must wrestle with the concepts in this book if you want to achieve real change—transformations that will truly make a difference in your life.

One of my favorite definitions of the role of leaders comes from business consultant Peter Block: “The real task of leadership is to confront people with their freedom.” In Healing Leadership, Steven and Howard do exactly this. It’s not comfortable, it’s vexing, and it goes against everything you were taught in business school. The difference is: it works.

John Kay. Obliquity.

John Kay is an economist who has written many books I highly recommend. He does a good job blending economic theory with business strategy.

This book is all about obliquity, which he defines as “Goals are often best achieved without intending them.” Achieving complex objectives indirectly rather than directly. The real world isn’t like Sudoku, where you can arrive at your objective directly.

Citing many different examples of this concept, Kay does an excellent job of applying it to business. A couple of example of the obliquity route: cities. Jane Jacobs despised the urban planners who believe they can directly create a great city. Great cities flourish when they are unplanned, which leads to creativity.

Creating shareholder value (which Jack Welch called one of the dumbest ideas) is an example of a direct objective, but it’s obtained indirectly by creating great products (think Apple). No one works to maximize shareholder value.

We do so more in line with Simon Sinek’s Start With Why. Kay does a good job dispelling the notion that business is based on greed: “A corporate culture that extols greed cannot, in the end, protect itself against its own employees.”

He talks about how measurements can cloud judgment. Using [Benjamin] “Franklin’s Rule” (drawing up a list of Pro and Con to make rational decisions), Kay illustrates that real decisions aren’t made this way—though we think they should be.

Robert McNamara’s tragic management of the Vietnam war by the numbers illustrates the flaw in this thinking.

Kay also discusses the “teleological fallacy,” which infers causes from outcomes, and how it’s one of the oldest mistakes people make. Today we call it the Halo Effect.

Kay explains why business autobiographers can describe their success, but not explain it. Sort of like John Paul Getty’s advice: “Strike oil.”

Kay also explains why it’s more important to be right rather than consistent (unlike, say, in legal matters, where precedent is more important).

The book validates much of my own thinking in Measure What Matters to Customers, especially the Seven Moral Hazards of Measurements.

Numbers give a false sense of precision and it’s no way to build a great business. Think Six Sigma when Kay writes: “The process in which well-defined and prioritized objectives are broken down into specific states and actions whose progress can be monitored and measured is not the reality of how people find fulfillment in their lives, create great art, establish great societies or build good businesses.”

Top Choice: Tim J. Smith. Pricing Strategy.

I met Tim Smith at the Professional Pricing Society conference in Chicago in April 2011. He told me he read my book (Pricing on Purpose) while in Prague, which kept him from getting into trouble…LOL.

He does cite my book in his, as a justification for pricing discrimination. Although this book is more like a textbook, and is very quantitative, it’s still very readable and enjoyable.

He’s got plenty of thought-provoking exercises (there’s a companion workbook for this text). Smith understands that pricing is not just about the numbers; that it’s more art than science, but he does discuss both, and even has a chapter on behavioral economics.

Overall, this book needs to be in every serious pricer’s library.

William Taylor. Practically Radical.

I enjoyed William Taylor’s other book, Mavericks at Work.

This book is also good, with three major themes: 1) Transforming your company; 2) shaking up your industry; and 3) challenging yourself.

A lot of it is profiles of change agents from a wide swath of sectors, some of whom you’ll find fascinating. Most change fails because it focuses too much on what’s wrong while undervaluing what’s right.

The book advises not to benchmark your competitors for new ideas (stop looking in the same places) and gather as many “zero-gravity” thinkers as you can—folks who are not weighed down by the baggage of industry expertise.

Taylor also understands the importance of a company’s “Why” or purpose, and provides many thought-provoking examples and research supporting this concept.

He’s wrong about the housing crisis at the start of the book, but other than that, this is good journalism, along with some important lessons. If you enjoy reading about entrepreneurs and change agents, this is well written and very interesting.

Dan S. Kennedy and Jason Marrs. No B.S. Price Strategy. Read full review here.

Andreas Widmer. The Pope & The CEO.

This is a great book by a former Swiss Guard, who are charged with guarding the Vatican.

Adreas Wedmer spent two years (1986-88) in his early 20s guarding Pope John Paul II, and this book discusses the leadership lessons he learned, which helped him become a successful entrepreneur.

He met Ronald Reagan at the Vatican in June, 1987, two days before Reagan delivered his “Tear down this wall” speech in Berlin. There’s a great discussion of ethics in the book, with the point being made that utilitarianism is the framework behind pornography.

Also, how firms are not moral agents because they have no soul. Hence, a person-centric framework is what the Pope espoused. Other lessons from the Pope apply to business as well, since business and faith go together.

I found the inside look at the Swiss Guards fascinating. A very worthwhile read.

Joseph Maciariello and Karen Linkletter. Drucker’s Lost Art of Management.

This is an incredibly deep book, which contains a wonderful idea: Management is really a liberal art—not a science or a profession—and should be a humanities discipline.

This would lead to a more humane and moral society. The idea that business is a science has always seemed strange to me, since we are dealing with human beings, not machines. This is an idea Matthew Stewart discusses in his excellent book, The Management Myth.

A liberal art is defined more by what it’s not: vocational training. Its purpose is to educate citizens to be society’s leaders, by emphasizing judgments and values.

Drucker first mentioned this idea in 1988, but he didn’t clearly define it. The two authors of this book both knew Drucker personally, and they are scholars, one from business and the other a historian.

They have researched all of Drucker’s writings on this link between liberal arts and management, shedding light on how this could be accomplished.

Drucker defined himself as a social ecologist—someone who creates and maintains a society of functioning organizations that anticipate change, and manage both continuities and discontinuities.

The book is a deep look at which philosophers, political scientists, economists, and other thinkers influenced Drucker’s worldview. It discusses his concept of the knowledge economy and knowledge workers. It’s a bit long, but still a very worthwhile read.

I now believe society would be better off closing its business schools and folding them back into the humanities. On average, I rather be led by someone with a liberal arts degree than an MBA.

Inder Sidhu. Doing Both.

Why do we build such beautiful bridges, such as the Golden Gate? After all, the military build utilitarian bridges all the time, capable of handling extreme loads. It’s costly to achieve the aesthetic appeal of the Golden Gate, so why bother, especially since the Bay Bridge right across the way does the job just as well without the flocks of visitors or suicide jumpers.

The premise of Inder Sidhu in this book is you can do both most of the time. He’s a veteran of Cisco, the 1984 startup that is now the 14th most valuable brand in the world, according in Intrabrand, and part of the Dow Jones Industrial Average.

This book was recommended to me by a colleague who suggested it would shed light on the “efficiency vs. effectiveness” that we have been engaged in over at VeraSage for years. It didn’t really help settle that issue, but actually reinforced the view that effectiveness everywhere and always trumps efficiency. But it’s an interesting book nonetheless.

Doing both is not a balanced compromise between two objectives but rather a mutually reinforcing multiplier. Each chapter provides an example in broad categories, such as:

Sustaining and Disruptive Innovations. A company doesn’t have to choose between one or the other, but should strive for both.

Multiple business models. Cisco embraces new business models either by acquisition or internal development. This is not easy, but it’s often necessary in order to capture new markets and not be cannibalized. Software as a Service and Subscription based pricing, as with WebEx, are examples of how they have changed their business model.

From volume to value with partners. Cisco evaluates its 55,000 partners not based on volume, but on value contributed—new customers, solving difficult technical problems, entering new vertical markets, etc. Rather than just providing discounts that can be used by bigger partners against smaller ones, Cisco changed the criteria to evaluating value, a great idea.

Excellence and Relevance. “By zeroing in on what matters most to customers, Cisco became excellent by focusing on customer pain points. But it became relevant by moving from customer frustrations to their aspirations.”

Superstars and winning teams. You can have both in your company. I think this one is tougher to achieve than the author leads us to believe.

Westpoint and Woodstock. This deals with the governance model of authoritative vs. democratic leadership. Cisco has both types, and it is a very interesting model, including councils, boards and working groups for decentralized management, and the traditional functions, geography and countries for centralized management. This has potential for professional firms as well.

Overall, this is a short book and a good read. But I still remain convinced that efficiency and effectiveness cannot be “balanced” as they are different things, and this book supports that view.

Honorary Mentions

Two of my VeraSage colleagues wrote books that I read in 2011.

Tim Williams. Positioning for Professionals.

Even with all my bias, this is a fantastic book—a concentrated, yet cogent, look at how professional knowledge firms can position themselves based upon value creation.

Tim dispels many myths in this work, from size being the path to profit, and why going broad is not really as profitable as going narrow.

Tim also takes on “commodity” thinking, debunking this myth as well. As he writes, “Service is a commodity. Smart thinking is not.”

If you are a leader of a PKF, you will profit immensely from Tim’s intellectual capital on how to position and differentiate your firm. As Tim argues persuasively, this is the only way to capture more of the value you create and command premium pricing. A fantastic read.

Jay Shepherd. Firing at Will.

This is an excellent guide to everything an employer needs to know in protecting its legal rights, and avoiding costly litigation and other legal issues. Written beautifully, and very non-lawyerly, it’s easily accessible to everyone. You will get the benefit of Jay’s 17 years of practicing law on the management side. Indispensable. (Ignore the foreword).

Book Review: No B.S. Price Strategy

Any book that states on the first page, “price is a terrorist,” is bound to grab your attention. It makes sense: price instills fear into sellers, and much of that fear is unwarranted.

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The other factor that impressed me immediately about this book was how the authors, Dan Kennedy and Jason Marrs, disagree that pricing and profit are about greed. They then suggest you read Ayn Rand’s Atlas Shrugged, and Rabbi Daniel Lapin’s Thou Shall Prosper (a fantastic book).

Your prosperity is your price strategy. We’ll never get paid more than we think we are worth. I like their line:

Go to the ocean with a teaspoon or bucket; the ocean doesn’t care.

They make the point that the rich are paid in advance, whereas the poor are paid after they work.

Another great insight is how the majority of customers want to make purchasing decisions on factors other than price—like, “It’s good for my family,” which is true for Michelin tires and even toilet paper.

The importance of price integrity—similar to brand integrity—is a theme throughout the book.

There are a few case studies that are very interesting. One by a Canadian doctor who has opted out of Canada’s health care system in favor of a concierge-type model.

Over 5,000 doctors in the USA have already done the same, and more are expected to do so if Obamacare remains the law of the land.

The author’s are on the same soapbox as VeraSage: There’s no such thing as a commodity, and they offer several poignant and entertaining examples:

  • Allen Brothers steaks: it places top steakhouse logos on its catalog pages, creating the framing effect of comparing its prices to that of dining out.
  • Kennedy Barber Clubs, just for my dad and brother.
  • MotoArt sells furniture made from real airline parts, obviously to a specialized customer segment.
  • In 2009, Americans spent $45.5B on their pets, up 5.4% from 2008, and $3 million of that went to Doggles—sunglasses for your pets! We often say in our economics course that American’s pets eat better than a lot of the world’s poor.
  • But my favorite has to be Kopi Luwak—cat-poo coffee. And you thought Starbucks was expensive.

The authors also deal with aspects of behavioral economics, especially the anchoring and framing effects.

One interesting example is a chiropractor who has sold more treatments when patients were escorted from the waiting room to the examining room, rather than simply being called out.

Differences and Annoyances

Jason Marrs brags about the hourly rates his therapists make relative to the competition. Yet he understands that customers buy results, not time or costs. I wonder if he’s ever run across the labor theory of value?

There’s a comment made about how most recent trends are disadvantageous: our diet, chemical-laden foods, stress, etc. But then why are we living longer than ever before?

One chapter mentions “intrinsic value,” but other than life itself, there’s no such thing. Because the book offers no theory of value, this is a shortcoming. But like Adam Smith, the authors may get some of the theory wrong, but they get the practice right.

The authors also claim that .99¢ pricing works, but ignore evidence to the contrary. But they also believe in testing.

I also have misgivings about Dan Kennedy’s idea that your business is not about improving your customer’s lives. He makes an interesting argument; I just don’t find it persuasive (but I do totally agree that business is not about creating jobs, which is something you rarely see in a business book).

After all, if business isn’t about improving human beings, what’s the point?

The most annoying aspect of this book is the constant sales pitches for both author’s websites, services, etc. This really grates on my nerves, and it will turn a lot of people off.

Which is too bad, because this book is a worthwhile read.

And, if after reading it, you say: “But my business is different!”—the authors rightly point out that this is the rallying cry of the poor.

Book Review: The E-Myth Accountant

I’ve long been a fan of Michael Gerber’s E-Myth book. His concept of working “on” the business rather than “in” the business was a major theme of the Accountant’s Boot Camp, developed by my good friends Paul Dunn and Ric Payne.

So when I learned that Darren Root co-authored The E-Myth Accountant with Gerber, and especially since I was presenting with Darren at the Sage Summit, I was looking forward to reading their views on what Darren calls The Next Generation Accounting Firm™. The Firm of the Future is a topic near and dear to my, and VeraSage’s collective, heart, and I was looking forward to learning another perspective.

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Areas of Agreement

There is a lot of good advice in this book with which I agree. Here is a bullet point summary of some of their better recommendations, most of which come from the chapters that Darren Root wrote:

  • Darren asks a good question: “How did the accounting profession become a mass of technicians and very few business leaders?” David Maister’s book, True Professionalism, is necessary reading to overcome this.
  • Firms engage in mass client acquisition, whether or not they are a good fit for the firm. We call this the market-share myth, a form of cancer (growth for the sake of growth). It leads to incredibly weak pricing power.
  • Same as above with offering too many services, which Darren argues keep CPAs at the technician level as well. The debate between the specialist and generalist is over—the specialist won. This video from the late Paul O’Byrne illustrates this very effectively.
  • Darren writes:

    It’s time to trust your people, let go, and give yourself the opportunity to work on your practice…not in it.

    Good point. Follow this path to its logical conclusion: it leads to scrapping timesheets and implementing a Results-Only Work Environment (ROWE).

  • It’s hard to disagree with this:

    The old business model has long been to sell billable hours. Instead of selling billable hours, your firm sells complete solutions. If your goal is to get off the proverbial hamster wheel and build a business, it is critical to abandon the billable-hour model and adopt value billing [sic—he means value pricing].

    Darren believes that accountants are finally starting to hear the value pricing message, and I hope he’s right. He says that hourly billing doesn’t take into account efficiency or new technologies.

    However, that’s not the major weakness of the billable hour. It’s Achilles heel is it doesn’t take into account customer value, and is based upon an incorrect theory of value.

  • In a chapter written by Gerber (“On the Subject of Clients”), he discusses how to deal with client dissatisfaction with a 7-step process. What’s missing, though, is the recommendation that firms offer a guarantee to all customers.
  • Darren suggests spending a good portion of your marketing budget geared toward strengthening existing client relationships. Indeed. As the AICPA pointed out years ago, it costs eleven times more to acquire a customer than to retain one.

The Gap

For as many topics as we agree on above, I’m afraid the chasm that exists between my vision of the Firm of the Future and the one laid out in this book is simply irreconcilable.

But as with most disagreements, this is more a conflict of visions rather than a disagreement about facts. I’m reminded of what Blaise Pascal wrote in Pensees:

When we wish to reprove with profit, and show another that he is mistaken, we must observe on what side he looks at the thing, for it is usually true on that side, and to admit to him that truth, but to discover to him the side whereon it is false. He is pleased with this, for he perceives that he was not mistaken, and that he only failed to look on all sides.

The side the authors are coming from is to build the McDonald’s of professional firms, by laying out a path for creating “a highly efficient money-making practice.”

Yet a glaring omission from this work is any mention of the knowledge economy, or knowledge workers. This is the dimension the book ignores completely.

A professional knowledge firm isn’t McDonald’s, nor should it be. This example of Gerber’s has always irritated me, but it is particularly egregious in a book for professionals.

This is where the author’s analogies to the importance of systems break down in a knowledge economy. Gerber posits “The People Law: without a systematic way of doing business, people are more often a liability than an asset.”

This is strange statement, given that 75% of the world’s wealth resides in human capital, according to the World Bank.

The prominence given to the “system” over people is redolent of Frederick Taylor, who wrote:

In the past the man has been first; in the future the system must be first.

Peter Drucker refuted this logic in his 2002 book, Managing in the Next Society:

What made the traditional workforce productive was the system—whether it was Frederick Winslow Taylor’s “one best way,” Henry Ford’s assembly line, or Ed Deming’s Total Quality Management. The system embodies the knowledge. The system is productive because it enables individual workers to perform without much knowledge or skill….In a knowledge-based organization, however, it is the individual worker’s productivity that makes the system productive. In a traditional workforce, the worker serves the system; in a knowledge workforce the system must serve the worker.

Yes, knowledge workers will create their own systems. That’s the point. Two surgeons will not perform an operation the same way. Even two barbers won’t cut hair the same way (nor would we want them to).

This is why Steve Jobs says:

The system [at Apple] is that there is no system. That doesn’t mean we don’t have a process.

Sure, there are things that can be turned into a repeatable process, but the value in knowledge work lies in where there is applied judgment, creativity, and wisdom. And you simply can’t systemized those virtues. Indeed, if you try—with Six-Sigma, Lean, etc.—you kill them.

The better solution is to capture the knowledge that is tacit in those unique ways of doing things so the knowledge can be spread across the firm. Yet any discussion of knowledge management and capture is missing from this book.

The authors also seem to think that the systems should only be designed by the firm’s owners, rather than its workers—this is a large part of working “on” the business rather than “in” it.

But to borrow from Steve Jobs again, does it really make sense to hire smart people and then tell them what to do? Apple hires smart people so they can tell Apple what to do. Welcome to the knowledge era.

The idea that all the intelligence rests with management didn’t work in Frederick Taylor’s industrial era and it certainly doesn’t work in a knowledge economy. Worse, you cannot inspire creative knowledge workers by spouting Taylor’s efficiency mantra.

Today, knowledge workers are the system, which means they have to have a hand is designing it. Even auto manufacturers understand that those closest to the work are the ones who can improve it the most. See Toyota.

Yet the cult of efficiency is worshipped throughout the book, even though Darren quotes Steven Covey:

If the ladder is not leaning against the right wall, every step we take just gets us to the wrong place faster.

Nowhere is the recognition that there’s nothing more wasteful than being efficient at doing something that shouldn’t be done at all. Or that efficiency—and technology—are mere table stakes, not a competitive advantage, since your competition can easily replicate those gains.

Darren even suggests you identify those services you do best, which he defines as being able to perform with a high level of efficiency. But surely you should identify those services that you can perform most effectively—better yet, efficaciously—and that create the highest value.

If there’s that much efficiency to be gained, they are probably low-value services that should be outsourced (see the Stan Shih Smile Curve).

Peak efficiency is a sign of no innovation.

The same error is made when he claims the major factor driving realization is the existence of proper systems and processes. But this is incorrect. Price drives profit more than any other factor.

Further, he writes that his firm’s realization is over 100%, but that just means he’s still comparing price to hours x rate; it has nothing whatsoever to do with pricing commensurate with value, as he claims.

He also proclaims he’s not a proponent of throwing away timesheets, since they can catch scope creep, measure efficiency, benchmark against other firms, and allow him to manage what he can measure.

These are weak arguments for timesheets. If you’re catching scope creep from timesheets, it’s way too late to price it—you’re billing and ducking in arrears at that point, and by the hour. Project management is far more effective.

And the idea that timesheets measure the efficiency of a knowledge worker has been well destroyed in all of my books. This is illusion of control and one of the seven moral hazards of measurement.

This defense of timesheets is particularly amusing when compared to what he writes toward the end of the book:

Remember: Just because you’ve always done things in a certain way doesn’t mean you have to continue that tradition. If it’s not working, it’s not working. Abandon the old and make way for the new.

Except, of course, when it comes to the ancient tradition of maintaining timesheets.

Also, towards the end of the book, Gerber explains that Time is not money; time is life. If true, then why are we dividing a firm’s revenues and costs by life?

[And even if you still believe the old canard that time is money, all that means is we are dividing cost by cost if we use the hourly metric system].

There are other major areas of disagreement with the book. Their concept of a firm’s vision is too focused on what and how, not why. It’s far more effective to develop your firm’s why, letting that drive your what and how, consistent with Simon Sinek’s TED talk, and book Start With Why.

Gerber posits that there are six types of clients around which your entire marketing strategy must be based. But I find this unconvincing, and it could benefit from Occam’s Razor. Asking customers about their expectations would be more effective. Also, innovation is the firm’s job, as customers don’t innovate, they iterate.

Then Darren writes that clients are a firm’s greatest assets. But customers are not owned by firms, anymore than human capital is owned. Speaking of them as assets is inhumane and demoralizing.

The book does not contain any endnotes, a bibliography, or index. Outside of the few books and authors mentioned, it would be helpful if the authors shared the books that have shaped their thinking.

In conclusion, if you read this book, do so with this caveat: the book’s gap of not discussing the knowledge economy is simply too wide for me to overcome. It overshadows everything they write, and the logic traps them into the cult of efficiency rather than one of creating value.

We no longer live in an industrial economy where the talisman is Frederick Taylor’s enigma of efficiency and the “one best way.” A PKF is a human relationships-based entity, not a factory.

On the positive side, now that I’ve met Darren, there’s an opportunity for ongoing dialogue. If all goes well, we’ll get him to trash his timesheets someday.

Book Review: Car Guys vs. Bean Counters

As a follow-up to my post yesterday on why CFOs know the least about your business, here is the book review I mentioned.

Bob Lutz has written an important diagnostic book on the demise of General Motors: Car Guys vs. Bean Counters: The Battle for the Soul of American Business.

Spanning a forty-seven-year career with the Big Three (and BMW), and after retiring from Chrysler in 1998, he was asked back into GM, serving as Vice Chairman from 2001 to 2010, during which time it had filed for bankruptcy.

Lutz is a “car guy,” who has the instincts to know what turns the customer on (see Chrysler’s Dodge Viper and PT Cruiser). This worldview would repeatedly clash with that of the “bean counters,” who were so mired in metric mania they substituted the perceived precision of numbers for common sense.

He certainly understands that marketing and quality is all about the customer, and he points out many of the ways in which GM lost its way and for decades produced a stream of mediocre, uninspiring cars.

He is, however, a lousy economist, and there’s much that is wrong when he discusses various economic issues, such as value, fuel prices, imports, etc., which I’ll discuss later.

First, let’s look at what he found upon returning to GM in 2001.

Process Over Results

There are countless examples in the book of how GM lost its way, and many lessons apply to Professional Knowledge Firms (PKFs) as well. Here are some of the highlights.

  • The bean counters decided in the 1980s that Cadillac needed to greatly expand its sales volume to become the nation’s number one luxury brand—sort of like aspiring to be the “World’s Tallest Midget,” according to Lutz. The over-production created a glut of Cadillacs on the market, lowering resale values, increasing the lifetime cost of ownership, and destroying the “aspirational and exclusive” image of the iconic brand.
  • There were fourteen VLEs—Vehicle line executives—modeled after Toyota “shusas,” usually engineers responsible for the entire production of an automobile. They were held accountable for various Key Performance Indicators: cost, investment, quality, warranty cost, assembly hours per vehicle, percentage of parts reused from prior vehicle (thought to be Toyota’s key to success), and time to program execution (duration, in Ed Kless’s project management parlance).

    Yet any measurement system will be gamed by us humans. Rick Wagoner, the CEO, in exasperation over one car program once blurted out:

    I’m tired of seeing financial analyses telling us it’s better to do a lousy car earlier rather than a good one later. We are going to delay this program and get it right!

    Worse still, the “world’s most appealing car in the segment” was conspicuously left out of all the measurements, since that’s too subjective—not quantifiable in wonk-speak.

    Also, according to Lutz, there’s not a car company in the world that has fourteen people qualified to produce aesthetically pleasing vehicle designs. Most are lucky to have two or three. Lutz is full of contempt:

    Having nondesigners pass judgment on design is a bit like sending a sports bar full of beer drinkers to a wine tasting.

  • Another ritualistic time-waster Lutz would have done away with if he had been CEO was the Performance Management Process, or PMP. This was to make sure that goals would be aligned, and individual objectives were consistent across functions and geographies. There’s no customer value in this process, for two reasons:

    First, the “objectives” are all based on a series of dubious projections on market size, economic activity, competitor actions—none of which ever come true.

    Two, a senior executive who needs a quantified list of objectives to know what he or she should be working on should not be a senior executive in the first place. [Amen!].

    The “value” is only to the small army of human resources personnel who keep track of the whole mess.

  • Lutz would continually point out that it was better to build high net-margin vehicles that took many more hours, than being the best in the world building low-hour vehicles that GM would take a loss on. Timesheet devotees take note!

    Lutz also understood that GM was an “interdependent” system:

    We need to recognize that everything is a trade-off, that we can’t maximize the performance of any one function to the detriment of overall profit maximization [another huge problem with the timesheet mentality in PKFs—the idea that you can optimize every six minutes and maximize the whole firm].

    Suboptimizing profitability by geographic entity makes about as much sense as declaring every U.S. state a “profit center” for GM North America.

    Another error of the PMP process is that it crowds out art, creativity, and spontaneous invention, not to mention doesn’t take into account human being’s irrational side:

    It assumes that automotive consumers are highly rational people who will perform analyses and elaborate feature comparisons before making their purchase. As we all know, they don’t. The customer buys brands, and some are cool, and some aren’t. The customer is highly design-sensitive, and some cars are attractive, and some aren’t.

    Lutz spares no contempt for “Total Quality Excellence” consultants [are you listening to this Six-Sigma belts?]:

    …then the concept of “process and standardized work” were expanded beyond manufacturing. If it’s good for the factories, some reasoned, why wouldn’t it be good for every other part of the company, even the creative ones?

    Here is where the profound intellectual error was made: the rest of the company isn’t a factory. Almost nothing is done repeatedly, exactly the same way, a thousand times per day. Whether it’s Design (the least amenable to standardized work), Sales, Marketing, Purchasing, Engineering…new situations, vendor products, competitive actions, legal changes, and software upgrades occur daily and weekly.

    The attempt to reduce these activities, which require flexibility, adaptability, initiative, and “Hey, let’s try this shortcut” thinking, to a “process” merely results in an unthinking, robotic organization where everyone is on autopilot.

    The best part is that if you follow process and the results stinks, you’re safe: you did what you were told. A lot of money was misspent in the last couple of decades of the last century on process apostles.

    One VLE came to Lutz, his PMP scorecard showing all green, hitting every target. He was asked, “How is it selling?” “Well, really not that well. But, I can’t be held accountable for that.”

    As TV’s House, M.D., said: “We must not let results get in the way of process.”

  • When Lutz complained that GM’s exterior body paint was dull and grainy, he was told by the bean counters he was wrong. J.D. Power reports the lowest number of paint defects per car of any company, including Toyota.

    Once again, the usual confusion: a restaurant that advertises “the lowest incidence of food poisoning of any restaurant in the state” does not necessarily serve the best food. “Absence of complaints” does not equal excellence.

    General Motors is testament to the failure of applying Six-Sigma thinking to knowledge work—whether it’s design, innovation, creativity, or other processes of the mind. It’s illustrative of the Seven Moral Hazards of Measurement.

    It’s also proof that companies need to measure what matters to customers, not just measure for the sake of measurement. The idea that a PMP would show all green but the car wasn’t selling is all you need to know about how far GM moved away from holding people accountable for creating results that mattered.

Lutz is a Lousy Economist

Even though Lutz’s diagnoses of GM’s problems are right on, when he ventures beyond microeconomics to macroeconomics, he’s much less of an expert. About the only area I agreed with him on is his skepticism regarding global warming.

He didn’t think Japanese imports were “fair,” but life isn’t fair. He believes the Volt is an example of GM’s vision and risk-taking capacity, but only if you believe government subsidies and risking taxpayer’s money equates to vision.

He’s a big believer in European-level fuel prices, to subsidize mass transit, which would also make us a poorer nation, with a larger government.

He thought the government was right to bail out Chrysler in the 1970s, since they paid it back, even making money. Well, you can win at Russian Roulette every once in a while, but in the long run the odds suck—see Chrysler’s bankruptcy thirty years later.

Lutz believes that the US has lost its manufacturing prowess, since we don’t make anything anymore. And those jobs are gone forever, which is why Obama’s trillion dollar stimulus isn’t working.

But this is nonsense, a form of manufacturilism [ok, I made that up]—like mercantilism—that Adam Smith refuted back in 1776.

In any event, the purpose of an economy is not to create jobs, but to create wealth. Otherwise, we could simply employ a guard for every mailbox, or indeed create the TSA—Thousands Standing Around.

But the most illiterate of Lutz’s views comes from this:

We need to remember that economic value is basically created only one of
three ways:

  1. Mining the material from the bowels of the earth
  2. Growing food and wood on the surface of the earth
  3. Manufacturing and distributing the products of the first two

Everything else is simply trading “value” that has already been created.

Wow, that would come as a shock to pharmaceutical companies, insurance companies, software companies, Google, Apple, and a myriad of other knowledge companies that don’t produce tangible things.

Lutz should stick with what he knows—how to make cool cars that people want to buy. Leave the economics to people who understand that wealth is far more than producing automobiles.

Book Review: Get Rid of the Performance Review!

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Samuel A. Culbert has written another useful book in the pantheon to demolish the Performance Review (hereinafter PR): Get Rid of the Performance Review!

This is an excellent companion to Tom Coens’ and Mary Jenkins’ book, Abolishing Performance Appraisals.

Culbert is a full-time, tenured professor at UCLA’s Anderson School of Management, who often describes his professional goal as “making the world of work fit for human consumption.”

What’s the purpose of PRs? Help improve skills, growth and development, and to improve the company’s performance.

Does this rhetoric match the reality? Culbert certainly doesn’t think so, and he lays out a cogent, lucid, and logical argument for why not.

In bullet point summary, here are some of his arguments against the PR:

  • PRs Create fear;
  • A PR should be based on need, not an arbitrary date on a calendar;
  • The real purpose of PR is to preserve authority and domination in the boss/employee relationship;
  • Most managers don’t have a clue how to hold people accountable;
  • There’s no built-in incentive with the PR to make the whole work place better;
  • It’s not a “legal backup” to avoid being sued. The ones who sue are the ones who get positive comments in their files. Get rid of needless documents and you’ll get rid of a lot of lawyers;
  • PRs endow HR department with keeper-of-dirty-little secrets/KGB-like authority. They do this to get and keep respect they believe they don’t deserve (they’re right about that, which might be the only area where Michael Scott, the boss from The Office, is right: he has overt disdain for HR);
  • PRs are not objective, since when people get new bosses they get very different evaluations;
  • The fad of 360-degree feedback is supposedly objective because it’s anonymous. So is hate mail;
  • Any acknowledged weakness by the employee is a club that can be used against them;
  • It’s all about deficiencies, which drown out everything else (including the positive), much like adding even a little dog poop to your favorite ice cream;
  • Team members are starved for feedback, but not PRs;
  • Self-obtained feedback is the most effective.

What about pay for merit? It’s an illusion. Culbert believes three factors, ultimately, determine pay:

  1. Want to retain the employee?
  2. Is a raise necessary to do it?
  3. Company’s budget.

He cites the Law of Compensation: A PR will always support the recommended pay action (how true is this?).

Culbert is no fan of Jack Welch/GE’s “rank and yank”—get rid of the bottom 10%, since the workplace is not a bell curve to be created by rankings.

Since leaders don’t know how to hold people accountable for results—like in a ROWE—they focus on inputs, like PRs.

The book contains an entire chapter “Still Have Doubts” that answers the many objections readers are bound to have who remain stuck in the PR mindset.

Culbert’s substitute to the PR is what he calls the Performance Preview, a two-sided conversation where both boss/subordinate are accountable.

I believe Peter Drucker’s Manager’s Letter and After Action Reviews are even better substitutes, but there are elements of Culbert’s idea that should be incorporated.

The only major disagreement I have with Culbert is his history of the PR. He claims it’s a post-World War II creation, derived from Management By Objectives.

But it’s not. It actually dates back to psychiatric reviews where the patient always presents with some problem (Drucker points this origin out in several of his books, which is one of the reasons he developed MBO in the first place).

But no matter where it came from, it’s past time for this relic to exit. Culbert ends by writing:

It is time that you put the performance review out of its misery.

I would say our misery.

Book Review: Islands of Profit in a Sea of Red Ink

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Islands of Profit in a Sea of Red Ink, by Jonathan L.S. Byrnes.

This book’s fundamental premise is quite simple, and very true:

Nearly 40 percent of every company’s business is unprofitable by any measure, and 20 to 30 percent is so profitable that it is providing all the reported earnings and cross-subsidizing the losses. The rest of the company is only marginal.

The underlying problem cannot be properly diagnosed—let along fixed—because most of our management processes and control information were developed in the Industrial Era and are no longer relevant to what the author calls the “Age of Precision Markets” (as opposed to the “Age of Mass Markets”).

The Chapters in the book, and there are 36 of them, are organized around four topics:

  1. Thinking for Profit
  2. Selling for Profit
  3. Operating for Profit
  4. Leading for Profit

The author says that these improvements will not cost you money, but I’m skeptical. After all, any real competitive advantage is rarely free, otherwise it’s too easy for competitors to duplicate. And since some of those advantages are adding value, customer service, and innovation, how can these be free?

Though perhaps the author means the mindset of these four topics are free. He also uses Dell as an example; but given Dell’s financial and profitability issues perhaps he regrets that choice?

The author later lays out three key elements to implementation of the above, which are central to the theme of the book:

  1. Profit mapping—which is where you look at the profit of each customer, product, etc., at 70 percent accuracy, which is close enough.
  2. Profit levers—turning bad accounts into good accounts
  3. Profit management process

I particularly liked the advice about seventy percent accuracy in cost accounting.

The author points out that arguments over cost allocations will not change action and the measurement itself ends up becoming the project. How true. Cost accounting is not an exact science, nor does it need to be. It needs to be close enough, and seventy percent seems generous.

And this is particularly true in professional firms, where most costs are fixed, like rent and salaries, and do not occur with every passing hour. That’s an assumption, not a fact. It’s cost allocation, not actual costs.

Where I depart from the author is his insistence that you tie out all costs to match the income statement, so you get a real “cost to serve.”

That’s right for cost accounting, but not for pricing. Most pricing decisions should be based on marginal costs, not total costs.

Moreover, if you match the income statement, and then add one customer, your costs are over-allocated to all prior customers.

This can become a ridiculous game, and no matter how you slice the cost pie, it’s still full of arbitrary assumptions.

Again, the goal is to be close enough. In a professional firm, you don’t have to worry about allocating every single cost, just get it close enough. You should focus your time and energy on creating value, then capturing it with better pricing.

10 Business Myths

Chapter 2 contains 10 business myths that I found to be very true, though not all of them apply to professional firms. Here are the myths (in bold) that do, along with some commentary:

  • Revenues are good, costs are bad.
  • We should give our customers what they want—this is usually different than giving them what they need, which may be a new business model.
  • All customers should get the same great service—this is a major problem in most firms, since they do, in reality, discriminate in customer service, but they don’t make it transparent, neglecting to manage customer expectations.
  • If everyone does his or her job well, the company will prosper—there’s no way to execute well a poor strategy. The goal is profit for the entire enterprise, not it’s individual components. This is very true in professional firms, which is the problem of trying to run a profit and loss on every 6- minute unit of time.
  • Big changes can’t be made without a crisis—it shouldn’t take a burning platform to implement significant change, since fear rarely produces clear thinking.

Three Core Principles of Strategy

I also enjoyed Chapter 4, and the three core principles of strategy:

  1. It’s all about customer value.
  2. Strategy is defined by what you say no to.
  3. You have to be best at something.

My colleague Tim William’s book—Positioning for Professionals—does a much better job explaining these points.

Overall Review

I was hoping the author would discuss how to rid a business of unprofitable customers, but his advice seemed to be try to make them better customers first, and/or raise their prices.

Fair enough, but in professional firms, those customers that firms can’t add value to should be let go, not just increased in price. An “F” customer does not become an “A” customer just because they are paying four times more, since that’s the ethic of the world’s oldest profession, not true professionals.

Maybe the author thinks strategy (what not to do) will handle this issue, but most firms have bad customers they should shed immediately, and this book provides no guidance on how to do so.

But after Chapter 5, this book becomes repetitive, and then degrades to boredom. The author assaults the reader with what needs to be done, a typical Mommy checklist. Each chapter is short, but contains a “What’s Next” section that just grates, and is completely useless.

The book didn’t get better until the end, where the author talks about paradigmatic change—that is, significant change, which is the most rewarding.

Think of your resume, detailing a job description. Do you want it to read: “Did a good job of doing what always was done.”

I also liked this line: “Continuous improvement beats postponed perfection.”

Overall, the book is too long (unless you need to dive into supply chain management), but if you read just the first section, along with the last, it has some worthwhile lessons, though I’ve read better.

Book Review: Target Cost Management

Target costing is a term often used in pricing circles but rarely defined. We know it was pioneered by Japanese companies, especially Toyota, but what, exactly, does it mean? Target Cost Management: The Ladder to Global Survival and Success by Jim Rains sets out to shed light on a practice that is all but unknown in the USA.

Rains has an interesting background: He worked for 32 years at General Motors. He learned about Target Costing (TC) in 1993 from an Arthur Andersen report, “Product Development: Global Best Practices.”

Rains admits he’s never deployed the techniques he writes about because GM wouldn’t listen to him (though he does consult on them now). Further, no USA company he knows of has embraced TC, leaving the USA 40 years behind the Japanese (Toyota began using TC in 1963, but I’ve read elsewhere it was doing it long before then, though admittedly maybe not in the way Rains describes now).

Obviously the book is written for manufacturers, but I think there are some lessons in here for Professional Knowledge Firms, which I’ll share at the end.

The Japanese term for TC is Genka Kikaku, literally ‘planning for the achievement of true costs.” Rains provides his own definition of TC:

TC is a system that plans for and expects a constant, consistent, and acceptable level of profitability now and far into the future.

TC is not about management of cost, but rather management by cost. Rains goes on to distinguish TC from budgets and cost accounting, which deal with past costs, not future costs:

TC is not just about setting cost targets. It is an entire value chain approach to managing an enterprise. Cost targets are not budget targets. Too many managers have been taught that budgets are what you spend. Cost targets, by contrast, are something that you achieve.

TC is not a financial system. Typically financial systems are used by the finance department to report costs that have already been spent, rather than to manage cost expenditures before they occur.

The definition used by the Japanese is probably better since it incorporates the customer:

TC is a comprehensive profit management activity to plan and develop a product through establishing targets for quality, price, reliability and delivery satisfying customer requirements and through striving to achieve the targets simultaneously across the processes.

The formula looks like this:

Market Price — Target Profit = Target Cost (TC)

The process is really value engineering (VE), recognizing that the design phase is where most costs are committed, and value is what drives the market price. This is different from Activity Based Costing (ABC), which allocates past costs based on activities.

VE focuses on the function (Function-Based Costing, FBC), which acknowledges that only a few functions drive the total cost, and the importance of the function has little correlation to the cost to perform the function.

What makes FBC so effective is the focus is on the functionality the customer is willing to pay for. Rains provides an example of door hinges. GM tends to change them every year, whereas Toyota keeps the same ones since the customer doesn’t really care about the aesthetics of the hinge, only its function.

The average car contains approximately 10,000 parts, so it’s easy to imagine how this approach can avoid a large number of costs.

Traditional managerial accounting has no way to capture cost avoidance, hence it’s not rewarded. Japanese companies think about cost avoidance through the entire design and manufacturing processes, which is why they are not guided in their decision making by standard cost accounting procedures. Indeed, Toyota and other Japanese companies don’t even utilize standard cost accounting.

Ladder to Global Survival and Success

A ten-rung ladder is illustrated that plots the journey to TC, while the book is designed to focus on the top three rungs. The bottom 7 include strategies such as Lean, Six Sigma, Value Analysis, Theory of Constraints, Benchmarking, VE, ABC and a host of other acronyms I won’t bore you with.

The top three rungs are “Begin TC; Utilize Cost Tables; and TC Institutionalized.” Developing Cost Tables is the Holy Grail of TC, as they allow companies to project future costs and achieve TC objectives. There are three ways to formulate cost tables:

  1. Time motion study
  2. Actual plant floor benchmarks
  3. Statistically derived parametric estimation or regression techniques

What’s interesting is how Japanese companies have embedded TC into their DNA. Every major Japanese company has a cost planning department, with half of them being separate departments, 40% report to engineering, the rest to purchase and finance.

Nissan alone employs 220 people in cost engineering. Cannon, the most profitable Japanese company, has 267 people, and even Isuzu has 60.

These folks aren’t just concerned with cost, but also are responsible for value creation and establishing the Market Price.

The chief engineer at Toyota, for example, spends one year in between projects in the field interacting with both dealers and customers to determine value. This is similar to the functions we advocate the Chief Value Officer (CVO) perform for PKFs.

Disagreements with the Book

Not everything in this book is worthwhile. The author seems to think that Japanese companies are superior because of TC, and no doubt that may be true among automobile companies. But the USA is far more innovative than Japan in many other sectors, so TC can’t be holy grail he claims it is.

The author also doesn’t seem to realize that costs are prices, and have their own value component built in. He advocates suppliers share full costing data with the company, and then tack on a desired profit—that is, cost-plus pricing, the very opposite of what he thinks companies should be doing.

If Value is right for Toyota, then why isn’t it right for suppliers to Toyota? The contradiction is never addressed.

He also claims that raising prices isn’t normally an option in today’s global economy, but this is nonsense. Price is set by value created, not costs incurred. Lowering costs is just one alternative to increasing profitability. Creating more value is another, not to mention more strategic pricing strategies.

Yet my biggest disagreement with this author is his attitude that business is war, and that you have to be so competitive your competition doesn’t survive.

This, too, is nonsense. Business is not war. It doesn’t destroy, it creates. Sure, a lot of companies fail—like GM—but that doesn’t mean that outcome should be the overarching the goal of Toyota. The market is big enough for many competitors, even in automobiles. The author’s zero-sum mentality makes me question other topics he addresses in the book on corporate strategy.

Lessons for PKFs

Rains also seems to believe in Frederick Taylor’s distinction between managers and workers, writing:

Those involved in intellectual work should not be diverted from it by other responsibilities. Line managers and workers are there to realize the plans created by the intellectual efforts of others.

I don’t know if this attitude comes from his years at GM and its militant unions, but it seems to me that Toyota treats all of its workers as knowledge workers, which is why they implement so many ideas (over a million per year) from line workers.

This attitude is very similar to the strategies laid out in the E-Myth Accountant by Michael Gerber and Darren Root, which are suboptimal because they don’t tap into the knowledge that exists across the entire firm.

In a PKF, everyone is a knowledge worker and is in charge of designing their own responsibilities, contributions, plans, processes, and systems. All the knowledge is not embedded at the top, but dispersed throughout the knowledge workers themselves.

There is no “one best way,” as Taylor and Gerber advocate, in a PKF.

In an auto plant, the worker serves the system and a lot of the knowledge is embedded in that system. But in a PKF, the system serves the knowledge worker, with the knowledge embedded in the human capital.

This is precisely the difference between an Industrial/Service Era organization and a PKF.

Reading this book taught me a lot about TC and it was interesting, but it also convinced me that TC is not the right approach for a PKF. Focusing on creating value, implementing Value Pricing, appointing a CVO, establishing a Value Council, implementing project management, and conducting After Action Reviews are far superior strategies than fretting about costs that are largely fixed.

Cost Tables really don’t apply to a PKF. You have to pay the rent and salaries (the overwhelming majority of costs in the average PKF) no matter what, and trying to allocate those costs to any activity or function by the hour is completely arbitrary and fraught with misguided and misleading assumptions. Hint: you can allocate rent by the hour, but you’re on the hook for the whole lease cost once you sign.

Perhaps Rains himself says it best:

Managing the intellectual effort should focus not on improving efficiency but on achieving effectiveness in product specifications.

Ultimately, effectiveness is achieved by creating value and capturing a fair portion of it, not achieving exact cost targets.

However, if you have manufacturing customers you may want to have them read this book. It could be the beginning of a very interesting journey.

There’s no doubt in my mind that TC is superior to standard cost accounting and Activity Based Costing.

I wonder how many Six Sigma Black Belts advocate TC? Rains is skeptical about Six Sigma, claiming the ROI on it has been much higher for the Black Belts than any company. I wonder why?