A Civil War

Posted on: December 9th, 2011 by
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by John Feinstein

When Charlie Weatherbie arrived to take up his first head coaching position, he was asked about Army-Navy. He’d seen other rivalries, he said. He knew about other rivalries, Oklahoma-Oklahoma State, for instance. Seemed no different to him. People at Navy spent way too much time worrying about Army when there was a whole season to play.

A subtitle to the Navy side might be “The Education of Charlie Weatherbie.” Even going into the game, after Army Week and a whole season of “Beat Army,” he was more focused on the winning season than on Beating Army. At the end of the game, Weatherbie broke down in tears, repeatedly apologizing to his players for a critical coaching mistake that probably cost them the game, taking responsibility in the best Academy tradition.

Talk about a transformative experience.

Army and Navy have been playing each other in football for 100 years, they’ve been fighting wars together for over 200. What Weatherbie didn’t understand – what most people don’t understand – is that while the Academies live to beat each other in football, they respect rather than hate each other. They save that for the Air Force, the kid brother who thinks it’s about winning games.

The book is 10 years old by now, and the football programs have changed a little. In 1995, both academies had programs on the rocks. Army had a respectable program, but Navy had suffered through a couple of 1-win seasons. Both schools were in the lower tier of Division I-A, and were regularly scheduling I-AA teams to pad their win totals. Bowl games were fond, distant memories. Since, while Army’s coaching has completely fallen apart, Navy has gone on to several bowl games and has recently dominated the series.

The Naval Academy was also suffering through a series of scandals – an Electrical Engineering cheating scandal, alumni involved in a murder-suicide, and three midshipmen killed in a freak car accident returning to the Yard. Army had won the previous three games by a total of five points, leaving this as the last chance for Navy’s graduating firstclassmen to win The Game. A popular superintendent had reluctantly returned to Annapolis at the end of his career to right a ship gone horribly wrong.

While West Point as a whole didn’t need the win as badly as Navy did, their coach probably did. And the Army football team didn’t lack for compelling characters with compelling stories. Often these reflect the harsh and somewhat anachronistic discipline that the Academies impose on their underclassmen. One of the best concerns Army team captain Cantelupe and Beast, the introductory hazing new plebes go through the summer that the enter West Point:

Like every plebe, Cantelupe hated Beast, although his approach to it was a little different than most. Cantelupe takes the things that are important to him very seriously: his family, his friends, his responsibilities, and his football. Beyond that, he sees most things in life as not being worth too much concern.

Cantelupe did what he had to do when it came to corps discipline. But he always did it with enough humor to keep himself sane. On one of the first nights of Beast, the first classman in charge of his squad sat everyone down after dinner and demanded that they tell him their family’s origins.

“Klein,” he demanded, looking at Derek Klein, “What kind of name is that?”

“Sir, it’s German sir,” Klein barked back.

“O’Grady,” the firstie continued, “What kind of name is that?”

“Sir, Irish sir.”

It continued like that until the firstie reached Cantelupe, who was both bored and bemused by the whole exercise.

“Cantelupe,” the first roared, “What kind of a name is that?”

“Sir,” Cantelupe replied, his face as straight and serious as everyone else’s, “it’s produce sir.”

The firstie stared at Cantelupe in disbelief. Everyone else stared at the floor, praying they wouldn’t burst into laughter. Klein was biting his lip so hard he thought it must surely b bleeding.

“Do you think that’s funny, Cantelupe?” the firstie screamed. He then gave Cantelupe several minutes of haranguing on what happened to wise-ass plebes who didn’t take their superior officers seriously.

If Feinstein has a problem, it’s that there are too many good stories, with too many good personalities. Guys who have to work their way through Academy prep school to make it in. Guys who fail out. And the ever-present tension between the Corps or the Brigade as a whole, and the football team’s special privileges.

He’s covering the story of two teams through a whole year, and it’s hard to make the narrative hang together. While Feinstein nominally tells the story through Cantelupe and Navy’s captain Andrew Thompson, they provide more of a common thread than a consistent point of view. Also, as the above passage indicates, his praise for his editor is somewhat misplaced.

That said, it was probably a mistake for me to read this book in August.

I already can’t wait for the last weekend in November.


Supreme Command

Posted on: December 9th, 2011 by
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by Eliot A. Cohen

Almost everything you think you know about the civilian-military relationship in a democracy is wrong. Sure, you know that the military needs to be subordinate to the civilian. But what, exactly, does that mean? You think you know that the politicians should declare war, and let the military win it. You think that war is too technical for politicians to understand. You think that political interference lost Vietnam, and military autonomy won the first Gulf War. You think that the US military is non-political. And you think that the best military is non-ideological and professional.

Think again.

Eliot A. Cohen’s Supreme Command makes a persuasive case that an active political leadership, willing to challenge and meddle, is the only way that a civilian political leadership makes sure that the conduct of the war conforms to the political aims that the county went to war for in the first place. Left to their own devices, the military will be tempted to start dictating policy, aside from the mandate of the elected leadership.

Cohen provides four character sketches of successful activist political leadership during wartime: Lincoln 1861-1865, Clemenceau 1917-18, Churchill 1939-45, and Ben-Gurion 1948. Each had a different challenge, and pursued it in his own way. Lincoln needed to find a general not only who could win, but also who had the will to press the war on to its conclusion. Clemenceau needed to balance two eminently competent and intelligent generals with very different ideas on how to prosecute the war in its final stages. Churchill not only needed to keep his coalition together, but also needed to prod his generals into thinking things through all the way. And Ben-Gurion needed to remake a group of local paramilitary forces into a single professional army.

So Lincoln wrote letters and telegrams. Clemenceau spent about 15% of his time at the front; Churchill relentlessly asked probing questions. And Ben-Gurion talked to everyone. All of these activist politicians ended up being thoroughly resented by militaries that thought they knew better. In the cases of Churchill and Lincoln, Cohen understands that he’s swimming against the tide of established orthodoxies, especially as regards Churchill.

Cohen’s claim is that the strong academic backlash against Churchill (whose war memoirs established the immediate post-war narrative) has simple gone too far in focusing on his mistakes rather than on the way he prodded his military chiefs to re-examine their plans. Churchill never overruled his military chiefs, he simply constantly prodded and questioned them, forcing them to defend their assumptions and therefore their conclusions. In fact, this is one of the key functions of a leader and chief executive. As Jack Welch puts it, a leader’s job isn’t to have the answers, it’s to have the questions. Historians who don’t grasp this don’t really understand executive leadership.

Cohen follows up with an survey of Vietnam and the Gulf Wars. Contrary to popular opinion, Cohen understands the restrictions Johnson put on the conduct of the war – preventing offensive ground operations in order to avoid provoking a Chinese reaction. What he doesn’t understand is Johnson’s almost complete faith in the military’s strategy, and why Johnson didn’t question whether that strategy could produce a victory within his constraints. In the end, it was the military and the next President who came up with Vietnamization, which failed when the US withdrew its air support and military subsidies.

His reviews of the Gulf Wars also go against received wisdom: the first Bush administration, learning the wrong lessons from Vietnam, all but ceded complete control over the war to the military chiefs, even allowing them to make such obviously political decisions as when the war was “won,” and to negotiate the cease-fire with Hussein regime. The Iraq War, by contrast, saw heavy management by SecDef Donald Rumsfeld, a man who had already alienated much of the top brass by questioning standing military doctrine. Rumsfeld’s management clearly subordinated war planning to political ends and constraints, to Cohen’s approval.

The Appendix looks at the historical development of the “normal” theory of civilian-military relations, taking aim not only at Huntington’s defense of that theory, but also at his assertion that a non-ideological “professional” military fights best. A moment’s reflection should be enough to convince anyone that the training and practice of a professional military work better when the men doing the fighting believe in their country and their mission.

In the end, Cohen makes a strong case that when a democracy conducts something as serious and potentially destructive as a war, something that requires the ongoing commitment of a people, not merely an organization, the politicans and not the military are best-suited to understanding the symbolism and morale of the people.


The (Mis)Behavior Of Markets

Posted on: December 9th, 2011 by
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by Benoit Mandelbrot

According to Modern Portfolio Theory, the basis for most of modern stock market analysis, the crash of October 1987 shouldn’t have happened in our lifetimes. In fact, it shouldn’t have happened in the lifetime of the country. It should have happened, perhaps, once in the lifetime of the universe. It was just our good fortune to have lived through it. Now we can relax.

In fact, even as Robert Merton and Myron Scholes were accepting the Nobel Prize for their contributions, the markets were preparing to given the Royal Swedish Academy second thoughts.

So what went wrong? Why did MPT fail so catastrophically? What assumptions failed? Why do academics and researchers continue to base their research on those assumptions? And is there anything out there that might be better?

Benoit Mandelbrot, Father of Fractals, Creator of Chaos Theory, Maker of the Mandelbrot Set, has some ideas, and The (Mis)Behavior of Markets tries to bring them to the public.

I fell in love with fractals and chaos theory in college, when both it and I were young. I didn’t pursue a career in physics, and left them behind, I thought for good. Ah, but life is strange, and just a couple of years before I decided to turn towards finance, so did Mandelbrot and fractals, and there there are, my old friends, waving me over to the table for drinks.

Actually Mandelbrot started out as a market analyst, but got sidetracked for a couple of decades, and is now turning his attention back to the problem that got him started: why historical cotton prices don’t look anything like a normal distribution.

Mandelbrot spends the first half of the book explaining the roots of Modern Portfolio Theory, and why the simplifying assumptions simplify it out of relevance to the real world. He doesn’t suffer fools gladly, and while he doesn’t actually come out and call anyone a fool, he does let the read draw his own conclusions.

I’ve covered the problems with MPT is previous reviews and comments, so I’ll just touch on them here. MPT is based on the early 20th Century work by M. Bachelier, who took his cue from Brownian motion, the random motion of particles suspended in water. That motion is normally distributed. Well, if dust motes, why not stock prices? Bachelier posited that stock prices moved some small amount each day, that the movement was normally distributed, and that there was no memory from one day to the next.

Why normally distributed? Well, like the guy who loses his keys over there in the dark, but looks for them over here under the streetlamp because the light’s better, it’s the only distribution that we can really find closed-form solutions for.

Modern Portfolio Theorists follow Merton in assuming that time is continuous. On the way down, or on the way up, the stock price hits every tick, (this used to be 1/8 of a dollar, now it’s a penny), so you can always get the share price when you put in your order,

These assumptions don’t hold. They’re made largely because they’re the only way to get to a closed-form solution to the math. What’s more, anyone with eyes in his head ought to be able to see that they’re not even usually true.

Mandelbrot starts from his distribution of cotton prices, and works from there. First, prices are more likely to follow what’s called a Cauchy distribution. More peaked in the middle, and with much, much fatter tails, the Cauchy distribution is very ill-behaved.

From there, readers familiar with fractals will find themselves skipping large sections. Mandelbrot reintroduces self-similarity, scaling, fractal dimension, and so on. But he also introduces the idea of time-warping, warping along the x-axis as well as the y-axis. Do this, the produces some very realistic-looking charts.

And that’s pretty much where the argument ends. Mandelbrot has produced charts that look right, and returns distributions that mimic reality, but he admits that it’s purely descriptive. There’s no mechanism, only behavioral speculation, and there’s no real way, yet, to make money other than by selling books about it.

What are the implications for finance? Well first, with those fat tails, the Cauchy distribution is much, much riskier than the normal distribution, with the likelihood of ruin much higher. Second, the thing about the realistic-looking charts, that are indistinguishable from real charts, is that they really are random. Technical analysts, beware! Mandelbrot has some sympathy for the illusory patterns you see in the charts, but illusory they are. If I can produce something randomly that looks like the real thing, and you think you see predictive patterns in it that aren’t there, what does that say about the predictive power of the patterns you see in real charts?

Mandelbrot also reminds us that he started to come up with this stuff just before the advent of MPT, but that in the trendy world of finance, his uncertainly was overshadowed by MPT’s promise of managing risk. He reminds us more than several times, and it does get a bit tiresome. There’s nothing the matter with enjoying being right, but even the disinterested observer, who’s only looking for something better, get weary of hearing “I told them so.”

He make up for it, though, but devoting the last chapter of his book to an uncritical discussion of current research based on his work. He’s boosting these guys, with no expectation of recompense, in the best academic tradition, and he deserves credit for that. If he can use his name and popularity to create a community pursuing these ideas, more power to him.

We are reminded that this is a field still in its infancy, not really allowed to grow by an industry that thought it had the magic key. Retrenching and pursuing this line of thought, which currently offers little if any profit path, is hard. But it’s better than building on sand, on a coastline whose length you can’t even measure.


The Wisdom of Crowds

Posted on: December 9th, 2011 by
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by James Surowiecki

How can a crowd correctly guess the number of beans in a jar, time after time, far more accurately than the average of the best guesser? How can all of us be smarter than the smartest of us? Especially when “all of us” includes some really dumb people?

That’s the question that James Surowiecki attacks in The Wisdom of Crowds, a deceptively short book packed with examples of collective wisdom.

The crowd collectively is smarter than any of its individuals – even the smartest. While there will always be someone smarter than the crowd in any given run, those individuals will vary from run to run, not able to consistently repeat their success.

In order to harness this collective knowledge, three conditions must obtain: 1) there must be a means of aggregating the results, 2) individual decisions must be made independently, and 3) the decisions must be unbiased, uninfluenced by an outside bias pushing the crowd in one direction. The first condition makes the results useful, the second keeps the crowd from turning into a mob, and the third prevents a dictator from manipulating that mob.

Surowiecki also identifies three different kinds of problems: cognition, coordination, and cooperation. Crowds are best at solving cognitive problems on their own. Coordination problems require a feedback mechanism, and cooperation problems, by far the most interesting, can require an entire social structure to enforce certain norms and incentives.

The first half of the book lays out the definitions and examples, the second provides increasingly complex applications.

Surowiecki discusses electronic markets, like Tradesports and the Iowa Electronic Market, supplementing data with anecdotal evidence. For instance, the very day of the Challenger Shuttle loss, Morton Thiokol stock dropped like a rock, even though dozens of contractors were involved in the shuttle program. Somehow, the market correctly aggregated the available information to arrive at the culprit.

I’d point out that the problem with anecdotal evidence is that it tends to be … selective. Surowiecki does deal with bubbles at length later in the book, but this is a different matter. The shuttle incident is supposed to provide evidence of the market’s ability to accurately aggregate information. But certainly there are times when the market is surprised by new information. While a comprehensive statistical analysis is well outside the scope of the book, one would expect counterexamples to be numerous and mentioned.

He also makes a spirited defense PAM, the abortive attempt by the US intelligence and defense community to harness such markets for intelligence purposes. One sympathizes with him here. No system in perfect, and one as high-profile as PAM would have attracted both sharpies and enemies attempting to game it. Still, with little money at stake, the outrage and horror expressed by certain US politicians may well have cost us a good source of information. One wonders if those morally offended by such markets are really just morally offended by markets.

Another interesting argument Surowiecki makes is in favor of shorting stocks – despite the regulatory, financial, and societal restraints on doing so -, in order to filter out the upward bias in stock prices (p. 227):

We know that the crowds that make the best collective judgments are crowds where there’s a wide range of opinions and diverse sources of information, where people’s biases can cancel themselves out, rather than reinforcing each other. If a company’s stock price, as we’ve seen, represents a weighted average of investors’ judgments, it’s more likely to be accurate if those investors aren’t all cut from the same cloth.

The case is compelling, but he ignores at least a couple of other reasons why short-selling isn’t more pervasive. First, it can be very hard to find someone to loan you the shares to sell. Second, if you’re an analyst, and you work hard, and do your do diligence, and go to meet a company’s management and find out about what they’re about, and still decide to short the stock, you make it harder for that company to raise capital, much harder than if you simply issued a “hold” recommendation. And maybe that management will never, ever talk to you again. There are good societal reasons working the other way, too.

Surowiecki also makes a logical error, arguing that rising stock prices aren’t necessarily a good thing, after all, look at Enron, and wouldn’t we have been better off if its price hadn’t gone up? Well, rising stock prices reflect a rising national economy, as any cursory comparison of 2005 and 1905 living standards will tell you. When people talk about rising stock prices, they’re generally speaking of aggregates over long times, not about accounting and financial abdication of responsibility.

Interestingly, companies, who gain the most from markets, are among the quickest to abandon collective decision-making in their own strategies and operations. Only a few companies, with very strong corporate cultures, such as IDEO, have managed to make it work. In IDEO’s case, it begins with unconstrained, non-judgmental brainstorming to solve problems, and pervades the entire company.

And this comes to social construct and social restraints. None of this works in a society without trust. Without going into great detail, the argument here goes that societal norms can be enforced, and form the background against which we operate. Since cooperation can’t be fairly coerced most of the time, society needs to subtly encourage it. It also suggests that the biggest cost of lawsuits isn’t the fees or even the fines, but the loss of trust that makes it possible to do deals in the first place, and the extra expense of proactively defending against every conceivable after-the-fact objection.

Like most interesting books, this one does overstate its case from time to time. There’s a fine line among collective wisdom, trusting your subordinates, and a society that works, and sometimes Surowiecki seems to cross it. Take Saturn’s much-discussed production line emergency rip-cord. Any worker on the line can pull the cord and stop production, if necessary. Is it really the Wisdom of Crowds that makes that work? The US military has always relied on platoon-level initiative. But it would hardly do to have Lt. Colonels voting on strategy.

He closes with an appeal that liberal democracy is collective wisdom applied to politics. It’s not a bad extension, especially when one considers that democracies do make mistakes, such as being fully unprepared for war. In the past, some have used this as an excuse to attack capitalism, although the real culprit was pluralism. In fact, democracies work quite well during peactime, just as markets work quite well in the absence of shocks. Perhaps the opening stages of wars are analagous to bubble or crashes, when the assumptions about how crowds function suddenly and catastrophically fail to obtain. This is most emphatically not an argument either against democracy or for martial law. It is a suggestion that Surowiecki’s analysis supports the conclusion that there are very limited times when normal political structures don’t work, and some level of command is necessary.

Still, experience bears out the overall principle, and an appealing principle it is. That within certain social constraints, we can all contribute simply by doing our best. Even if sometimes that’s not very good.


The Last Bubble

Posted on: December 9th, 2011 by
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Inventing Money: The Story of Long-Term Capital Management and the legends behind it

by Nicholas Dunbar

When Genius Failed: The Rise and Fall of Long-Term Capital Management

by Roger Lowenstein

Just when you think you’ve got it all figured out, Life comes along, sneaking up behind you with a bit of lead piping, to steal from P.G. Wodehouse.

The story of Long Term Capital Management is the story of The Smartest Guys in the World, and how maybe they just managed to outsmart themselves. In the meantime, they almost collapsed the world financial system, gave hedge funds a bad name, and called into question 30 years of financial orthodoxy.

Since finance is one of the intersections of math and men, Long Term Capital Management represents the failure of both. In Inventing Money, Nicholas Dunbar emphasizes the math. Roger Lowenstein’s When Genius Failed emphasizes the men.

LTCM based their strategy on Modern Portfolio Theory. MPT is essentially Brownian motion – random motion with normally-distributed action – applied to financial markets. It produced the famed Black-Scholes equation, now used statutorily for pricing options.

The problem is, they forgot the fine print. The normal distribution is one simplifying assumption. Another is that returns in different markets are uncorrelated, that is, what one does has no effect on the others. Another is that markets are always liquid – they trade at the smallest tick, and unlike the Hotel California, you can actually leave anytime you want.

The problem is, when everyone heads for the exits, none of these conditions holds. LTCM essentialy was making the same bet all over the world – that the difference in interest rates between government and corporate bonds would narrow. When people lost faith in overseas private credit in the wake of 1997 and 1998 currency meltdowns, they fled to quality – US & western government bonds. This forced down US interest rates, and forced up other interest rates.

Things didn’t get any better for LTCM when their competitors began front-running, or trading ahead of them, both denying them profits and widening these spreads even further.

This meant that their basic models estimating their losses failed, because markets were no longer behaving independently. Worse, they couldn’t sell when they wanted – their positions were too large, and the markets were moving too quickly.

I read Inventing Money just as I had finished a Risk Management course in business school. The professor was quite good at stressing concepts over equations, but as I read, I couldn’t help thinking that he could have assigned Dunbar’s book as supplementary reading. Dunbar follows the history of Modern Portfolio Theory as well as I’ve seen in any lay book, tying it in with the bets that LTCM was placing at the time.

While he certainly devotes chapters to the collapse, Dunbar spends most of his time discussing the rise of derivatives markets, and the boost that Black-Scholes gave them.

It wasn’t like the bankers didn’t know this sort of thing could happen. They had devised a measure called “Value at Risk,” or VAR, which estimated, again according to MPT, how much they could expect to lose in the worst month out of any 20. Or 100. Armed with these calculations, fund managers believed they could calculate how much cushion they needed.

VAR had its limits. In a 1995 article in the Financial Analysts Journal Tanya Styblo Beder made the following all-too-prescient statements:

Although a model may produce adequate views of capital at risk on an overnight or weekly basis, it may produce inadequate risk views over time horizons of several months, a year, or longer. For example, the calculation of short-horizon VAR may be misleading for customized or exotic products that cannot be liquidated und the assumed time horizon.

and

As experience during the European currency crisis, the Gulf War, and the Mexican peso crisis, not only are the key factors such as “maximum” volatility difficult to predict but also correlation relationships change substantially during extreme market moves. (emphasis added -ed.)

They can’t say they weren’t warned. But what they did with the warning, like defenders of the earth-centered solar system, was to go back and tinker with the model, secure and comfortable in the rightness.

When Genius Failed spends much more time with the people, fitting in the finance concepts along the way. Lowenstein’s extended description of the frantic inter-bank negotiations puts you right in the room. That the bankers, who frankly hate each other, are all sinking in the same boat, doesn’t keep them from trying to screw each other as they plug the holes.

The personalities stand out in bold relief. Meriwether is confident, affable, and takes care of his people. Victor Haghani should be wearing an Al Davis jumpsuit and grabbing free drinks off the tray. Born in 1930s Europe, Lawrence Hilibrand would have ended up running some Balkan fascist state. Future Senator and would-be Governor of New Jersey Jon Corzine comes across as well-meaning, but in over his head, even standing on his tip-toes.

And what of the Really Smart Guys, the academics who put the sand under the foundation in the first place? They provided much of marquee value for the company, but afterwards tried to portray themselves as uninvolved. Fischer Black died warning of the potential misues of this models, but Merton and Scholes, while nervous about the direction the company took towards the end, didn’t have the force of personality to put on the brakes. They produced theory. Haghani and Hiliband produced money.

Lowenstein also covers a few topics in detail largely missing from Dunbar’s account. The eagerness of banks to do business with LTCM is dramatized by UBS’s willingness to sell LTCM a call option on their own fund. UBS hedged that risk by investing in LTCM. The only way that UBS wouldn’t have to pay off the option was if the fund lost money, meaning that UBS would lose money. He also details the miswording – deliberate or not – of Warren Buffet’s last-minute offer to rescue the fund.

In the years since, LTCM has become the poster child for what can go wrong in a market. Both James Surowiecki and Benoit Mandelbrot cite it in their recent books. Scholarly articles are still being written on what went wrong.

These two books are best read together for their different perspectives on this seminal event in US financial history.


Blink: The Power of Thinking Without Thinking

Posted on: December 9th, 2011 by
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by Malcolm Gladwell

Shoot/Don’t Shoot. Speed Dating. Student teacher evaluations. Coke or Pepsi? How do you decide?

The answer, according to Malcolm Gladwell, is quicker than you think. Quicker than you can think. The thesis of his book, Blink, is that you make snap decisions by filtering out extraneous information, a process Gladwell calls “thin-slicing.” You go with pattern recognition and pre-existing associations that you can’t possibly be conscious of at the time. Further, he argues persuasively, unless you’re a trained professional, you can’t get inside the “locked box” holding your thought processes – any attempts to verbalize what’s going on will only make things worse. The good news: you can be trained to make better snap-judgments.

Bill Bellichek said something related after his Patriots beat Peyton Manning’s Colts in the playoffs this year. He said that he just wanted to make Manning think one split-second longer than he was used to. It’s also why Allen Iverson is suddenly helping, rather than carrying, his team. Attendance at practice (“we’re talkin’ about practice“) has improved his in-game judgment. In fact, sports relies so heavily on this kind of thinking that the whole book could have been nothing but sports stories. Happily, Gladwell doesn’t take this easy way out.

Gladwell puts together disparate information into a sometimes-disturbing pattern. It turns out that many of our judgments – frequently about other people – that we consider to be well-thought-out are in fact reached in a couple of seconds. If these judgments are based on association, and if we unconciously associate certain races with “good” or “bad”, for instance, we can believe that we’re consciously compensating and still reach a biased conclusion.

One may disagree with the conclusions, but Gladwell makes a reasoned, unhysterical case that needs to be taken seriously. The experiment to uncover these associations is astonishingly simple. I have not investigated the literature on its reliability. Another experiment involved sending testers of different races and sexes to negotiate car deals. Gladwell’s point, that there’s a whole subconscious world of signals and counter-signals, is evident, but he admitted in an email reply that he could have been clearer that it cuts both ways.

Another problem is that language – and facial expression, for that matter – define as well as express our thoughts. The act of describing a face forces us to use certain imprecise words. If it’s not a face we know well, we will modify our recollections to fit the archetypes described by those words. Tricked into thinking we can accurately analyze what’s going on, we find ourselves trapped by, rather than enlightened by words.

Here’s where a professional actually does have an advantage. He has a specialized vocabulary that lets him precisely pigeon-hole each of the complex flavors he’s tasting. Which means, when he labels them, he gets just what he’s looking for – he doesn’t have to modify his memories to fit the words. The words allow for precise recall of even so nebulous a concept as taste or smell. I certainly have make fun of wine reviewers who refer to “smoky, rounded overtones with a hit of fruity undercarriage,” but it turns out that stuff really does help the reviewer. Whether or not it helps the reader is another question, of course. The key here is that it takes years to trains yourself this way.

Taking the key point, that there’s critical information that your brain can focus on in a blink, Gladwell compares the Amadous Diallo shooting in New York a few years back to a similar case where the policeman didn’t shoot, correctly, as it turns out. He marvels at the staggering amount of focused detail that can be taken in by the brain in much less than a second.

Gladwell is at his best when he’s examining people in systems. Tipping Point is about why ideas seem to reach a critical mass. Another essay is about how some people are “connectors” who know everyone. This is about an individual as a system. It’s full of big, interesting ideas, and it doesn’t disappoint.


Good to Great: Why Some Companies Make the Leap…And Others Don’t

Posted on: December 9th, 2011 by
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by Jim Collins

The good is the enemy of the best. Good enough is good enough. Then, when the water’s smooth and it’s a clear night out and everyone’s asleep in their cabins, it isn’t good enough anymore. In the face of a crisis, or with the insight into an impending crisis, some companies fold up, call it a good run, and go look for something else to do. Others start flailing and picking battles they can’t win. Still others go all ostrich-like as they fade from memory.

The winners move from good to great. What makes some companies go gently and others reform themselves is the subject of Jim Collins’s Good to Great: Why Some Companies Make the Leap…And Other Don’t. Collins identifies six basic characteristics of companies that make that transition, and posits a virtuous cycle of both confidence and competence that keeps things turning until takeoff: 1) Leadership that immerses itself in the company rather than seeing the company as evidence of its greatness, 2) a willingness to pick the right people first, even before setting new goals, 3) the stomach to look at the hard facts while retaining confidence in ultimate success, 4) a simple identification of a business mission, even though that mission may have many parts, 5) discipline, and 6) intelligent integration new technology into a successful business model.

Collins looked for companies that had done well for at least 15 years, and then, usually slowly at first, took off and beat the market by at least seven times over the next 15 years. He wasn’t looking for companies that had succeeded over decades, and he wasn’t looking for success that was the creation of one charismatic leader. Indeed, such leadership frequently prevents sustained success after that leader leaves.

Collins’s metrics are self-reinforcing. Non-egotistical leadership won’t be afraid to hire the best people first. It will be more likely to look and report facts straight, rather than feel threatened by them. A good business concept reinforces the discipline to stay away from tempting but destructive projects, and provides an economic measure for integrating new technology.

While Collins claims that all the elements are necessary for success, what struck me most was number 4), or what he calls, the “Hedgehog Concept,” after Isaiah Berlin’s famous essay. A great company needs not merely core competence, but something that people are passionate about, that will drive the company’s economic engine, and that it can be the best in the world at.

A Hedgehog Concept is clarifying. It helps decide on business opportunities, and to define operations. Walgreen’s defined their core business as convenient drugstores. But it also helped define their economic metric: profit per customer visit. Walgreen’s looked for convenient rather than cheaper locations, often closely clustering the stores in high-traffic areas.

Fidelity to the “Hedgehog Concept” doesn’t mean lack of innovation. Walgreen’s tried out the drive-through pharmacy and then built hundreds of them. It does mean integrating new technology into your existing business model. Instead of being spooked by drugstore.com, Walgreen’s incrementally developed Net technology to tie their stores together and create a useful online presence.

In fact, the Hedgehog Concept, like much of the book, is useful in almost any “soft” intellectual pursuit. Once you have the core lessons down, that framework is tremendously powerful in interpreting events and actions. It does not mean that there’s nothing left the learn. It does mean that you have gone a long way towards understanding what things mean, rather than just what they are. When Ronald Reagan died this last year, people often referred to him as a Hedgehog, since he had a few, very powerful ideas that drove his thinking.

One other note. I’ve read a fair number of business books, and it’s striking how many executives and authors are surprised by the violence of boardroom arguments. Veins bulging, faces reddening, papers flying, provided that you have the right people, this isn’t something to be afraid of, it’s how you get real buy-in. It’s easier to just nod, collect opinions, and impose some pre-determined solution, but the best managers will actually encourage this sort of confrontation. (This is different from encouraging competition, which can be destructive.)

Collins is readable, his research is well-defined, and his results have the ring of well-modified common sense. In the end, Good to Great is as clarifying as any good Hedgehog Concept.


Blog: Understanding the Information Reformation

Posted on: December 9th, 2011 by
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by Hugh Hewitt

Combine freedom with low barriers to entry and you’ll be continually amazed at the results.

That’s one of the messages from Hugh Hewitt’sBlog: Understanding theInformation Reformation That’s Changing Your World. Hugh’s been a follower and booster of theblogsphere as an alternative and corrective to the mainstream media for years now. He recognized theincipient media early on, and has been relentless in promoting the best of the individual blogs. Now,he’s turned his attention to the medium as a whole, and how it may be useful outside of mediacriticism and politics.

Hewitt disdains the notion of blogging as a revolution, instead comparing it to the Reformation.Everyone remembers the 95 Theses, the debate they engendered, and the split that followed. But thatdebate wouldn’t have been possible without the printing press, invented 70 years earlier. It was theprinting press that made feasible the broadsides and cartoons (some of which make Ted Rall look like aresponsible, upstanding exemplar of demeanor). Without Gutenberg, Luther’s complaints would haveremained confined to an internal scholastic church debate. With Gutenberg, they set Western Europe onfire. (For those interested in a more in-depth discussion of this history, James “Connections”Burke’s The Day theUniverse Changed has a fine chapter on it.

He compares 2004 not to 1789, but to 1449 and 1517. The blog is the printing press, the mainstreammedia the Church. The blog, like printing, democratizes speech. The MSM, like the Church, is slow torealize that it no longer controls the medium or the message. Also like the Church, it’s notgoing away, but it will have to change.

The most interesting part of the book, the part where Hugh’s clearly playing with ideas, is wherehe tries to detail blogs’ usefulness to companies. The most obvious use is narrowcasting blogads onblogs with highly relevant readership. In this way, blogs closely resemble talk radio, or radio ingeneral. One would be tempted to suggest that Hugh’s radio show made it natural for him to see makethe connection, except that he was one of the only radio hosts even talking about blogs for a longtime.

Hewitt also discusses how companies need to deal with negative PR from a decentralized media crisis.Openness is always advised, but now it’s not enough to post press releases on the website, or call apress conference with the local newspapers and tv crews. Companies need to identify which blogs peopleread, and which blogs the bloggers read, and make sure they have access, too.

It’s in the area of content that the book gets more intriguing. How to take advantage of all thatdistributed knowledge about the company and its industry? He suggests leadership blogs, managerialblogs, or employee blogs, each with its own risks and rewards. If the company’s large enough, thesecould be of value even if limited to the company’s intranet. External blogs have potential, too.Hugh suggests hiring talented writers to blog for the company, but blogging interest comes fromknowledge and insight, something an industry professional is more likely to have.

The story of the rise of blogs, from the Trent Lott takedown to Rathergate, is probably familiar toanyone reading these words. In a section clearly aimed at newbies, but good review for us all, Hewittgoes over that history, and explains how the MSM got itself into this fix.

Blog has a conversational, almost Blognerian, style. Occasionally he lapses into Blogosphericself-referentiality (“As Lileks would say…”). For those just discovering blogs, the book is litteredwith good blogs and their URLs, in bold, although Hugh did manage tooverlook anumber ofexcellent localpublications.

If you haven’t heard of blogs, this is as good a place as any to start. If you have, it’ll decodesome of the secrets of successful blogging, and perhaps get you thinking about some new ways to makeuse of the medium.


How Would You Move Mt. Fuji?

Posted on: December 9th, 2011 by
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by William Poundstone

Puzzle: You’re responsible for hiring a team. They need to work well together, respond to changing business conditions, solve problems. You have one hour to interview each candidate. What questions will you ask them? Think about it before answering. There is no time limit.

Twenty years ago, the answer was obvious. Ask the prospect about his experience, about his plans, and then call his prior employer and find out if the guy’s worth it, or a deadweight who’ll spend his time running the office football pool. Round about the time people started suing over bad references, they also started writing down answers to the traditional interview questions on notecards. Employers came up with “behavioral” questions, asking people to describe their past work experiences. Since the expected answers were paragraphs, rather than sentences, it took a little longer for people to figure those out.

Then, two things happened. First, businesses (read: Microsoft) realized that they were hiring people for what they could do, not for what they had done. They had to be able to solve problems, not just apply formulas. Second, researchers figured out that people make their basic judgments about other people in the first two seconds. Two Seconds. Everything that comes after that, in a traditional interview, serves to validate that impression. Which means they aren’t worth much.

In the absence of now-illegal IQ testing, how do you test a prospective employee’s ability to solve problems? Why, give them problems to solve! Poundstone identifies three different types of problems: design problems, impossible problems, and puzzles. Puzzles tend to be variations of logic problems from 50 or 100 years ago. (My favorite: you have a closed room and three switches. With 10 minutes, and only one visit to the room, find out which switch controls the room’s light.) Impossible problems ask you to estimate the number of ping-pong balls you can fit in a 747, or how long it would take to move Mt.Fuji. Design problems ask you to design, say, VCR controls.

The point of all these questions is to give the interviewer insight into how the applicant solves problems under pressure. Is he persistent? Does he ask questions or make assumptions? Does he have enough wits even to know what the assumptions are? Puzzles have answers, impossible problems have approximate answers, and design questions have only processes. But the point of all of them, in theory, is to look at thought processes.

Do they help? Depends on what you’re really measuring? Almost all of the problems are math-oriented or algorithmic. They ignore fundamentals of human psychology in favor of Perfectly Logical Beings. So they might be better-suited to programming or finance types than to managers or planners. Also, some companies have rather rashly taken to making the interview itself a puzzle, playing games like having the interviewers not introduce themselves, or pretend to fall asleep. What this tells them about the applicant is anyone’s guess.

Poundstone doesn’t mention the popularity and usefulness of other testing. If you’re hiring someone to program in a specific language, for instance, it couldn’t hurt to look for certification. As for personality, with credit checks, background checks, legal checks, driving records, VCR/DVD rentals, library records, companies hardly need to subject people to the increasingly popular psychometric exams. Big Brother’s not only watching you, he’s hiring you.

The great fun of the book is the large number of puzzles Poundstone puts in. The Impossible Questions get old after about one, since they’re all variations on the same theme. The Puzzles are more fun, since they actually have answers.

Just be careful how you answer them. Or how you use them.

Answer to Puzzle: Turn on Switch #1 for 10 minutes, and then turn it off. Turn on Switch #2. Check the room. If the bulb is on, then it’s Switch #2. If the bulb is off, but hot, then it’s Switch #1. If the bulb is off and cold, then it’s Switch #3/


Pour Your Heart Into It

Posted on: December 9th, 2011 by
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by Howard Schultz

Reading this book was like taking a trip back through b-school. Virtually everything Howard Schultz mentions is standard fare now at the DU curriculum, from the founding ideals of a company, to how companies raise money, to the strategies for growth, and how to keep those core values as the company turns from underdog into 800-pound gorilla. The story is fascinating, and even if you don’t care much for Starbucks’s coffee (I prefer a lighter blend, myself), it’s worth the read for any American whose business is business.

Schultz moved west in 1987 to help manage a small coffee company, dedicated to missionizing Great Coffee to the American public. For most Americans at that time, coffee shops were sandwich bars at best, and the coffee was mostly office-brewed, lighter, and not very good. While Schultz was happy at first with just selling coffee, a trip to Milan, and the social life of its espresso bars, lit him up. He left Starbucks to go found his own chain of coffee shops dedicated to imitating those espresso bars, and the Starbucks we know now was born when he bought it out and merged the two.

So Schultz had a vision of what Starbucks could be, sold most of his employees on that vision, and sought out new managers and executives who could share in it. As the company grew, Schultz faced two primary challenges: how to make the transition from entrepreneur to professional manager, and how to grow the company without sacrificing its ideals. Control is a big thing with Starbucks. Their stores at the time were all company-owned, alliance and joint-venture partners have been carefully chosen and trained. The company has jealously guarded its brand-equity, even as it’s gone into ice cream and beer.

While the former was one transition point, the latter has been an ongoing pre-occupation. In picking new markets, Schultz felt he needed to expand to Chicago before Portland, to prove that the concept would work someplace where it snows rather than rains. And while we may make fun of the “venti non-fat frappucino with a shot of hazelnut,” every noun in that phrase was the object of intense internal debate. Remember, the mission was to introduce Americans to Great Coffee. Non-fat milk, blended ice drinks, and added flavorings are all bastardizations of the espresso experience, but Starbucks found a way to include them all. You can judge for yourself whether these are extensions of the ideal or dilutions of it, but the customer has been forgiving.

For the finance department, Schultz gives a little lesson in both corporate and investment-track finance. People often assume that just because a company’s growing, it’s profitable. In fact, small, growing companies often starve for lack of cash. Each individual store may be making a profit, but not enough to fund an ambitious growth plan. And as a company grows, the need for cash grows with it. Since Starbucks funds almost all of its growth through equity rather than debt, its plans live and die by its stock price.

Even after Schultz stepped down as CEO (although he remains Chairman), the company has continued grow quickly even during the recent recession. The recent vertical climb in its stock price is evidence of that. But much of the initial senior management team remains, so we still don’t know if the company has developed a culture than can outlast them.

Schultz only hits one really false note. Starbucks was one of the first companies to offer benefits to same-sex partners, “not as a political statement,” of course. One could be pardoned for Schultz claiming that there’s no political attitude at Starbucks, except that it’s not true. He credits his idealism growing up in the 1960s, the time of Kennedy, when “capitalism stood for opportunity, not oppression.” Mr. Schultz seems to have missed that for most of us, it has always stood for that. No points for guessing the one and only Republican that Mr. Schultz, or any senior Starbucks executive, has given to.

Aside from that, though, budding executives looking for the overarching lessons in building a behemoth can learn a lot from this book. While the main lesson is vision, values, and people, Schultz is able to reiterate without repeating. The values come from hard experience – seeing his father getsick, and and employer who plainly couldn’t care less. And it’s certainly a lesson that some corporate executives could stand to hear.