Economics

City government waste in San Francisco

A 33% hike in Muni fares was announced today. This will hit the poorest people in the city first, and to add insult to injury, this is accompanied with cuts in service.

San Francisco has a budget of over $6B, about the same size as much larger cities as Chicago or Paris, and exceeding the budget of 20 of the US states. It also exceeds the entire GNP of countries like Mongolia or Georgia (in the Caucasus). San Franciscans get little to show for it in services.

One reason why: SF has over 8,000 city employees making over $100,000 a year (the head of Muni is one of them, making $325,000, or more than US Cabinet ministers who make $191,000). The share of the city budget spent on those high flyers is over $1B…

Real-world organizational change

The economic crisis headlines are rife with CEOs and other executives behaving in ways contrary to the interests of shareholders. Business schools teach agency theory, an economic discipline that aims to solve the problem where an agent of principals (e.g. shareholders) needs to be given wide power to perform his job, but could abuse these powers in ways inimical to the principal’s interests, specially when accountability is difficult because the agent controls the information fed back to the principals. The standard recommendation of agency theory is to align the agent’s incentives with those of the principal by setting performance-based compensation such as stock option schemes.

In the real world, of course, the reaction of an agent given a set of incentives is not to act in the way they were designed (too much work) but rather to game the system. In the case of stock options, take large amounts of risk that mostly pays off, but in unlikely cases fails catastrophically, the opposite of insurance, in fact. In the most likely case, they deliver apparently excellent results, and pocket handsome bonuses. When the bets turn spectacularly bad, the shareholders foot the bill. The failure of agency theory is just another example of how intellectually bankrupt and disconnected from reality most B-School curricula are.

This is not a new problem. Historical rulers from Cyrus the Great to Alexander to Peter the Great to Stalin had to control power-hungry and untrustworthy satraps or barons. The way they solved the problem was invariably to set up a network of spies and run two parallel and competing chains of command constantly at each other’s throats, to keep each other honest. To a certain extent, the more arbitrary and capricious the ruler’s favor seems to be, the more effective it is at keeping the underlings in line.

Investors would be well advised to study the tried and proven methods of the great tyrants. The way to control untrustworthy agents is fear and setting up parallel information-gathering networks unbeholden to the agent, not by lavishing rewards that only motivate even worse behavior. Instead of relying on corporate governance consultancies like ISS, they should hire private eyes like Pinkerton to infiltrate their companies.

The Tropicana redesign: marketing genius?

One of the great things about living in the United States is the ubiquity and affordability of high-quality orange juice. A few weeks ago, while going through the aisles at Target to buy a carton of Tropicana, I couldn’t find any. It looked like Target had replaced them with cheap generic knock-offs. On closer inspection, it turned out Pepsi redesigned the packaging. To say the new design is ugly is an understatement. Many comments on the redesign compare it to generics in its amateurism.

Pepsi’s marketers are not legends in the field like those of Procter & Gamble, but still, I find it hard to believe no one there perceived how bad the new cartons look, and how off-putting they are. This led me to think if this wasn’t intentional.

In this economy, sales of Spam are exploding even though the ersatz canned meat is actually more expensive than more nutritive fresh meat and a much worse value. One explanation is that spam is what economists call an inferior good, a good for which demand increases as incomes decrease because people can’t afford the better stuff. One extreme type of an inferior good is a Giffen good, a product for which demand increases even as its price increases. Economists still debate whether Giffen goods even exist. One often-quoted (and just as often disputed) example are potatoes during the Great Irish famine of 1847. As the price of potatoes rose, the poor were locked in a vicious circle of not being to afford anything else and being more dependent on potatoes, which only accelerated the price explosion.

Perhaps the Tropicana marketers have figured that in a severely down economy, people are settling for inferior goods, and making Tropicana look downmarket may increase its sales…

Update (2009-02-23):

So much for my theory. Although you could make the case this is more like the New Coke fiasco (that many conspiracy theorists still think was deliberate).

The tail wagging the dog redux

I don’t understand why the media make such a big fuss about computer companies like Apple, Dell, Gateway or now Cisco entering the consumer electronics business. Consumer electronics is a puny industry compared to IT. Just compare the market cap and revenues of Apple, HP or Cisco to that of Sony.

Diversifying into consumer electronics is a no-brainer because entertainment’s migration to digital makes many technologies dual-purpose, but consumer electronics will remain a marginal sideline to IT companies’ business, not a replacement growth engine.

A similar instance of the media industry’s myopia (and indeed narcissism) is how they make a big fuss of telecom and cable companies entering the market for music – the entire content industry’s revenues, music movies et al, does not amount to more than a couple weeks’ revenues for telcos.