Tag Archives: Firms

Decision Theory Remains Neglected

By Robin Hanson · February 1, 2020 7:40 pm · Comments (3)

Back in ’84, when I first started to work at Lockheed Missiles & Space Company, I recall a manager complaining that their US government customer would not accept using decision theory to estimate the optimal thickness of missile walls; they insisted instead on using a crude heuristic expressed in terms of standard deviations of noise. Complex decision theory methods were okay to use for more detailed choices, but not for the biggest ones.

In his excellent 2010 book How to Measure Anything, Douglas W. Hubbard reports that this pattern is common:

Many organizations employ fairly sophisticated risk analysis methods on particular problems; … But those very same organizations do not routinely apply those same sophisticated risk analysis methods to much bigger decisions with more uncertainty and more potential for loss. …

If an organization uses quantitative risk analysis at all, it is usually for routine operational decisions. The largest, most risky decisions get the least amount of proper risk analysis. … Almost all of the most sophisticated risk analysis is applied to less risky operational decisions while the riskiest decisions—mergers, IT portfolios, big research and development initiatives, and the like—receive virtually none.

In fact, while standard decision theory has long been extremely well understood and accepted by academics, most orgs find a wide array of excuses to avoid using it to make key decisions:

For many decision makers, it is simply a habit to default to labeling something as intangible [=unmeasurable] … committees were categorically rejecting any investment where the benefits were “soft.” … In some cases decision makers effectively treat this alleged intangible as a “must have” … I have known managers who simply presume the superiority of their intuition over any quantitative model …

What they seem to take away from these experiences is that to use the methods from statistics one needs a lot of data, that the precise equations don’t deal with messy real-world decisions where we don’t have all of the data, or that one needs a PhD in statistics to use any statistics at all. … I have at times heard that “more advanced” measurements like controlled experiments should be avoided because upper management won’t understand them. … they opt not to engage in a smaller study—even though the costs might be very reasonable—because such a study would have more error than a larger one. …

Measurements can even be perceived as “dehumanizing” an issue. There is often a sense of righteous indignation when someone attempts to measure touchy topics, such as the value of an endangered species or even a human life. … has spent much time refuting objections he encounters—like the alleged “ethical” concerns of “treating a patient like a number” or that statistics aren’t “holistic” enough or the belief that their years of experience are preferable to simple statistical abstractions. … I’ve heard the same objections—sometimes word-for-word—from some managers and policy makers. …

There is a tendency among professionals in every field to perceive their field as unique in terms of the burden of uncertainty. The conversation generally goes something like this: “Unlike other industries, in our industry every problem is unique and unpredictable,” or “Problems in my field have too many factors to allow for quantification,” and so on. …

Resistance to valuing a human life may be part of a fear of numbers in general. Perhaps for these people, a show of righteous indignation is part of a defense mechanism. Perhaps they feel their “innumeracy” doesn’t matter as much if quantification itself is unimportant, or even offensive, especially on issues like these.

Apparently most for-profit firms could make substantially more profits if only they’d use simple decision theory to analyze key decisions. Execs’ usual excuse is that key parameters are unmeasurable, but Hubbard argues convincingly that this is just not true. He suggests that execs seek to excuse poor math abilities, but that seems implausible as an explanation to me.

I say that their motives are more political: execs and their allies gain more by using other more flexible decision making frameworks for key decisions, frameworks with more wiggle room to help them justify whatever decision happens to favor them politically. Decision theory, in contrast, threatens to more strongly recommend a particular hard-to-predict decision in each case. As execs gain when the orgs under them are more efficient, they don’t mind decision theory being used down there. But they don’t want it up at their level and above, for decisions that say if they and their allies win or lose.

I think I saw the same sort of effect when trying to get firms to consider prediction markets; those were okay for small decisions, but for big ones they preferred estimates made by more flexible methods. This overall view is, I think, also strongly supported by the excellent book Moral Mazes by Robert Jackall, which goes into great detail on the many ways that execs play political games while pretending to promote overall org efficiency.

If I ever did a book on The Elephant At The Office: Hidden Motives At Work, this would be a chapter.

Below the fold are many quotes from How to Measure Anything:

Continue reading "Decision Theory Remains Neglected" »

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Firms & Cities Have Open Borders

By Robin Hanson · November 1, 2019 5:00 pm · Comments (0)

Cities usually don’t much limit who can move there. If you can find someone in a city to give you a job, to rent you an apartment, to sell you food and other stuff, and to be your friends, etc. and if you can pay for your move, then you can move to that city from anywhere in a much larger region. Of course individual employers, landlords, and stores are mostly free to reject you, but the city doesn’t add much in the way of additional requirements. Same for other units smaller than a nation, such as counties and states.

Large firms also don’t usually much limit who can work there. Oh each particular small work group is usually particular about who works there, but the larger firm will mostly defer to local decisions about hires. Yes, if the larger firm has made commitments to trying never to fire anyone, but to always find someone another place in the firm when they are no longer wanted in any one part, then that larger firm may put more limits on who and how many folks can be hired by any one small group. But when the larger firm has few obligations to local workers, then local groups are also mostly free to hire who they want.

The obvious analogies between cities, firms and nations make it somewhat puzzling that nations are much more eager to limit who can enter them. The analogy is strongest when those who enter nations can only do so in practice if they can find local employers, landlords, suppliers, friends, etc. willing to deal with them. And when the nation assigns itself few obligations to anyone who happens to live there.

Yes, in principle there can be externalities whereby the people who enter one part of a nation effect the enjoyment and productivity of people in other parts of a nation. But those same sort of effects should also appear within parts of a city or of a firm. So why don’t cities and firms work harder to limit local choices of who can enter them?

You might claim that cities and firms don’t need to attend to limiting entry because nations already do it for them. But most nations already have a lot of internal variation; why is none of that variation of interest to cities and firms, yet the variation between nations would supposedly be of huge interest, if nations were not handling that? And firms and cities within the nations that hold all those bad people that you think good nations are focused on excluding don’t have firm- or city-wide exclusion policies either.

Furthermore, many multinational firms today already have employees who are spread across a great many nations, nations that vary a lot in wealth, development, etc. Yet such multinationals usually don’t have much in the way of centralized limits on who can be hired by their divisions in different firms, nor on who can be transferred between such divisions. These firms may face limits imposed by nations, but they seem to mostly lament such limits, and aren’t eager to add more.

Firms and cities live in more competitive environments than do nations. So we should expect their behavior to be shaped more by competitive pressures. Thus we can conclude that competitive entities tend not to create entity-wide limits on who can enter them; they are mostly content to let smaller parts of them made those decisions.

So if nations act differently from firms and cities, that should be because either:
1) there are big important effects that are quite different at the national level, than at firm and city levels, or
2) nations are failing to adopt policies that competition would induce, if they faced more competition.

My bet is on the latter. In that case, the key question is: is there a market failure that makes the entry policies that competition pushes lamentable? If not, we should lament that competition isn’t inducing more free entry into nations. That is, we should lament that competition isn’t inducing national open borders, like we mostly have for cities and firms.

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Marching Markups

By Robin Hanson · August 24, 2017 1:30 pm · Comments (34)

This new paper by De Locker and Eeckhout will likely be classic:

We document the evolution of markups based on firm-level data for the US economy since 1950. Initially, markups are stable, even slightly decreasing. In 1980, average markups start to rise from 18% above marginal cost to 67% now. .. Increase in average market power .. can account for .. slowdown in aggregate output. .. The rise in market power is consistent with seven secular trends in the last three decades.

Yes, US public firms have only 1/3 of US jobs, and an even smaller fraction of the world’s. Even so, this is a remarkably broad result. I’d feel a bit better if I understood why their firm-level simple aggregation of total sales divided by total variable costs (their Figure B.5a) gives only a 26% markup today, but I’ll give them the benefit of the doubt for now. (And that figure was 12% in 1980, so it has also risen a lot.) Though see Tyler’s critique.

The authors are correct that this can easily account for the apparent US productivity slowdown. Holding real productivity constant, if firms move up their demand curves to sell less at a higher prices, then total output, and measured GDP, get smaller. Their numerical estimates suggest that, correcting for this effect, there has been no decline in US productivity growth since 1965. That’s a pretty big deal.

Accepting the main result that markups have been marching upward, the obvious question to ask is: why? But first, let’s review some clues from the paper. First, while industries with smaller firms tend to have higher markups, within each small industry, bigger firms have larger markups, and firms with higher markups pay higher dividends.

There has been little change in output elasticity, i.e., the rate at which variable costs change with the quantity of units produced. (So this isn’t about new scale economies.) There has also been little change in the bottom half of the distribution of markups; the big change has been a big stretching in the upper half. Markups have increased more in larger industries, and the main change has been within industries, rather than a changing mix of industries in the economy. The fractions of income going to labor and to tangible capital have fallen, and firms respond less than they once did to wage changes. Firm accounting profits as a fraction of total income have risen four fold since 1980.

These results seem roughly consistent with a rise in superstar firms:

If .. changes advantage the most productive firms in each industry, product market concentration will rise as industries become increasingly dominated by superstar firms with high profits and a low share of labor in firm value-added and sales. .. aggregate labor share will tend to fall. .. industry sales will increasingly concentrate in a small number of firms.

Okay, now lets get back to explaining these marching markups. In theory, there might have been a change in the strategic situation. Perhaps price collusion got easier, or the game became less like price competition and more like quantity competition. But info tech should have both made it easier for law enforcement to monitor collusion, and also made the game more like price competition. Also, anti-trust just can’t have much effect on these small-firm industries. So I’m quite skeptical that strategy changes account for the main effect here. The authors see little overall change in output elasticity, and so I’m also pretty skeptical that there’s been any big overall change in the typical shape of demand or cost curves.

If, like me, you buy the standard “free entry” argument for zero expected economic profits of early entrants, then the only remaining possible explanation is an increase in fixed costs relative to variable costs. Now as the paper notes, the fall in tangible capital spending and the rise in accounting profits suggests that this isn’t so much about short-term tangible fixed costs, like the cost to buy machines. But that still leaves a lot of other possible fixed costs, including real estate, innovation, advertising, firm culture, brand loyalty and prestige, regulatory compliance, and context specific training. These all require long term investments, and most of them aren’t tracked well by standard accounting systems.

I can’t tell well which of these fixed costs have risen more, though hopefully folks will collect enough data on these to see which ones correlate strongest with the industries and firms where markups have most risen. But I will invoke a simple hypothesis that I’ve discussed many times, which predicts a general rise of fixed costs: increasing wealth leading to stronger tastes for product variety. Simple models of product differentiation say that as customers care more about getting products nearer to their ideal point, more products are created and fixed costs become a larger fraction of total costs.

Note that increasing product variety is consistent with increasing concentration in a smaller number of firms, if each firm offers many more products and services than before.

Added 25Aug: Karl Smith offers a similar, if more specific, explanation.

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Variety Is Shallow

By Robin Hanson · November 21, 2015 11:45 am · Comments (29)

I haven’t read that much in the field of marketing, but what I have read so far has tended to confirm what I’ve read and taught in economics industrial organization: firms try hard to make products have distinctive feature packages in order to gain market power over customers whose ideal product is closer to that package. Even if some of those features are symbolic and created via how ads make people see products.

Reading the book How Brands Grow: What Marketers Don’t Know, by Byron Sharp, leads me to doubt this usual story. Sharp presents a lot of data (some shown in these figures for the Audible version) in support of these points (from this summary):

1. Penetration is key .. all brands have similar levels of loyalty.
2. Light users are as or even more important as heavy ones
3. Leading brands are distinctive, not different
4. Create memory structure to build “mental availability”
5. The power of “physical availability”
6. People don’t want a love affair with most brands

Most price promotions, and ads that don’t reinforce easy-to-recall product cues, are wasted money. We can model the distribution of purchase choices pretty well via these assumptions:

A. People vary a lot in how often they buy from any given product category; most buys are from very infrequent buyers, who mostly buy from other brands.
B. People have a some “loyalty” in having a better than random (but far from certain) chance to buy the same brand choice as last time.
C. If they don’t pick the same brand as last time, buyers pick a brand at random in proportion to product popularity.

Product categories are surprisingly large. For example, to a first approximation all fast food competes nearly equally with all other fast food. It isn’t that pizza places compete mainly pizza places while burger places compete mainly with other burger places. There are some exceptions, such a rich people tending more to buy expensive brands, or people with kids tending to buy books for kids, but these are rare and weak. Mostly there is no “space” of product features; there is just a set of distinct but equally different options, some more popular than others.

Over the last century consumers have moved to choosing a LOT more product variety, which ends up being expensive because of all the fixed costs to support all those different products. We like to tell ourselves that we do this because the new products we pick are closer to the ideal points of our complex authentic identity. Marketers like to tell the same thing to us, and to the firms who buy marketing services. But in fact we just want the appearance of having specific feature packages we like that fit who we are; we mostly don’t actually have coherent identities, but instead just wander around in the space of available products.

This greatly strengthens the welfare case for reducing product variety, in order to reduce unit costs. It seems we are mostly trying to gain a zero-sum status via showing off our wealth and not-actually-there distinct identity.

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Testing An Idealistic-Tech Hypothesis

By Robin Hanson · November 14, 2013 5:15 pm · Comments (10)

Katja:

Relatively minor technological change can move the balance of power between values that already fight within each human. [For example,] Beeminder empowers a person’s explicit, considered values over their visceral urges. … In the spontaneous urges vs. explicit values conflict …, I think technology should generally tend to push in one direction. … I’d weakly guess that explicit values will win the war. (more)

The goals we humans tend to explicitly and consciously endorse tend to be more idealistic than the goals that our unconscious actions try to achieve. So one might expect or hope that tech that empowers conscious mind parts, relative to other parts, would result in more idealistic behavior.

A relevant test of this idea may be found in the behavior of human orgs, such as firms or nations. Like humans, orgs emphasize more idealistic goals in their more explicit communications. So if we can identify the parts of orgs that are most like the conscious parts of human minds, and if we can imagine ways to increase the resources or capacities of those org parts, then we can ask if increasing such capacities would move orgs to more idealistic behavior.

A standard story is that human consciousness functions primarily to manage the image we present to the world. Conscious minds are aware of the actions we may need to explain to others, and are good at spinning good-looking explanations for our own behavior, and bad-looking explanations for the behavior of rivals.

Marketing, public relation, legal, and diplomatic departments seem to be analogous parts of orgs. They attend more to how the org is seen by others, and to managing org actions that are especially influential to such appearances. If so, our test question becomes: if the relative resources and capacities of these org parts were increased, would such orgs act more idealistically? For example, would a nation live up to its self-proclaimed ideals more if the budget of its diplomatic corps were doubled?

I’d guess that such changes would tend to make org actions more consistent, but not more idealistic. That is, the mean level of idealism would stay about the same, but inconsistencies would be reduced and deviations of unusually idealistic or non-idealistic actions would move toward the mean. Similarly, I suspect humans with more empowered conscious minds do not on average act more idealistically.

But that is just my guess. Does anyone know better how the behavior of real orgs would change under this hypothetical?

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Expect Bigger Orgs

By Robin Hanson · September 2, 2013 11:40 am · Comments (24)

Me last year:

Over the last year I’ve reviewed several ~1900 era future dystopias, such as Metropolis, We, and Pictures of the Socialistic Future. I wanted to see fears of the industrial revolution, from an era when that revolution was still young. … The strongest concerns were about the new scales of social organization, arguably the central distinguishing feature of the industrial era. … People imagined entire cities and nations being organized as were factories and firms, with commands sent down from above, and little room for local discretion. … Today, it seems that such fears were overblown. … But it is also too soon to claim that these fears will not be realized. The scale of cities, firms, and nations continues to climb. (more)

Industry has made humans rich. And we have spent this wealth improving our lives in many ways. Which is why most long run industry-era trends are positive. But we aren’t very willing to give up the golden goose that lays our golden eggs: the industry processes itself. Which is why some trends are negative. For example, dense living is fairly central to industry, so density has increased, even though it seems to hurt our health, and many would prefer more space. Even more central to the industry process is big organizations. So firm sizes continue to get larger, even though most folks say they don’t like big firms.

Yes booster futurists often claim big firms are passé and the future is all startups and lean nimble firms. Don’t believe them. The rate of new firms has been declining with wealth and time, and firms continue to get bigger. (Data quotes below.)

I instead predict that future work life will look more like the work life at bigger firms today. So there will be less overall coordination and coherence, even as more effort is put into coordination via more meetings by more managers in more layers of management. Firms will have offices in more locations, with less in-person and direct communication. Workers will have more specific operational roles, and each do a narrower range of tasks. Firms will have stronger corporate cultures that depend less on distinctive individual personalities, and more on well-defined structures, like policy manuals and job descriptions.

Governments won’t save us from this: increasing regulation tends to favor larger firms, and government organizations are getting larger. Also, government functions are drifting up to be handled by larger scales of government. That is, functions once done by cities were next done by states, and finally by nations. I have seen the future, and it has many middle managers in long meetings discussing policy manuals. Count on it. Happy labor day.

Those promised data quotes:

FirmSizeUp

First, the entrepreneurship rate falls with per capita income across countries. Second, average firm size increases with per capita income. … Third, the standard deviation of fim size increases with per capita income across countries. Fourth, the skewness of the firm size distribution also increases with per capita income across countries. … Average firm size increased with per capita income over U.S. history (1900-70). Figure 2.2 shows that this time-series relationship persists. … Firm size dispersion is substantially higher in industrialized countries compared to emerging markets. (more)

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Cooperate Or Specialize?

By Robin Hanson · May 12, 2013 10:45 am · Comments (19)

Futurists sometimes get excited about new ways to encourage cooperation in Prisoner’s Dilmena like games. For example, future folks might interact via quantum games, future AIs might show each other their source code, or future clans of em copies might super-cooperate with one another. Folks who know just enough economics to be dangerous sometimes say that this “changes everything”, i.e., that future economies will be completely different as a result. In fact, however, not only do we already have lots decent ways to encourage cooperation, such as talking and reputation, we also consistently forgo such ways to better encourage flexibility and specialization.

As I reviewed in my last post, we have strong reasons and abilities to cooperate within family clans, especially when such clans heavily intermarry and live and work closely together over many generations. And our farming era ancestors took big advantage of this. To function and thrive, however, our industry era economy had to suppress such clans, to allow more flexibility and specialization. Industry needs people to frequently change where they live, what kinds of jobs they do, and who they work with, and to play fair within industry-era reimagined firms, cities, and nations. Strong family clans instead encouraged stability and nepotism, and discouraged people from moving to cities and new jobs, and from cooperating fairly with and showing sufficient loyalty to other families within shared firms, cities, and nations.

Our industry era institutions consistently forgo the extra cooperation advantages of strong family clans, to gain more flexibility and specialization. This is now a huge net win. Our descendants are likely to similarly forgo advantages from new ways to cooperate, if those similarly reduce future flexibility and specialization. For example, future societies of brain emulations are likely to be wary of strongly self-cooperating clans of copies of the same original human. While such copy clans have even stronger reasons to cooperate with each other than family clans, copy clans might cause future organizations to suffer even more than do family-based firms, cities, and nations today from clan-based nepotism, and from low quality and inflexible matches of skills to jobs. Ems firms and cities are thus likely to be especially watchful for clan nepotism, and to avoid relying too heavily on any one clan.

Yes game theory captures important truths about human behavior, including about costs we pay from failing to fully cooperate. But prisoner’s dilemma style failures to cooperate in simple games comprises only a tiny fraction of all the important things that can and do go wrong in a modern economy. And we already have many decent ways to encourage cooperation. I thus conclude that future economies are unlikely to be heavily redesigned to take advantage of new possible ways to encourage prisoner’s dilemma style cooperation.

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Brands Show Identity

By Robin Hanson · November 9, 2012 8:15 am · Comments (21)

Marketers have long noticed puzzlingly high levels of brand loyalty:

Consumers appear to have high willingness to pay for particular brands, even when the alternatives are objectively similar. The majority of consumers typically buy a single brand of beer, cola, or margarine, even though relative prices vary significantly over time, and consumers often cannot distinguish their preferred brand in blind “taste tests”. Consumers pay large premia to buy homogeneous goods like books and CDs from branded online retailers, even when they are using a “shopbot” that eliminates search costs. A large fraction of consumers buy branded medications, even though chemically equivalent generic substitutes are available at the same stores for much lower prices.

Brand loyalty is big barrier to innovation, and an important reason why inefficient firms manage to survive so long.

Brand preferences create large entry barriers and durable advantages for incumbent firms, and can explain persistence of early-mover advantage over long periods

In the latest American Economic Review Bronnenberg, Dube, & Gentzkow offer new clues:

Variation in where consumers have lived in the past allows us to isolate the causal effect of past experiences on current purchases, holding constant contemporaneous supply-side factors such as availability, prices, and advertising. … 60 percent of the gap in purchases between the origin and destination state closes immediately when a consumer moves. … The remaining 40 percent gap between recent migrants and lifetime residents closes steadily, but slowly. It takes more than 20 years for half of the gap to close, and even 50 years after moving the gap remains statistically significant. … The relative importance of brand capital is higher in [product] categories with high levels of advertising and high levels of social visibility. (more)

This ad effect is puzzling because:

Large literatures have measured the effects of advertising, but these studies often find no effects [of ads on sales], and the effects they do measure are estimated to dissipate over a horizon ranging from a few weeks to at most five or six months.

Let me suggest that an important use of brands is to create and signal identities. We create a coherent understandable idea of the kind of person we are, integrated with the kind of products we use, and we prefer not to change that concept, so that others can continue to rely on their expectations about us. We are willing to pay higher prices, and neglect info about quality, in order to keep a persistent style and appearance. So brands are naturally more important for products we use that others see more, and where ads have made connections to identity more salient.

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Are Firms Like Trees?

By Robin Hanson · February 20, 2012 8:35 pm · Comments (26)

Trees are spectacularly successful, and have been for millions of years. They now cover ~30% of Earth’s land. So trees should be pretty well designed to do what they do. Yet the basic design of trees seems odd in many ways. Might this tell us something interesting about design?

A tree’s basic design problem is how to cheaply hold leaves as high as possible to see the sun, and not be blocked by other trees’ leaves. This leaf support system must be robust to the buffeting of winds and animals. Materials should resist being frozen, burned, and eaten by animals and disease. Oh, and the whole thing must keep functioning as it grows from a tiny seed.

Here are three odd features of tree design:

  1. Irregular-Shaped – Humans often design structures to lift large surface areas up high, and even to have them face the sun. But human designs are usually far more regular than trees. Our buildings and solar cell arrays tend to be regular, and usually rectangular. Trees, in contract, are higgledy-piggledy (see pict above). The regularity of most animal bodies shows that trees could have been regular, with each part in its intended place. Why aren’t tree bodies regular?
  2. Self-Blocking – Human-designed solar cells, and sets of windows that serve a similar function, manage to avoid overly blocking each other. Cell/window elements tend to be arranged along a common surface. In trees, in contrast, leaves often block each other from the sun. Yet animal design again shows that evolution could have put leaves along a regular surface – consider the design of skin or wings. Why aren’t tree leaves on a common surface?
  3. Single-Support – Human structures for lifting things high usually have at least three points of support on the ground. (As do most land animals.) This helps them deal with random weight imbalances and sideways forces like winds. Yet each tree usually only connects to the ground via a single trunk. It didn’t have to be this way. Some fig trees set down more roots when older branches sag down to the ground. And just as people trying to stand on a shifting platform might hold each other’s hands for balance, trees could be designed to have some branches interlock with branches from neighboring trees for support. Why is tree support singular?

Now it is noteworthy that large cities also tend to have weaker forms of these features. Cities are less regular than buildings, buildings often block sunlight to neighboring buildings, and while each building has at least three supports, neighboring buildings rarely attach to each other for balance. What distinguishes cities and trees from buildings?

One key difference is that buildings are made all at once on land that is calm and clear, while cities and trees grow slowly in a changing environment, while competing for resources. Since most small trees never live to be big trees, their choices must focus on current survival and local growth. A tree opportunistically adds its growth in whatever direction seems most open to sun at the moment, with less of a long term growth plan. Since this local growth end up committing the future shape of the tree, local opportunism tends toward an irregular structure.

I’m less clear on explanations for self-blocking and single-support. Sending branches sideways to create new supports might seem to distract from rising higher, but if multiple supports allow a higher peak it isn’t clear why this isn’t worth waiting for. Neighboring tree connections might try to grab more support than they offer, or pull one down when they die. But it isn’t clear why tree connections couldn’t be weak and breakable to deal with such issues, or why trees couldn’t connect preferentially with kin.

Firms also must grow from small seeds, and most small firms never make it to be big firms. Perhaps an analogy with trees could help us understand why successful firms seem irregular and varied in structure, why they are often work at cross-purposes internally, and why merging them with weakly related firms is usually a bad idea.

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