Tag: Gresham’s Law

Charlie Munger: Bad Morals Drive Out The Good

Reading Time: 2 minutes

Charlie Munger on applying Gresham’s Law.

The idiotic ideas are all from the social science department and I would put economics in the social sciences department although it has some tinges of reality that remind you of arts and science.

In economics textbooks they teach you Gresham’s Law: Bad money drives out good. But we don’t have any bad money that amounts to anything. We don’t have any coins that are worth a lot, that have precious metals that you can melt down. Nobody cares what the melt-down value of the quarter is in relationship to the dime, so Gresham’s Law is a non-starter in the modern world. Bad money drives out good. But the new form of Gresham’s Law is ungodly important. The new form of Gresham’s Law is brought into play – in economic thought, anyway – in the savings and loans crisis, when it was perfectly obvious that bad lending drives out good. Think of how powerful that model is. Think of the disaster that it creates for everybody. You sit there in your little institution. All of the builders [are not good credits anymore], and you are in the business of lending money to builders. Unless you do the same idiotic thing [as] Joe Blow is doing down the street. Pete Johnson up the street wants to do something a little dumber and the thing just goes to a mighty tide. You’ve got to shrink the business that you love and maybe lay off the employees who have trusted you their careers and so forth or [make] a lot of dumb loans. At Berkshire Hathaway we try and let the place shrink. We never fire anybody, we tell them to go out and play golf. We sure as hell don’t want to make any dumb loans. But that is very hard to do if you sit in a leadership position in society with people you helped recruit, you meet their wives and children and so forth. The bad loans drive out the good.

It isn’t just bad loans. Bad morals drive out the good. If you want to run a check-cashing agency in [a] downtown big city, more than 100 percent of all the profit you could possibly earn can only be earned by flim-flamming people on the finance contracts. So if you aren’t willing to cheat people – basically minorities – more than 100 percent of the profit can’t be earned. Well, if you inherited the business or your idiot son-in-law is in it, you don’t know what else to do. This is what I would call an adult problem and most people solve it in the adult fashion: They learn to tolerate the cheating. But that is not the right answer to people who want to live a larger and better life. But it is a form of Greshem’s Law, the new Gresham’s Law. One that is not taught in economics courses and should be. It is a really serious problem and, of course, it relates deeply to what happened to create the economic crisis. All kinds of people who you would be glad to have marry into your family compared to what you are otherwise going to get did things that were very regrettable under these pressures from the new Gresham’s Law.

Tagged: , , ,

Trust Me, I’m Lying: Why Sites Like Gawker Manipulate You

Reading Time: 9 minutes

“A newspaper is a business out to make money through advertising revenue.
That is predicated on its circulation and you know what the circulation depends on. …”
 — The Long Goodbye, Raymond Chandler

***

Ryan Holiday’s book Trust Me, I’m Lying: Confessions of a Media Manipulator, offers a penetrating look at the incentives of media.

Holiday, himself, is a practitioner of the dark arts of media manipulation and uses these techniques to make a living.

“Usually, it is a simple hustle,” Holiday writes. “Someone pays me, I manufacture a story for them, and we trade it up the chain — from a tiny blog to Gawker to a website of a local news network to the Huffington Post to the major newspapers to cable news and back again, until the unreal becomes real. Sometimes I start by planting a story. Sometimes I put out a press release or ask a friend to break a story on their blog. Sometimes I ‘leak’ a document. Sometimes I fabricate a document and leak that. Really, it can be anything, from vandalizing a Wikipedia page to producing an expensive viral video. However the play starts, the end is the same: The economics of the Internet are exploited to change public perception — and sell product.”

For me, the most interesting part of the book was the history of the press, which begins with the Party Press, moves on to the Yellow Press and ends with the Modern Press (aka Subscription Press). Holiday gives us this history lesson to explain how news outlets sold their product over the years.

The Party Press

The earliest forms of newspapers were a function of political parties. These were media outlets for party leaders to speak to party members, to give them the information they needed and wanted. … These papers were not some early version of Fox News. They usually were one-man shops. The editor-publisher-writer-printer was the dedicated steward of a very valuable service to that party in his town. The service was the ability to communicate ideas and information about important issues. …

This first stage of journalism was limited in its scope and impact. Because of the size and nature of its audience, the party press was not in the news business. They were in the editorial business. It was a different time and style, one that would be eclipsed by changes in technology and distribution.

The Yellow Press
Newspapers changed the moment that Benjamin Day launched the New York Sun in 1833. It was not so much his paper that changed everything but his way of selling it: on the street, one copy at a time. He hired the unemployed to hawk his papers and immediately solved a major problem that had plagued the party presses: unpaid subscriptions. Day’s “cash and carry” method offered no credit. You bought and walked. The Sun, with this simple innovation in distribution, invented the news and the newspaper. A thousand imitators followed.

These papers weren’t delivered to your doorstep. They had to be exciting and loud enough to fight for their sales on street corners, in barrooms, and at train stations. Because of the change in distribution methods and the increased speed of the printing press, newspapers truly became newspapers. Their sole aim was to get new information, get it to print faster, get it more exclusively than their competition. It meant the decline of the editorial. These papers relied on gossip. …

… He (James Gordon Bennett) knew that the newspaper’s role was “not to instruct but to startle.” His paper was anti-black, anti-immigrant, and anti-subtlety. These causes sold papers—to both people who loved them for it and people who hated them for it. And they bought and they bought.

… The need to sell every issue anew each day creates a challenge I call the “One-Off Problem.” Bennett’s papers solved it by getting attention however they could.

The first issue of Bennett’s Herald looked like this: First page—eye-catching but quickly digestible miscellany; Second page—the heart of the paper, editorial and news; Third page—local; Fourth page—advertising and filler. There was something for everyone. It was short, zesty. He later tried to emphasize quality editorial instead of disposable news by swapping the first two pages. The results were disastrous. He couldn’t sell papers on the street that way.

The One-Off Problem shaped more than just the design and layout of the newspaper. When news is sold on a one-off basis, publishers can’t sit back and let the news come to them. There isn’t enough of it, and what comes naturally isn’t exciting enough. So they must create the news that will sell their papers. When reporters were sent out to cover spectacles and events, they knew that their job was to cover the news when it was there and to make it up when it was not.

Speaking of the markers of “yellow journalism” (the One-Off problem), author of Yellow Journalism and media historian W.J. Campbell wrote:

As practiced more than 100 years ago, yellow journalism was a robust, enterprising genre characterized by these practices and features:

  • the frequent use of multicolumn headlines that sometimes stretched across the front page.
  • a variety of topics reported on the front page, including news of politics, war, international diplomacy, sports, and society.
  • the generous and imaginative use of illustrations, including photographs and other graphic representations such as locator maps.
  • bold and experimental layouts, including those in which one report and illustration would dominate the front page. Such layouts sometimes were enhanced by the use of color.
  • a tendency to rely on anonymous sources, particularly in dispatches of leading correspondents.
  • a penchant for self-promotion, to call attention eagerly to the paper’s accomplishments. This tendency was notably evident in crusades against monopolies and municipal corruption.

As defined above and as practiced more than a century ago, yellow journalism could not be called predictable, boring, or uninspired — complaints of the sort that are not infrequently raised about U.S. newspapers in the early twenty-first century.

Does any of that sound familiar? It should. Just take a look at Gawker and The Huffington Post. It’s the modern version of the One-Off problem. Instead of trying to sell you a copy of the newspaper by shouting on the street corner, today’s media want page views. In yellow journalism, headlines and promotions were more important than content.

So what happened after the yellow press? Holiday continues:

The Modern Stable Press

… Adolph S. Ochs, publisher of the New York Times, ushered in the next iteration of news. Ochs, like most great businessmen, understood that doing things differently was the way to great wealth. In the case of his newly acquired newspaper and the dirty, broken world of yellow journalism, he made the pronouncement that “decency meant dollars.”

He immediately set out to change the conditions that allowed the Bennett, Hearst, Pulitzer, and their imitators to flourish. He was the first publisher to solicit subscriptions via telephone. He offered contests to his salesman. He gave them quotas and goals for the number of subscribers they were expected to bring in.

He understood that people bought the yellow papers because they were cheap—and they didn’t have any other options. He felt that if they had a choice, they’d pick something better. He intended to be that option. First, he would match his competitors’ prices, and then he would deliver a paper that far surpassed the value implied by the low price.

It worked. When he dropped the price of the Times to one cent, circulation tripled in the first year. He would compete on content. He came up with the phrase “All the News That’s Fit to Print” as a mission statement for the editorial staff, two months after taking over the paper. The less known runner-up says almost as much: “All the World’s News, But Not a School for Scandal.”

Of course, the transition to the modern press wasn’t immediate. The subscription model, however, better aligned the incentives of the reader and newspaperman. Subscriptions change everything because readers who are misled unsubscribe. Content, not headlines, ruled the day.

“With Ochs’s move,” Holiday writes, “reputation began to matter more than notoriety. This was the era of the professionalization of journalism. “For the first time, it created a sense of obligation, not just to the paper and circulation, but also to the audience.”

While subscription journalism meant you didn’t have to peddle papers on the street, that didn’t make it a perfect system.

As the character Philip Marlowe observed in Raymond Chandler’s novel The Long Goodbye:

Newspapers are owned and published by rich men. Rich men all belong to the same club. Sure, there’s competition—hard tough competition for circulation, for newsbeats, for exclusive stories. Just so long as it doesn’t damage the prestige and privilege and position of the owners.

We’ve had a good run. For a long time journalism was primarily sold via subscriptions (the stable press model) but now we’re moving quickly towards online à la Carte offerings. Journalism is no longer selling a package. Now each story is like a mini paper on the side of the street corner in the 1840’s trying to be heard over all of the other stories.

Eli Pariser wrote in The Filter Bubble:

Our bodies are programmed to consume fat and sugars because they’re rare in nature. Thus, when they come around, we should grab them. In the same way, we’re biologically programmed to be attentive to things that stimulate: content that is gross, violent, or sexual and that gossip which is humiliating, embarrassing, or offensive. If we’re not careful, we’re going to develop the psychological equivalent of obesity. We’ll find ourselves consuming content that is least beneficial for ourselves or society as a whole.

… Each article ascends the most-forwarded lists or dies an ignominious death on its own…. The attention economy is ripping the binding, and the pages that get read are the pages that are frequently the most topical, scandalous, and viral.

Think about how you consume media today. You don’t read one newspaper or blog. You read an assortment of many newspapers and blogs. And you don’t pay for any of it. The trust relationship is fractured. Competition centers around who can create the most read story. That means journalism becomes about what spreads – not what’s good.

MIT Media Studies Professor Henry Jenkins gives publishers and companies the following advice: “if it doesn’t spread, it’s dead.” Spreading is traffic. Traffic is money.

So what spreads?

Joseph Campbell and Katherine Milkman, of the Wharton School looked into over 7,000 articles that made it on to the New York Times Most Emailed List. They conclude:

Virality is partially driven by physiological arousal. Content that evokes high-arousal positive (awe) or negative (anger or anxiety) emotions is more viral. Content that evokes low-arousal, or deactivating, emotions (e.g., sadness) is less viral.

Basically, virality is determined by how much anger the article causes. Not all extreme emotions spread. Sadness doesn’t spread. Anger spreads. If anger spreads and financial incentives are somehow aligned to ‘page views’ more of our journalism will move towards what spreads.

Something analogous to Gresham’s Law can be found in the One-Off problem. If each story has to find its own audience (i.e., it’s no longer sold as a bundle) and compensation is derived from page views, we can expect incentives to favor a lot of low-cost articles with catchy headlines. In the end, we’re likely to get the stories we want to read — not the ones we should read. If not part of subscription, we’ll likely lose the in-depth reporting we’ve come to expect from some of the old media guards.

(side-note: I found the first part of Holiday’s book — where he explains how page view media works and how he manipulated the system — pretty good. The book is not without it’s “controversy” though. Overall it’s a great read for anyone interested in the economics of new media.)

(update: a previous version of this post (ironically) sourced a site that accused Holiday of mis-quoting a study. Holiday contacted me and it appears that he used an older version of the study, which did, in fact, contain the quote he referenced in his book. The other site was wrong and my verification process was lax. My bad.)

***

“If you’re not paying for something,
you’re not the customer; you’re the product being sold.”
— Andrew Lewis

Still curious? If you want to know more about how the media is manipulated, read Trust Me, I’m Lying: Confessions of a Media Manipulator.

Tagged: , , , , , , ,

Former Canadian Prime Minister Mackenzie King on The Law of Competing Standards

Reading Time: 2 minutes

I came across that passage while reading “Industry and Humanity,” by former Canadian Prime Minister Mackenzie King. We’ll add this to our previous knowledge on Gresham’s Law.

In the reign of Queen Elizabeth, an official named Gresham observed that where different metals were in circulation as coinage and some were better than others of the same nominal value, the coins made of the inferior metal tended to drive the better out of circulation. The better coins were either hoarded or melted down and sold as bullion, were used in the fine arts, or were absorbed in the foreign exchanges. In other words, what Gresham discovered was that cheaper money tends to drive out dearer; that when people begin to discriminate between two coinages, they will invariably pay out the inferior and hoard the better, thus removing the better from circulation. This phenomenon once generally observed came to be described as a “Law,” and was identified with Gresham’ s name, since it was Gresham who was first successful in drawing public attention to it. Amongst money-changers, Gresham’ s Law of the precious metals is better known than the Ten Commandments.

Something analogous to Gresham’s Law will be found to obtain in the case of competing standards in Industry. Assuming there is indifference in the matter of choice between competing commodities or services, but that in the case of such commodities or services the labor standards involved vary, the inferior standard, if brought in this manner into competition with a higher standard, will drive it out, or drag the higher down to its level. This is effected by the opportunity of under-selling which comes, where in such cases human well-being is sacrificed to material ends. The superior standard, not being recognized or demanded, is unable to hold its own, and in time disappears. This Law is just as real and relentless in its operation in Industry as Gresham’s Law of the precious metals is with respect to money and the mechanism of exchange. Indeed, a more accurate exposition would describe both as manifestations of one and the same law, which I propose to call the Law of Competing Standards. I see no reason why economists should not recognize the existence of such a law, and incorporate it immediately in economic science as being quite as significant as the Law of Supply and Demand, the Law of Diminishing Returns, or any other Law accorded a place in its nomenclature.

The Law of Competing Standards is doubtless a part of the general Law of Competition, under which the cheaper of two commodities gains in competition a preference over the dearer. What Gresham discovered was an important sequence of the Law of Competition as applied to coinage; namely, the disappearance, in the course of time, of the superior metals. Observance of a like sequence in the case of standards in Industry is highly desirable. As respects labor standards, I believe that recognition of the operation of the Law of Competing Standards over ever-widening areas would do more than aught else to clear up the most baffling problems with which Industry is confronted, and to point the way to a solution of many situations which hitherto have seemed incapable of solution.

Tagged: ,

The Art and Science of High-Stakes Decisions

Reading Time: 4 minutes

How can anyone make rational decisions in a world where knowledge is limited, time is pressing, and deep thought is often unattainable?

Some decisions are more difficult than others. Yet we’re often forced to make all of our decisions the way we make easy ones: on autopilot. 

One particular difficulty we have is with making decisions that help us avoid threats which are low probability, but high stakes. We are least prepared to make the decisions that matter the most.

Sure we can pick the right brand of peanut butter with ease. But life offers few opportunities to prepare for the type of decisions which could have catastrophic consequences. The kinds of decisions which could wipe us out if we mess up.

Shortly after 9/11 some well-known academics got together to discuss1how people make choices involving low and ambiguous probability of a high-stakes loss.

High-stakes decisions involve two distinctive properties:

1) existence of a possible large loss (financial or emotional) and

2) the costs to reverse decisions once made are high.

More importantly, these professors wanted to determine if prescriptive guidelines for improving decision-making process could be created in an effort to help make better decisions.

Whether we’re buying something at the grocery store or making a decision to purchase earthquake insurance, we operate in the same way. The possibility of catastrophic outcomes does little to reduce our reliance on heuristics (rules of thumb.) These serve us well most of the time, when the cost of an error is low. However, they can often be a poor technique for high-stakes decisions.

In order to make better high-stakes decisions, we need a better understanding of why we generally make poor decisions.

Here are several causes.

Poor understanding of probability.

Several studies show that people either utilize probability information insufficiently when it is made available to them or ignore it all together. In one study, 78% of subjects failed to seek out probability information when evaluating between several risky managerial decisions.

In the context of high-stakes decisions, the probability of an event causing loss may seem sufficiently low that organizations and individuals consider them not worth worry about. In doing so, they effectively treat the probability of something as zero or close to it.

An excessive focus on short time horizons.

Many high-stakes decisions are not obvious to the decision-maker. In part, this is because people tend to focus on the immediate consequences and not the long-term consequences.

A CEO near retirement has incentives to skimp on insurance to report slightly higher profits before leaving (shareholders are unaware of the increased risk and appreciate the increased profits). Governments tend to under-invest in less visible things like infrastructure because they have short election cycles. The long-term consequences of short-term thinking can be disastrous.

The focus on short-term decision making is one of the most widely-documented failings of human decision making. People have difficulty considering the future consequences of current actions over long periods of time. Garrett Hardin, the author of Filters against Folly, suggests we look at things through three filters (literacy, numeracy, and ecolacy). In ecolacy, the key question is “and then what?” And then what helps us avoid a focus solely on the short-term.

Excessive attention to what’s available.

Decisions requiring difficult trade-offs between attributes or entailing ambiguity as to what a right answer looks like often leads people to resolve choices by focusing on the information most easily brought to mind. Sometimes things can be difficult to bring to mind.

Constant exposure to low-risk events without realization leads to us being less concerned than we probably would warrant (it makes these events less available) and “proves” our past decisions to ignore low-risk events were right.

People refuse to buy flood insurance even when it is heavily subsidized and priced far below an actuarially fair value. Kunreuther et. al. (1993) suggests underreaction to threats of flooding may arise from “the inability of individuals to conceptualize floods that have never occurred… Men on flood plains appear to be very much prisoners of their experience… Recently experienced floods appear to set an upward bound to the size of loss with which managers believe they ought to be concerned.”Paradoxically, we feel more secure even as the “risk” may have increased.

Distortions under stress.

Most high-stakes decisions will be made under perceived (or real) stress. A large number of empirical studies find that stress focuses decision-makers on a selective set of cues when evaluating options and leads to greater reliance on simplifying heuristics. When we’re stressed, we’re less likely to think things through.

Over-reliance on social norms.

Most individuals have little experience with high-stakes decisions and are highly uncertain about how to resolve them (procedural uncertainty). In such cases—and combined with stress—the natural course of action is to mimic the behavior of others or follow established social norms. This is based on the psychological desire to fail conventionally.

The tendency to prefer the status-quo.

What happens when people are presented with difficult choices and no obvious right answer? We tend to prefer making no decision at all, we choose the norm.

In high-stakes decisions many options are better than the status-quo and we must make trade-offs. Yet, when faced with decisions that involve life-and-death trade-offs, people frequently remark “I’d rather not think about it.”

Failures to learn.

Although individuals and organizations are eager to derive intelligence from experience, the inferences stemming from that eagerness are often misguided. The problems lie partly in errors in how people think, but even more so in properties of experience that confound learning from it. Experience may possibly be the best teacher, but it is not a particularly good teacher.

As an illustration, one study finds that participants in an earthquake simulation tended to over-invest in mitigation that was normatively ineffective but under-invest when it is normatively effective. The reason was a misinterpretation of feedback; when mitigation was ineffective, respondents attributed the persistence of damage to the fact that they had not invested enough. by contract, when it was effective, they attributed the absence of damage to a belief that earthquakes posted limited damage risk.

Gresham’s Law of Decision making.

Over time, bad decisions will tend to drive out good decisions in an organization.

Improving.

What can you do to improve your decision-making?

A few things:

1) learn more about judgment and decision making;

2) encourage decision makers to see events through alternative frames, such as gains versus losses and changes in the status-quo;

3) adjust the time frame of decisions—while the probability of an earthquake at your plant may be 1/100 in any given year, the probability over the 25 year life of the plant will be 1/5; and

4) read Farnam Street!

Tagged: , , , , , , , ,
Footnotes

The Inevitable Failure of Organizational Planning

Reading Time: 7 minutes

A beautiful excerpt from Herbert Simon’s Strategy and Organizational Evolution:

Anticipating the future means detecting, preferably prospectively,novel features in the environment that may affect the firm significantly in the future, and determining at what point in time attention should be focused on them and energy devoted to dealing with them. The available management time and attention is never sufficient to deal with all the contingencies that may arise; relative priorities for attention, planning and action need to be revised continually. A major function of strategic planning is to conserve scarce managerial, engineering and science attention for the things that matter. …

Large organizations are plagued by a kind of Gresham’s Law: the pressures of everyday activities and of crises drives out planning. Short-term concerns create priorities and deadlines that absorb managerial attention and energy at the expense of long-range concerns. The obvious remedy for this universal problem is to create special organizational units whose sole responsibility is to handle various facets of the strategic planning activity. With such a definition of its base function, such a unit has no excuse to be diverted.

There are two reasons why creating specialized planning units does not automatically repeal Gresham’s Law of Planning. First, if the planners are sagacious and effective, they are sure to experience increasing demands on their time for advisory services to top management and to other divisions across the organization. They will have to be very strong-minded indeed to ward off these interruptions of their mainstream activities, and not to find themselves increasingly entangled in short-run deadlines.

Second, the more tightly a planning group is sealed off from the day-to-day affairs of an organization, the more difficult it becomes for its plans to influence company operations. Participation of many organizational members in the strategic planning process is the surest way of securing the dissemination of ideas that is the basis for implementation; and isolation of the planning activity from the rest of the organization greatly complicates the process of dissemination, among other reasons because those who have not participated in the process will find it hard both to understand and to accept its product.

The problem of isolation of the planning unit arises not only in general strategic planning but in the development and introduction of new products as well. One of the advantages that Japanese manufacturing firms have exploited in their international competition is the speed with which ideas for new products or product improvements are converted into actual production lines. Observation has shown that this speed is possible because manufacturing engineers and even sales engineers participate in the design process almost from the beginning. This enables design engineers to take manufacturing constraints and convenience into account in the designs. Conversely, it involves the manufacturing staff in the product from the outset, secures their commitment to it, and enables them to begin planning the manufacturing operations while design is still going on. At the same time, of course, this procedure does shift some of the attention of design engineers to manufacturing problems and perhaps creates a danger that they will be diverted from their basic responsibility for product innovation.

As in most matters of organization, what is called for, in order to secure a proper attention to strategic planning but at the same time maintaining strong communication links between planning and operating units, is balance, and top management attention to maintaining that balance. On the whole, it is probably unwise to allow specialists to make their whole careers in planning, while others spend their carers in line responsibilities. Some rotation, even at some short-run expense to expertise, can do a great deal to disseminate the products of strategic planning, while keeping planning units in touch with the realities of the world of operations.

Institutionalizing intelligence activities
How can a firm organize so that it will scan the horizons with sufficient vigor, identifying potential problems and potential opportunities? It is no accident that the eyes and ears are located on the surface of the body and not in its interior. Intelligence requires continual contact with the relevant environments, and in the case of business firms two of the most relevant and important environments are the end-use (customer) environment and the science and technology (research and development) environment. Other parts of the firm should not be excluded from the search for information, but these are perhaps the two most important in it.

The marketing function is not simply a function of selling and distributing products to customers. It is equally a function of acquiring, through contact with the end-use environment, information about the future of the firm’s markets and of markets into which it might enter. Salesmen and sales engineers may play an important role in this intelligence activity, but only to the extent that it is an explicit part of their function, they are trained to do so and they are linked effectively in communication with top management, planning and design units. Specialized units may also provide various kinds of intelligence—products of customer polls, for example. I shall not attempt to describe in detail how one organizes intelligence about the end-use environment, but simply call attention to its importance.

Research and development organizations are commonly thought of as aimed at inventing and developing new products, but this is only a small part of the function they should perform. Just as sales organizations are windows on the world of customers, so R&D organizations are (or should be) windows on both the world of nature and the scientific and engineering communities that are engaged in examining nature. A scientist or R&D engineer is not merely an inventor but also a channel of communication between the company and the discipline in which he or she works.

Scientific disciplines operate as huge blackboards (collections of journals and books, professional meetings) on which the discoveries of all of the participants are recorded. Only a tiny fraction of the knowledge that any one scientist holds, including very new knowledge, was produced by his or her research or the research of the home laboratory. Most of it was read off the blackboard. Thus, the knowledge that a company R&D department produces should be not only the product of its own laboratory effort, but also the whole body of relevant knowledge that it obtains from the blackboards belonging to is professional domains.

Too great a preoccupation with the patentable products invented by the R&D department will obscure its broader intelligence function, and restrict its contribution to the strategic planning effort. The NIH (‘not invented here’) syndrome is endemic in R&D organizations that do not understand that their intelligence responsibilities extend far beyond their laboratory research programs.

Companies in industries where there is a rapid turnover of products (clothing and pharmaceuticals are salient examples) usually take conscious pains to organize their intelligence activities. If they did not, they would not survive long. They are prime examples of organizations where success at a particular time will be short-lived unless it is followed continually by new successes. To the extent that they can patent new products or develop brand-name loyalties, they may be able to buffer to some extent the volatility of their environments. But basically they live, not by making isolated innovations, but by organizing to produce a steady stream of innovations. Without strongly developed intelligence capabilities, they are unlikely to be successful at this.

CONCLUSIONS
Strategic planning is aimed at dealing with the enormous uncertainty and constant change that modern organizations find in the environments to which they must adapt. A market ‘niche’ is typically a transient thing. Statistics of firm growth show that special firm advantages typically have half-lives measured in a few years rather than in decades or generations. The task of strategic planning is to assure a stream of new ideas that will allow the organization to continue to adapt to its uncertain outside world.

In my remarks, I have tried to view the strategic planning function in its broader setting of the whole decision-making process in an organization. Making choices and evaluating them are simply the final stages in the decision process, and seldom the most important stages. Before choices are made, the occasions for choice must be identified, effort must be focused on problems or opportunities and possible courses of action must be designed. Classical decision theory has relatively little to say about these crucial initial stages of decision but students of strategic planning have become increasingly aware that problem identification and alternative generation are crucial components of strategy. Cognitive science and artificial intelligence have learned a great deal about these processes in recent years, and are becoming important sources of ideas for planning theory and practice.

Strategic planning will not happen by itself, or even if we simply set up organization units formally charged with doing it. The planning effort will be effective only to the extent that it permeates the entire organization and only if its products are disseminated effectively. A central idea (call it a ‘mission’ or a ‘company goal’ or ‘basic principles’), embedded in many heads where it is evoked on the occasion of decisions, is more crucial than an elaborate written list of things that are somehow supposed to happen. Organizational identification, essential to the implementation of strategic plans, is a good deal more than simple loyalty. Identification implies absorption of strategic plans into the minds of organization members where they can have direct effect upon the entire decision-making process, starting with the identification of problems, continuing with the design of alternative courses of action, and leading ultimately to effective implementation.

If you’re interested in learning more about Herbert Simon, I recommend reading Models of My Life. Also, if you liked this article you’ll like Solution by Recognition and Choice Under Uncertainty.

Tagged: ,

Gresham’s Law: Why Bad Drives Out Good As Time Passes

Reading Time: 5 minutes

Whenever coins containing precious metals have been used along with base metal coins of the same denomination, both legally accepted as tender, the bad coins have driven the good coins out of circulation.

Gresham’s Law is named after Sir Thomas Gresham (1519-1579), an English financier in the time of the Tudors.

However, the original principle had been stated at least forty years before by Nicolaus Copernicus and has been credited to Christian and Islamic scholars even before that. In some parts of the world (mostly Central and Eastern Europe), the law is still known as the Copernicus Law.

The idea may practically date back as far as the Athenian playwright Aristophanes. In his play The Frogs, Aristophanes compares the degradation of great politicians to the introduction of bad coinage.

I’ll tell you what I think about the way

This city treats her soundest men today:

By coincidence more sad than funny,

It’s very like the way we treat our money.

The noble silver drachma, which of old

We were so proud of, and the one of gold

Coins that rang so true

Throughout the world have ceased to circulate.

Instead the purses of Athenian shoppers

Are full of phoney silver-plated coppers.

Just so, when men are needed by the nation,

The best have withdrawn from circulation.

The coinage problem is mostly obsolete in the modern age, but the practical problems are as large as ever.

The outcome described by Aristophanes is common in competing human groups or organizations: When bad behavior has taken root, and that bad behavior has a “survival advantage” against good behavior, it becomes difficult, and occasionally impossible, to drive out the bad behavior; a process akin to natural selection.

In fact, one might call Gresham’s Law something of a special case of natural selection itself.

Forms of human behavior survive because they have a competitive edge against other behaviors. Self-interested groups naturally tend towards what works, so bad drives out good (in a moral sense) if it causes superior practical effects. This is one large reason why forms of regulation and policing are needed in human systems, to prevent the Law from working its magic.

In an illustration of this tendency, Charlie Munger applied Gresham’s Law to 1980s savings and loan banking practices in his 1984 Letter to Wesco Shareholders:

Although interest rates have subsided from the 1981-82 peak, the low and slowly changing interest rates of former years are plainly gone with the wind, as are the former government-decreed limits on interest rate competition for savings accounts and the favouritism for savings and loan associations over banks. But an agency of the U.S. Government (…) continues to insure savings accounts in the savings and loan industry, just as it did before. The result may well be bolder and bolder conduct by many savings and loan associations. A sort of Gresham’s Law (“bad loan practice drives out good”) may take effect for fully competitive but deposit-insured institutions, through increased copying by cautious institutions of whatever apparent-high-yield loan and investment strategies seem to allow competitors to bid away their savings accounts and yet report substantial earnings. If so, if “bold conduct drives out conservative conduct,” there eventually could be widespread insolvencies caused by bold credit extensions come to grief.

This can be common in some business fields. Take two drug salespeople – one willing to bribe doctors to make sales, and one not willing to do so. If the industry functions such that fraudulent business practices are not punished, and the bribery goes uncovered by the buyer’s organization, then bribery obviously gains a sustainable competitive advantage over non-bribery. Clearly, the deceptive practice will take hold, as salespeople unburdened by morals are promoted and compensated better than the high-roaders. It’s a clear form of Gresham’s Law.

Take also sub-prime mortgage lending practices in the lead up to the 2008 financial crisis. If two banks are competing for borrowers and one lets their standards slide to zero (or less), which is likely to prevail? Even if the practice is a “long-term loser,” it can still take hold in systems where short-term incentives provide encouragement to the actual decision-makers.

Canadian Prime Minister Mackenzie King once described the origins of Gresham’s Law and its effects in a similar fashion, dubbing it the Law of Competing Standards.

In the reign of Queen Elizabeth, an official named Gresham observed that where different metals were in circulation as coinage and some were better than others of the same nominal value, the coins made of the inferior metal tended to drive the better out of circulation. The better coins were either hoarded or melted down and sold as bullion, were used in the fine arts, or were absorbed in the foreign exchanges. In other words, what Gresham discovered was that cheaper money tends to drive out dearer; that when people begin to discriminate between two coinages, they will invariably pay out the inferior and hoard the better, thus removing the better from circulation. This phenomenon once generally observed came to be described as a “Law,” and was identified with Gresham’ s name, since it was Gresham who was first successful in drawing public attention to it. Amongst money-changers, Gresham’ s Law of the precious metals is better known than the Ten Commandments.

Something analogous to Gresham’s Law will be found to obtain in the case of competing standards in Industry. Assuming there is indifference in the matter of choice between competing commodities or services, but that in the case of such commodities or services the labor standards involved vary, the inferior standard, if brought in this manner into competition with a higher standard, will drive it out, or drag the higher down to its level. This is effected by the opportunity of under-selling which comes, where in such cases human well-being is sacrificed to material ends. The superior standard, not being recognized or demanded, is unable to hold its own, and in time disappears. This Law is just as real and relentless in its operation in Industry as Gresham’s Law of the precious metals is with respect to money and the mechanism of exchange. Indeed, a more accurate exposition would describe both as manifestations of one and the same law, which I propose to call the Law of Competing Standards. I see no reason why economists should not recognize the existence of such a law, and incorporate it immediately in economic science as being quite as significant as the Law of Supply and Demand, the Law of Diminishing Returns, or any other Law accorded a place in its nomenclature.

The Law of Competing Standards is doubtless a part of the general Law of Competition, under which the cheaper of two commodities gains in competition a preference over the dearer. What Gresham discovered was an important sequence of the Law of Competition as applied to coinage; namely, the disappearance, in the course of time, of the superior metals. Observance of a like sequence in the case of standards in Industry is highly desirable. As respects labor standards, I believe that recognition of the operation of the Law of Competing Standards over ever-widening areas would do more than aught else to clear up the most baffling problems with which Industry is confronted, and to point the way to a solution of many situations which hitherto have seemed incapable of solution.

***

Perhaps the most important application of Gresham’s Law is to avoid becoming part of systems where good behavior cannot win. Certain industries and activities lack the “policing” necessary to keep systems free from bad behavior. While it’s admirable to be the “cleanest shirt” in a pile of dirty laundry, certain areas of human life do not allow the clean shirts to win.

On the flip side, you’ll occasionally find situations where the good money drives out bad, and the cleanest shirts end up being worn the most. Those are the areas to aim your focus.

Gresham’s Law is one of Farnam Street’s Latticework of Mental Models.

Tagged: , , , , , ,

Explore

Browse