Constant Dissatisfaction: Google's Approach to Understanding New Media

Jonathan Lister, Country Manager for Google Canada came to give a talk at Rotman about what he calls "Constant Dissatisfaction: Google's Approach to Understanding New Media".

He highlights 3 major changes in technology
1. Ubiquitous Access
2. Cheap Storage
3. Falling Costs of Production

A few interesting points he raised:
- Google Wave released today. Its a new product which integrates many social features like photos and comments. My initial reaction was that it looks an awful lot like Google's version of Facebook.

- there are 20h of video uploaded every 5 minutes on Youtube. There is a shift towards paid premium content which has major implications for the media and advertising industry

- Google's search page has a unique web metric: "Get people OFF our website as fast as possible". They recognize that they are always "one click away from losing market share" and as a result have four focuses for their search engine:
1. Size of index
2. Speed
3. Relevancy
4. User Experience

- they have developed Ad Exchange, a sort of stock exchange of advertising (spot prices). They hope to improve on what they percieve as the inefficiency in display ads

Google's DNA
1. Innovation, not Instant Perfection - Launch early and often
2. Focus on the User and All Else Will Follow
What is scarce? User patience
3. You don't have to be at your desktop need an answer
4. A License to Pursue Your Dreams - 20% Projects
Google News as a needs based project organically spawned from the events of Sept 11
5. Data is Apolitical
6. Morph Projects, Don't kill them
7. Share as much information as you can
8. Make money without being evil
9. Creativity loves constraints

Prognosticate - 5 Google Myths

1. Big beats small: fast beats slow
2 . You need all 4P's: for many brands there are now just 3P's (not price, promotion is less relevant - free flow of info) - Youtube symphony, place reduced by globalization, product is staring role
3. Mass marketing is impersonal: today it is possible to engage 1:1 - on a mass scale
4. Marketing can't be accountable: marketing is the new finance (60s / 70s - tied to actions and responses) - quants are starting to move from Wall st to Madison ave
5. Management comes from the top: - Wisdom of crowds is creating a new bottom-up style of management. For example, Doodle for Google - a project getting kids to design Google's logo: Egypt orphanages and the "my Egypt" project

One of the notable points he mentioned is that creativity thrives with constraints. A very counter intuitive argument, he explained how when you are faced with constraints it requires to you to create unique solutions to overcome those challenges.

I apologize for the format of my notes, but there was so many interesting points it was tricky capturing all of it.


Sent from my BlackBerry device on the Rogers Wireless Network

What the Wednesday?

We were warned. We were told. "Your Wednesdays are 'free', but they are not 'free'". It's all fine and dandy to hear a current student tell you that at a recruitment info session. It's another thing to watch all your 'free' time quickly vanish. No complaints though. This is what I asked for and what I wanted. But here is a quick run down of what happened today:

8:30 I am a slave to routine. I could sleep in, but the habit of getting up in time for a class at this time of day is hard to break (nor would I want to). It gives me a chance to catch up on emails, review what is happening for the next few days and maybe sign up for upcoming events. It's like our mid-weekend, a good time to prepare for the course work for the upcoming classes. It's a good time to get that MPO or FIT reading out of the way, or review those Econ notes I didn't fully get a chance to appreciate (and write a math blog post about).

10:30 Meeting with my team. Although we have a great group of people, I'm feeling a bit worried about our time constraints. This quarter is evapourating very quickly (a common theme I'm noticing) and I'm concerned that we aren't where we need to be. However, our team (despite a relatively slow start) quickly gets into gear and within minutes we are having very energetic and passionate discussions about ideas for our project. We create a fantastic idea for our Foundations of Integrative Thinking presentation and the momentum requires that Poonam to furiously write the ideas on the blackboard that her team mates are throwing at her. After a whirlwind brainstorming session, our team has finally settled on a great idea and has already moved on to how our model can be used to explain CEO compensation (more details after we present)

12:20 Rotman Ambassador interview. I've applied to be a Rotman Ambassador, which is a position which allows us to participate in the recruitment process by giving potential students an insiders view on Rotman. I've done this before, for both McMaster Engineering and RIM, and feel like it would be natural for me to continue. After all, it was through talking with other "Rotman Ambassadors" (I don't know if they officially held the title, but they certainly acted in that capacity) that I was so attracted to the merits of the program.

1:00 Resume Drop in clinic. This may be one of the few items which I can front load. It appears my resume seems to be in decent shape, but it's nice to get a second pair of eyes.

2:00 Case prep team. Wow. This "little team" has grown quite a bit. We've gone from three (Neesha, Fei and myself) to about nine or ten and I've already heard some whispering in the grape vine that there are more people interested. We did some basic case prep and decided we'll stick to market sizing questions for now until our group normalizes and warms up before we start tackling the more complicated cases. Katie was phenomenal in giving some advice (she clearly has had some experience before) and between all the input in the room, we came up with some great preliminary strategies for how to tackle cases (beyond what is given in the Wetfeet and Vault guides).

3:30 International Study Tour interview. I applied for the study tour in the Middle East (UAE and Jordan). As I mentioned in my Rotman application, I want to get into Private Equity and M&A advisory, but have a particular interest in emerging markets (as the most likely place to find high IRRs for projects and investments). It was probably the most difficult interview I've had in a while and I actually think I didn't perform as well as I could. I am certainly impressed (border lining on intimidated) by the caliber of the questions asked. It would be a fantastic opportunity to go, both in terms of what I would get out of the experience as well as what I think I could potentially offer to the program through my participation.

4:00 Meet up with our financial accounting prof, Franco Wong (no relation), as our Section's Rep. He asked to talk about his mid-quarter review. There are no major issues in our class and the students seem to like him and his style well enough (which is true of all our classes). We did talk about that incessant buzzing noise which seems to only plague our class room, but I've already spoken to the PSO and they'll be talking to us about it in class tomorrow. It's a signal transmission problem caused by... 'phones with data service'. Our room is like a Faraday cage, and gives phones just enough signal to connect, but loses that signal just as quickly. The constant connecting and disconnecting of phones induces a charge in the cables, so even if the speaker system is off, it will still create that insufferable clicking noise.

5:00 Google! This will get it's own post (which still doesn't do the presentation justice).

6:30 The details. Cooking. Cleaning. Laundry. It's surprising how much time these essentials eat up.

9:00 Go to Rotman to read Stat's (for our upcoming quiz).

10:30 Finish readings, but decide I'm too tired to read ahead and go home. Start blogging.

Exploiting Chaos, trend-spotter Jeremy Gutsche on sparking innovation

Having graduated from the "most innovative university in Canada" (according to Macleans), you'll have to excuse me if I appear skeptical when I hear the words "sparking innovation". After all, is innovation something you can practice systematically? Is it something you can teach? To most of us, it would appear as if innovation just happens in the right conditions under the right circumstance with the right people and has a large component of happenstance (I deliberately refrain from using the word 'luck'). You'll notice that many of the arguements here are the same counterpoints that Roger Martin encounters when talking about Integrative Thinking.

Not intending to actually attend the lecture (I have quite a bit of work to catch up on for our Foundations of Integrative Thinking class as well as an upcoming Stats quiz), I was nonetheless drawn into the commotion in the Rotman's Fleck Atrium as Jeremy Gutsche began his presentation. While I must admit ignorance to his background, I was drawn into his captivating presentation style. I came for the noise and distraction, but stayed for the message and content. (Aside: There is an interesting parallel here to his example of Joshua Bell, noted as one of the best violinists in the world, playing out of context, i.e. not in a concert hall, and not attracting much attention.)

He discussed the content of his book, Exploiting Chaos (which I bought a copy of and will review once I've read it) which describes a framework and methodology for builiding and disseminating ideas in a new and developing (polite words for chaotic) market place.

His methodology?

1. Culture of Revolution
2. Trend Hunting
3. Adaptive Innovation
4. Infectious Messaging

He askes the question, which is more important? Culture or strategy? And replies with a resounding "Culture eats strategy for breakfast". He labels the four most important pieces of his framework as:

1. Perspective
2. Experimental Failure
3. Consumer Obession
4. Intentional Destruction

(Aside: Each of these points deserve a more explicit description which I will provide after I've completed the book.)

His Rule #1? Relentlessly obsess about your story. It must be:

1. Simple
2. Direct
3. Supercharged - the "I have to tell someone" test

He provides an example of the Fleurburger, "the worlds most expensive hamburger" which has qualities 1 and 2 (simple and direct), but not supercharged. His perspective? "a $5000 burger" a pitch which contains all 3 points.

His final take away is this:

Viral Trends + Methodical innovation =

Generate ideas,

Stimulate Creativity, and

Ultimately Exploit Chaos

Official First Acts as Class Rep

I had an opportunity to begin to make good on my GBC election promises yesterday as I performed my first official act as Section 2's Class Rep. Our Financial Accounting Prof was conducting a mid-quarter (an eighth?) course review and I was required to collect all the course feedback for the Program Services Office (PSO). While hardly the most glamourous of duties, it did give me a sense of nostalgia for my undergrad student council days and a mild sense of elation that also acted as a confirmation that I'm doing the right thing.

Katie, who also keeps a great Rotman blog and was also elected Class Rep for her section, organized a lunch for us (the four class reps) later today so that we can talk about our plans for the coming year to make the most of our time as Reps. The other class reps are good friends of mine: Amit and Thi. Besides the other GBC reps, there are now also elections open for club positions (RFA, MCA, etc) and I've already heard some buzz about people interested in running for various positions so I'm very excited to see more people assume leadership roles as they describe their view of how they can best serve the students.

I have a series of other interviews coming up for Rotman related opportunities and I'll be continuing to post as I have more news in this area.

Capturing Consumer Surplus

In our Managerial Economics class, we were discussing methods of capturing consumer surplus. Our models of demand (and supply) are starting to get more complicated than "two straight lines, one going up and one going down". We are beginning to build strategies which allow firms to capture more profit in the form of consumer surplus.

One ingenious method describes the idea of cover charges and ticket entry fees as generalized by two part pricing schemes. It essentially boils down to this idea: Charge a per quantity price (marginal revenue) at the marginal cost. However, in order to capture consumer surplus, the second component of price is determined as a fixed entry fee (cover charge) which encompasses all of consumer surplus. This idea is particularly clever because it ensures that the quantity sold is identical to the profit maximizing quantity.

Another clever idea is the concept of product differentiation (common as an undergrad economics concept), which allows a profit maximizing firm to distinguish and segment their market based on "invisible" characteristics of customers based on their purchasing preferences. However, this segmentation allows you to break up a market and more effectively capture more consumer surplus by treating each market segment differently. The more you can accurately segment the market based on pricing preferences (elasticities) the more you can capture consumer surplus. One of the interesting components of this strategy is the fact that consumer characteristics can be "invisible" or as our prof described "self selected" in that consumer preferences are revealed through their purchasing habits rather than some visible characteristic. However, in a monopoly where the company can segment the market perfectly (charging each individual exactly their full marginal revenue) a firm could technically assume all of the consumer surplus.

Informal Case Study Preparation Team

As I had mentioned before, we have a small but growing group of people preparing for case interviews at this early stage. While many people are focusing on the academic component of the MBA, those who are ahead are looking for opportunities to prepare for upcoming interviews. While I've often been critical of colleagues who need to "chill out" (sometimes doing work in advance is 'doubling work' rather than 'front loading', such as reading cases too far in advance), I think that those who are aware of the need to understand case preparation earlier rather than later are getting a distinct advantage. For those with little experience in this area, there is always the initial shock value when they realize that case interviews can become very complicated very quickly.

I've been nominated to 'chair' our little informal group as I've had the good fortune of doing case preparation over the recent past and I've been building a list of skills which most people are not aware of as being important for case interviews.

There will be a meeting with the Management Consulting Association (MCA) today to talk about what the club can offer us. They are one of the most expensive clubs on campus, second only to the Rotman Finance Association (I am a member of both). As I have a keen interest in Private Equity and Advisory services (such as M&A or restructuring), I have to decide if I will take the investment banking route or the management consulting route to get to where I want to go.

Elected GBC Class Rep for Section 2

I had the good fortune to discover that I've been elected to the position of Graduate Business Council Class Rep for Section 2. I am ecstatic that my classmates have entrusted me with this position and I will work hard to ensure that their faith in me is well placed.

As I mentioned in my speech, the Rotman Recruitment staff has done an excellent job of recruiting high caliber MBA candidates to our school and it is an honour to represent such a diverse and talented crowd. It is my hope that I can play a role in helping each person reach their maximum potential.

Other classes had some phenomenal candidates, however, I would like to make special mention of a friend of mine, Arash. I've known him since we studied engineering together at McMaster and he was a more "typical" engineering student back then. However, even in this early stage of our MBA he has impressed me with his personal development and growth. His speech was in the form of a poem which, besides having good rhyme and meter, was also content heavy as to why he would be great for the job. While he lost out in the election to another good friend of mine, he has displayed an impressive leadership ability and it is my hope that Rotman will benefit from his talents in one form of leadership or another.

Position Versus Performance: Financial Accounting Trade Offs

In financial accounting class, we were discussing two methods of accounting for bad debt expense: percentage of sales versus aging AR accounts and both have pros and cons.

For instance, using the matching principle, the percentage of sales has the advantage of providing a more accurate picture of performance in the period, whereas aging accounts is more accurate when describing your current financial position because it describes probabilities of default for individual accounts based on age (a more accurate predictor of current position, but will skew financial performance). Sound familiar? These trade offs are common when discussing the advantages or disadvantages of different accounting methods. This was the same discussion for LIFO versus FIFO as well where LIFO is a more accurate description of performance (COGS is based on most recent info) whereas FIFO is a more accurate description of position (Inventory is based on more recent info).

Continuing my physics analogy, it's almost like the accounting equivalent of the Heisenberg uncertainty principle in thermodynamics and quantum mechanics: "The more accurately you measure position, the less certain you can be of speed". In the same way, the more accurately you assess financial position (balance sheet) the less certain you become of your financial performance (income statement).

Rotman International Fair

Earlier this evening, Rotman hosted it's International Fair. There were a surprising number of booths filling the Fleck atrium. I was expecting only to see the International Study Tours program as well as the International Exchange program, however there were even booths from the American Consulate, CIC, Continuing Studies and even some NPOs for international entrepreneurship.

Personally, my interest was in the international study tours and exchange opportunities. The first deadline for applications is less than two days away on the morning of the 25th, so I'll have to start putting my application materials together. This application is for a study tour in January. There is another tour in May. I've been debating time commitment as I've been told that both of those times are disadvantageous for first year students to be away (January is a hot recruiting time and May is when you should be starting your internships). These are factors I have to consider as I am building my applications.

However, besides the business side of the program, there was a lot of fun activities as well (by activities I mean food). I have registered as a member of the Global Business Association (GBA) and the different regional clubs were giving away great deals of international food, yang zhou chao fan (China), samosas (India), sushi (Japan), jerk chicken (Caribbean) etc.

YCIF - Managing Your Career... In a Downturn

The Young Canadians In Finance team hosted a phenomenal event tonight titled: "Managing your career... In a downturn" and it was hosted by Fraser, Milner and Casgrain and was MC'd by Bill Vlaad of Vlaad & Co, one of the top recruitment firm in Toronto. The main speaker was Brent Belzberg, Senior Managing Director and Founder of Torquest capital partners.

The theme of the talk was about the lessons to be learned in a recession (the ones that can't be taught in school) and how credibility and reputation are the only true assets that anyone really has. While things may seem bleak for most of us, especially the ones who are looking to get out of the gate running, a depressed economy with few opportunities can certainly strain our ability to perform to our full potential.

Although readily admitting that his circumstances were much different, Brent was gracious to the audience by attesting to the competitive environment we were in and gave those of us with "irregular" backgrounds hope for still being able to pursue our interests if we showed the right traits. Bill had previously expounded that the two most important qualities of candidates in his mind were integrity and passion. Brent built on this point by saying that technical skills are table stakes, that without them you can't expect to perform in the most junior roles. However, he was also quick to point out that you can't expect to succeed in this business if you are lacking in the fundamental ability to build relationships. This is a common theme I've heard, specifically as it relates to the "magic line" between moving from an Associate to a VP.

The talk was very informative and enjoyable (the open bar didn't hurt) and it is always good to meet people from different walks of life with similar interests.

Population Distributions

In our statistics class, we have begun to move into the realm of distribution parameters and describing data for management purposes. We were discussing how standard deviations could be used to approximate distributions and probabilities of occurrences with appropriate assumptions. CFA candidates will immediately perk up and remember concepts like Chebyshev's inequality, which describes the percentage of a population which lies within k standard deviations regardless of the underlying population by the formula:

(1 - k^-2) * 100%

k = 2 --> 75%
k = 3 --> 89%

Or more common normal distributions where:
1 σ = 68%
2 σ = 95%
3 σ = 99%
(values shown above are 'expected knowledge' for MBAs and slightly oversimplified)

However, like the CFA exam, I anticipate that the trick in demonstrating an understanding of this concept will be more related to picking appropriate bounds rather than the pure memorization of the percentages for different values of sigma. For instance, in our stats class, we had a problem where we needed to know the probability that our value would not fall below 1 σ. As a clue, that indicates that we need to do a 'one-tailed' test. It is important not to fall into the trap of saying "I see 1 σ, therefore the answer is 68%". In this case, the answer is:
100% - ((100% - 68%) / 2)
100% - (32% / 2)
100% - 16%
= 84%
because it is only a one tailed test.

I have always loved stats. Not just for the pure math value, but more importantly, when trying to prove when math (or anything else for that matter) works or doesn't work, stats is the first place people should go to to determine correlations as a precursor to causality.

Defining Economies of Scope

I've previously written posts on the idea of Economies of Scale versus diminishing returns (both describe what happens as you enlarge your operations by adding more factors of production, but in seemingly contradictory ways). As an interesting aside: In that post, I had accidentally introduced a concept we are currently discussing now: the idea of the Leontief production function (which assumes that inputs are used in fixed proportions or in other words the idea of bottlenecks or "limiting reagents" in production factors). And it seems that economies of scale are quite easy to visualize (especially when you bring up ideas like Ford's Model T assembly line).

Economies of SCOPE, however, are a little more difficult to visualize in my opinion. After all, it may not be implicitly obvious how producing an additional good can provide new efficiencies. While this is true, our professor showed us a great example in class, but seemed to go over it very quickly. It wasn't until I was reviewing the material that I seemed to get the full impact. It all stems from the formula below which we'll look at:

C(Q1, Q2) = f + aQ1Q2 + Q1^2 + Q2^2

C(Q1, Q2) is the cost function for any given production quantities of good 1 and 2 at quantities Q1 and Q2.
The 'a' term describes cost complementarity. If a is negative the aQ1Q2 represents a cost savings between the goods.

Let's look at the two possible options:
Option 1: Produce both goods together. This is represented by the original cost function:
C(Q1, Q2) = f + aQ1Q2 + Q1^2 + Q2^2

Option 2: Produce the goods separately. This is represented by:
C(Q1, 0) + C(0, Q2)
= [f + Q1^2] + [f + Q2^2]
= 2f + Q1^2 + Q2^2

How can we describe economies of scope? Well it is the difference in cost between option 1 and option 2 or described as:
C(Q1, 0) + C(0, Q2) - C(Q1, Q2)
= 2f + Q1^2 + Q2^2 - [f + aQ1Q2 + Q1^2 + Q2^2]
= f - aQ1Q2

In order for economies of scope, the formula above must be greater than 0:
f - aQ1Q2 > 0
f > aQ1Q2

Now here is the trick which was on one of our sample quizzes (and I would anticipate on our upcoming quiz):
If you have cost complementarity (a is negative), you will ALWAYS have economies of scale. Q1, Q2 and f are all positive quantities, so the right side will be negative (less than) the positive left side.

However, if you do NOT have cost complementarity (a is positive) you MIGHT have economies of scale depending on the relative values of Q1, Q2 and f.

Not having cost complementarity actually means that for each additional unit of Q1, the cost for Q2 actually becomes more expensive. However, if that marginal inefficiency is less than the inefficiency of reproducing the fixed cost 'f', then it is still considered economies of scale (because as a whole, the system can still produce units of each cheaper in one factory than in two).

Now that I think about it and extend the idea, I wonder if you can express economies of scale in a similar fashion with the same formula. Let's focus on an example with just one good:
C(Q1,0) - let's re-label this as C(Q) = f + Q^2
if the Q^2 term became sufficiently large (which can happen quite quickly with squared terms) it might be worth while to encounter another 'f' cost to reset your Q term. What do I mean? Because of the second order relationship of the cost function, there is an economy of scale to be determined when Q becomes sufficiently large. How can we generalize this?
C(Q) = 2 * C(Q/2)
f + Q^2 = 2f + (Q/2)^2
(3/4)Q^2 = f
Q^2 = 4f/3
Q = (4f/3)^(1/2)

While not an entirely elegant solution, I think it does a decent job of describing economies of scale. This also describes a slightly non-standard cost curve as you will have small diseconomies of scale as Q increases, but at some point, it becomes more efficient to add more capacity.

As an undergrad, the idea of economies of scope had always bothered me, as professors couldn't give a concrete example of how the mechanics would apply (especially not without this formula).

GBC Section 2 First Year Class Rep Speech

Today was the official start of the Graduate Business Council (GBC) First Year Representative Elections. There were three positions for each section: Class Rep, Sports Rep and Social Rep.

As you may know, I'm currently running for Class Rep and Alejandro is the other candidate for my section. In talking to friends from other sections, there are going to be some tight races. My boy, Arash, surprised me as I found out he did a poem (with good rhyme and meter) expounding the virtues of his candidacy.

If you are reading this and are a Rotman 1st year student, you can vote for your candidates of choice by following the link below:
http://www.rotman.utoronto.ca/MBAProgramServices/election
(l/p: your R-World Credentials)

Elections are now open (except for Section 2 - I'm guessing ours will open after we hear the last candidate speech tomorrow) and will be so until 4pm on Thursday. Election results will be available on Friday.

Foundations of Integrative Thinking: When Models Breakdown

In foundations of integrative thinking last week, we were discussing building models of human behaviour in negotiating. It was a case about two companies from two different countries (we were told they were constructed from "archtypes", but most people could guess which they were) who were going to be negotiating.

The point of the exercise was to demonstrate the interactions and perceptions (modeling) of ourselves and other people and how that is affected by available information. For instance, the Beta team was considered very passive, formal and unified whereas the Alphas were considered aggressive, disorganized and informal. Although this is a gross over simplification, I wanted to extend this idea to what happens when models of behavour are incongruent with behaviours that we are familiar with. This is very much related to the case we did in our Managing People in Organizations case with the Canadian bank acquiring the Mexican bank.

I would propose that in homogeneous groups, where people have very similar cultural backgrounds, it is very easy to develop models because they are similar to how we model ourselves. Slight differences can be accounted for with small exception rules.

However, if cultures are more polar, there seems to be large disconnects between our model of the other person and their model of themselves (and vice versa). Behaviours which might be presented as respectful in one culture might be received as extremely rude in another. For instance, Beta's tended to be very formal in their responses and gave vague answers instead of "No's". Alpha's considered that rude and unproductive, focusing on the task rather than the relationship.

I would suggest that when we don't understand the models of other people (literally in this case as not having read their behavioural instructions, but in more pragmatic terms as not having lived and breathed a different culture), we tend to project our own models on them. Therein lies the problem, that our models (polar and absolutely different) break and we are unable to understand what is happening. The incongruency is then read along the lines of: "Why are they doing that? I would never do / think that. They must be stupid or evil.*"

* Roger Martin's criticism of "conventional thinkers" is exactly this... That what they don't understand is often labeled as a lack of competency or as evil.

One of my favourite commercials of all time, from HSBC a few years ago, highlights this idea:



HSBC has always bragged about having a good understanding of international business and culture and I think this commercial is a great example (I love the Englishman's face at the end). (Also, this is my apology to my readers for having text and formula only posts in the last few days... This MBA is very involved and I don't usually have time to draw graphs like I used to).

Signal Analysis and Non-Standard Marginal Cost Curves

We were discussing cost curves in Managerial Economics. Aside from the standard mechanics of cost curves, a great question was asked about non-standard cost curves where examples weren't as simple as they tell us in the textbook.

Our prof used the example of Fed Ex, where the marginal cost for an additional package (assuming additional capacity) are very low, resulting in a flat Total Cost curve. However, once the capacity of individual planes were at maximum, Fed Ex had contracts with other carriers to deliver their packages (at higher marginal costs) resulting in a higher marginal cost (and steeper TC curve) for a portion of the curve.

Yet again, there is another inflection point when there is a certain degree of over capacity at which point Fed Ex decides that it shouldn't pay the exorbident service fees and would rather purchase another plane, resulting in additional capacity, lower marginal costs and flattening out the TC curve. The final cost curve looks like a step ladder, flat in areas where there is additional capacity but steep in areas where over capacity is such that it doesn't justify a new plane.

Note as well, fixed costs in this example also exhibit "step ladder" like characteristics (the purchase of the additional plane).

Besides being a good example of when a standard model doesn't entirely describe what is actually happening, I also thought it was a good example of using a type of signal anaysis methodology to describe what is happening. What do I mean?

Managing the capacity of planes has similar characteristics of frequency analysis of signals and systems. That is to say, the number of packages before maximum capacity is reached and partner carrier contracts are used (as well as the number of packages before a new plane should be purchased) represent a frequency function related to quantity. Assuming uniform capacity of planes (you are buying the same planes to carry your packages, let's say 1000 packages), you can actually predict what the shape of the curve.

Also, imagine that after buying an additional 20 planes, you need to also hire an additional management team to handle them. This would be an example of a low frequency component of the Total Cost "signal" (or more accurately, the marginal cost "signal"). Because planes can be expressed as capacity for 1000 packages, additional management teams can be anticipated at every 20,000 packages which would appear like an infrequently appearing (low frequency) marginal cost signal component.

Marginal Revenue Derived from Elasticity

I'm studying for my second Managerial Economics quiz next week when I was reviewing something our professor showed us in class which I thought was absolutely brilliant. We had previously talked about elasticity as being defined as percent change in quantity demanded over percent change in price. Now, you can intuitively already begin to tell that there is probably some relationship between elasticity and maximum revenue (using calculus, it would be related to the idea of finding the value of a curve at dy/dx = 0).

It's basically the idea that you total revenue is maximized at elasticity = -1 where any change would either decrease the price or quantity demanded more than it's counterpart resulting in a decline in total revenue. The only way to not have unit elasticity is if the numerator and denominator were not equal implying one was shrinking faster than the other was growing.

What I thought was brilliant was the mathematical proof he used to describe the relationship by focusing on marginal revenue. At first I got incredibly confused with his notation: He writes "Price as a function of quantity demanded Qd" as P(Qd) where I misunderstood that as meaning "Price multiplied by quantity demanded" (which would actually give you revenue, not price). It's hard to "type formulas" in text boxes rather than use software like Equation Editor in Office.

Anyways, he described the concept of profit maximizing by assuming a constant or target marginal cost (MC) and tried to derive a formula for marginal revenue which incorporated elasticity. For simplicity (and clarity) I'll define my notation:

P0 - Old price
P1 - New price
Q - Quantity demanded at old price
Note: New quantity is (Q + 1)

Total revenue is price x quantity, so for two different prices P1 and P0, the difference in total revenue (marginal revenue or for an increase in quantity by 1 unit) is:

= Total Revenue at one more unit - Total Revenue at original quantity
= P1 * (Q+1) - P0 * Q
= P1Q + P1 - P0Q
= P1 + Q(P1 - P0)
= P1(P0/P0) + Q(P1 - P0)(P0/P0)
= P0 [P1/P0 + Q(P1 - P0)/P0]
Now using calculus like assumptions (the line where the prof states the lines are "approximately the same") you can assume for a "small" increase in quantity (Q only increases by 1), that P1 - P0 is the slope (because the change in unit is only 1 unit increase of Q) and that P1 is approximately the same as P0 or P1/P0 is approximately 1 to arrive at
= P (1 + (1/E))

Where E is elasticity as defined in our previous neat little math trick.

So if you know your target MC, to maximize profit, you set MC = MR
= P (1 + (1/E))

But wait... there's more! I was just looking at this formula and realized something... This looks an awful lot like a growth rate when doing financial modeling! Like revenue growth year over year (or like NPV using EBITDA with a growth rate and a discount rate):
Revenue Next Year = Revenue This Year * (1 + Year over year growth rate)

or more generically:

New Value = Old Value * (1 + % rate of change)

Recall that E = P/mQ therefore 1/E = mQ/P or [% change in price] / [% change in quantity demanded] (acting as a sort of elasticity correction factor).

In the same way:
Marginal Revenue = Revenue from one additional unit plus change Total Revenue due to elasticity
Note that Price is approximately (calculus like assumption) equal to the revenue from one additional unit so
MR = P + P/E
And the P/E term acts as a compensation term in total revenue using the elasticity of an additional unit (or the % change in price for a % change in quantity) multiplied by the current price.

This goes back to the original idea that elasticity and marginal revenue "feel" like they should be related.

Diversity in the Class: More than just a "nice to have"

I was recently reflecting on our Managing People in Organizations class and how we analyze cases in order to develop models we use. Last week, we had a case regarding cultural issues and how they affect the performance of organizations (for better or worse) as well as being able to differentiate between different definitions of "culture" and being able to apply those definitions in order to improve our own models.

In this particular case, it was very clear that there were some huge difficulties within the company caused by cultural issues. Now this probably comes as no surprise. As my undergrad strategy prof at McMaster, Dr. Terrance Flynn, used to say: "We learn the most with companies in distress"... I loved his class and got a good grade, but used to call it "doom and gloom" because the companies we analyzed always had problems. This case was no different. The two organizations had major organizational friction during the acquisition and restructuring.

What WAS interesting is that the bias reflected in the case was also reflected in our class. Our class, composed mostly of Canadians, were incredibly quick to side with the Canadians in the case (it was a case of a Canadian bank acquiring a Mexican bank). They say that those who don't study history are doomed to repeat it. However, there were some South Americans in the class who identified more with the Mexicans and were very quick to correct our biases with concrete examples from their past experiences.

When we used to do interviews to hire managers, you could quickly tell who was inexperienced when you asked them a behavioural question, such as "What would you do to resolve a conflict?"
An inexperienced manager would start by saying: "I would..."
Whereas an experienced manager would say: "In the past, I have..." and finish with a powerful example.

This is exactly what the two South Americans, Alejandro and Jenny, did in our class. They were the first two people in our class to add value to our conversation beyond just doing an analysis of the case as provided by injecting their own personal experience and unique perspective. I thought it was wonderful. We often hear MBA recruiters telling us how great their programs are because they can attract international students with diverse backgrounds (Rotman's official number this year is 36%), but it's an entirely different thing to have your case conversation redirected (in a good way) such that you would have missed out otherwise if you had a homogenious class of Canadians.

Clubs Day

Talk about choice. Yesterday was clubs day at Rotman (and I'm told UofT as well). Between the two, there is enough choice to join a club for virtually any interest you want. Typically, I've been told that Rotman MBA's tend to over do it, sign up for more clubs then they can handle. In a typical MBA, Integrative Thinking, 'AND' not 'OR' mentality, the average MBA student seemed to be between 5 and 7 activities per person (not a scientifically rigourous poll).

The Fleck atrium was filled with tables as was the upper floors of the Rotman building covering interests from the Rotman Finance Association to the Outreach program to the Wine Club.

Today, we are doing our first piece of graded work, a quiz in Managerial Economics worth 5%.

Toronto CFA Sociey - The Geopolitics of Investing

At lunch today, I went to my first Toronto CFA event (where I am an Associate Member). The speech was given by Pierre Fournier, Geopolitical Analyst, National Bank Financial at the National Club.

His talk covered a broad range of topics as they related to investing in foreign and emerging markets (such as the BRIC countries: Brazil, Russia, India and China). When asked at the end of his presentation which country he liked best, he responded with 'Brazil', for it's long term outlook, resource base and demographically young population.

In his team's specific role, he described this small foray into geopolitical analysis as a comprehensive peek at research and analysis relating to current geopolitical challenges facing investors in major foreign and emerging markets. He framed geopolitical analysis as focusing on the political structure of governments as well as their relationship with super powers. He described systematic risk in this arena as event risk based on or affecting the international investment system versus country specific risk and characterized the new challenges facing emerging countries as based on economic power struggles rather that the outmoded ideological struggles (ie. as a resource race rather than communism versus democracy). He described the decline of the US as a super power to resulting in multipolar rather than unipolar and the move away from unilateral as moving away from a "nice to have" towards a necessity.

There are other notable changes as well when investing on foreign soil. Rather than nationalization and outright appropriation being a challenge, hostile countries will now rather increase taxation and regulation in order to 'show you the door'. These more subtle tactics may make investors feel safer on the surface, but are a much more subtle way to indicate that you've outstayed your welcome.

In terms of Obama's plans for the US, there comes an interesting challenge as it relates specifically to oil. On one hand, the country aims to have more energy security, however on the other side getting at oil poses significant environmental challenges, a seemingly disparate and irreconcilable challenge (perhaps a good integrative thinking question). Pierre went on to predict that China's move into the Calgary oil sands project would probably move forward after approval from the Investment Canada Board and result in increase M&A activity, China continuing to search for more resources resulting in a squeeze for the US.

Project Manager, Statistics for Managers

We had our first meeting with our project team today regarding our first team project which will be Statistics for Managers. I was nominated to be our Project Manager. Each team member will have an opportunity to be PM, however, I was a little worried about whether or not I should be at this juncture and have decided that it's probably for the best.

The PM will be a co-ordinating role and I don't think it will involve a dramatically larger commitment then any other team member at the moment. And in terms of PM term timing, it's really a zero sum game anyways, as you either pick up the responsibility now or later.

Anyways, having said that, we have a pretty good team. I don't know if we've just skipped the 'Storming' stage, but everyone seems ready to go. We're meeting up with our team mentor, a second year student, tomorrow to go over a few ideas and begin to prepare for our statistics course.

Our team also seems to be on the same page as it relates to several key issues:
None of us are fooled by the fact that the project design is officially worth 0%. We all know that the project design is the most important aspect and a good design will translate into a much smoother and higher quality project. We plan to work hard to craft an excellent proposal and I feel confident that we can deliver stellar execution.

GBC First Year Rep

I'm officially running to be the Section 2 First Year Class Representative for Graduate Business Council (GBC). I was debating before I started the MBA program if I should continue to be involved with student government, and have decided that it would be more a more enriching experience if I could participate.

I was nomitated by Mark Wang, who offered to nominated me after he heard the presentation from the current GBC. The election is next week and a bit less involved in terms of process to what I was used to in undergraduate engineering. There we had a much more extensive process (going to classes to speak, putting up posters etc).

While the process is different, I would suspect this to be quite challenging. Candidates are only permitted 1 minute to speak before the class and we are in a group of very competitive and type A personalities.

Either way, it is my hope that I am given the opportunity to represent my fellow classmates as I embark on my MBA career. I feel I have a lot to offer my classmates as we build the Rotman Brand together through our learning and networking so we can leverage this brand in now and into the future.

As I prepare to craft my election speech, I'm looking to expound and demonstrate the qualities that I would like to have in a Class Rep. Wish me luck!

One Man's Inferior Good is Another Man's Normal Good

In our Foundation of Integrative Thinking course, we were discussing the models we use and when they break down. The example discussed was the supply and demand model and how an increase in price will generally lead to less quantity demanded. In order to attempt to "break" the model, we discussed "luxury" goods, and how an increase in price seems to increase demand.

I think this is a naive and superficial analysis of the problem. I think the main problem is the definition of the problem. For instance, people will quickly acknowledge that there is a market segment that will pay the premium for the luxury component and will argue that because the price increases, there is more quantity demanded in this segment. But what I feel was ignored was the fact that the increase in price will increase the quantity demanded in ONE segment (the high end luxury segment) at the expense another (the moderate luxury segment). In this way, I don't believe that the model "breaks down" as quickly as some in my class would criticize.

In this way, if the price drops, a good can be percieved as inferior by the higher end luxury segment and quantity demanded in one segment will drop, but another will rise (disproportionately) meaning a larger overall increase in quantity demanded.

The point I'm trying to propose is that understanding a model (salience and causality) developed by others have implicit rigor and would require extensive study before being dismissed as 'broken'.

Rotman Management Consulting Association - 2nd Year Case Comp

Yesterday, there was a second year case comp was organized by the Rotman Management Consulting Association (MCA). I've already paid the fees, so I didn't feel too guilty eating their lunch. It was good to see our second year colleagues in action and get a preview of what case competitions are all about.

There were industry judges from some of the major consulting firms in Toronto: BCG, Monitor, Accenture, Deloitte, etc. I even met a good friend of mine who was judging, now an Associate for Monitor and had a chance to speak with his boss. We had a great chat about consulting and life beyond the MBA.

The actual case was quite interesting, involving the analysis of a product. There were some great insights provided by the groups and I learned a lot about the process of developing a case as well as where to look for opportunities and challenges.

I'm building a team with some colleagues: Neesha Patel and Fei Yu (the only two other first years to show up). Neesha and I had previously arranged to meet up at this competition to start discussing building a team and I had met Fei earlier (we share the same Rotman buddy, another good friend of mine). Neesha was an analyst for McKinsey in India and Fei is from the University of Toronto Skoll Program (like Engineering and Management at McMaster). Both are smart cookies and clearly go getters. We'll meet regularly to practice cases and probably enter into competitions together. Neesha has hinted that she might know two more people to fill the last few spots, and I'm looking forward to working with this crack team.

$24 for Manhattan a Good Deal? The Finance Perspective

You may have read in history books about how native Americans 'sold' the island of Manhattan for $24 dollars worth of trinkets and how that was a lousy deal. Some writers have tried to rationalize (with deductive reasoning) how this was a good deal.

Here is the finance perspective (with facts taken at face value):

Current estimated* value of Manhattan: $8 Trillion
Initial investment: $24
Investment year: 1626
Current year: 2009
Compounding periods: 383 periods (years)
Compounding rate: Between 4% (considered risk-free - proxy for this is US T-Bill) to 8% (year over year average equity market return)

Considering that financial theory assumes that these principals should hold especially in the long run, if they don't hold for this example (predating the existence and origin of the country itself - 1776) it won't hold for anything!

To calculate the Net Present Value of $24 in 1626 in today's dollars using the two different rates, the formula is:

NPV = Initial Investment * (1 + Compounding rate) ^ Compounding periods

at 4% (RFR, beta = 0) we get
NPV = $24 * (1.04) ^ 383
= $80,164,150
= $80 Billion (bad deal)

at 8% (equity market rate, beta = 1) we get
NPV = $24 * (1.08) ^ 383
= $1.51883E+14
= $151 Trillion (GREAT deal)

So obviously, the implied IRR for this project is between the RFR and the equity market expected rate of return. I think the native Americans would have needed a diversified portfolio with at least some asset allocation in equity.

If only there was a good stock market that they had access to in 1626. They could have bought back the island and then some! This just goes to show, for all the money and advice in the world, the one thing you can't buy is time... and compounding.

* There is a more detailed description of some of the assumptions used here. While this calculation is quite good (especially the cost estimate of Manhattan which I use), I would criticize the use of monthly compounding as I think that unfairly inflates the rate of growth.

Peter Godsoe Scotiabank Scholarship in Financial Engineering Award

I just found out that I have been selected as the recipient of the 2009-2010 Peter Godsoe Soctiabank Scholarship in Financial Engineering Award at the Rotman School of Management at the University of Toronto.

There will be an annual awards ceremony on Thursday October 15, 2009.

Part of my application essay was describing my achievements in finance while using integrative thinking to merge models from seemingly disparate disciplines to describe the mechanics and physics of finance (example: geometric series and EBITDA to create terminal value).

Thank you to all the supporters of my blog and my colleagues for your questions, comments and critiques. Your readership and participation encouraged me to keep posting and find challenging topics.

Accounting: The Fundamental Physics of Finance

In our Financial Accounting class, our professor refreshed the idea of balance sheets, assets, liabilities and equity (A = L + E) and debits and credits in T accounts.

In the same way that physics in engineering boasts a model to explain the universe in such a meticulous way such that energy cannot be created or destroyed, so too does accounting explain that value can move and change shape, but can not 'mysteriously' evapourate from a balance sheet without an income or cash flow transaction.

In each of the examples provided, it's shown how no matter the transaction, the balance (which can also be seen as an allocation of value to different accounts) is maintained in the above equation. No exceptions.

While accounting fraud is still possible, there is a valuable point to make based on a case we had read in a previous (our first) class. There is a fine line between what is illegal versus legal in accounting (misreporting revenues and expenses versus deferring revenue for the next reporting period respectively).

With accounting, the first action, misreporting revenues and expenses, is illegal and undetectable by reading financial statements (hence why accountants are often required to statistically sample and verify inventories, revenue recognition methods etc). Most illegal activities tend to be undetectable as off book transactions (Think Enron and it's 'sale' of three oil tankers to bankers which was recorded as a non-operating gain whereas it was a financing deal and deflated their debt and inflated their earnings).

However, the second action, legal earnings 'manipulation' can be detected and can be accounted for. As with my previous posts regarding valuation of companies based on financial statements and earnings, profit smoothing and managed earnings are criticized as being dishonest and misleading. But again, I would say that it is the responsibility of the analyst doing the valuation to do the proper homework to account for these factors. I had previously spoke about how some companies were reporting positive earnings in one of the greatest financial declines since the great depression of the 30's and it is absolutely necessary to understand the underlying reasons for the numbers.

Neat Little Elasticity Trick with Proof

Our Managerial Economics professor was going over elasticity and mentioned the formula for quantity as it relates to price as a linear demand relationship (for simplification):

P = yQ + b

Note: For price elasticity for a product, y is usually negative (the more something costs, the less people will buy)

In a linear demand relationship, he was showing us a trick for approximating the elasticity at a given price and quantity. Just like my lecture on terminal value (in which we were told something worked without really understanding why) I wanted to demonstrate the proof (as Roger Martin says: "We shouldn't use models we don't understand").

So how can we simplify the formula for elasticity, given a linear demand curve?

Well:

Elasticity is defined as % change of Quantity / % change in Price.

Unlike the CFA which calculates % change with averages in the denominator:
% change = (first - last) / average

Rotman MBAs calculate % change as
% change = (first - last) / first

Either way, the trick still works:

Elasticity = % change Q / % change P

% change Q = (Q0 - Q1) / Q0
% change P = (P0 - P1) / P0

However: recall P = yQ + b
Therefore:
% change P = [(yQ0 + b) - (yQ1 + b)] / P0
= (yQ0 - yQ1) / P0
= y(Q0-Q1) / P0
= y (change in Q) / P0

Therefore Elasticity
= [(Q0 - Q1)/Q0]/[(P0 - P1)/P0]
= [(Q0 - Q1)*P0]/[(P0 - P1)*Q]
= (change in Q * P) / (y * change in Q * Q)
= P / yQ

QED
Elasticity can be accurately approximated by P/yQ for any given point Q, P on the linear demand relationship.

Note: Because the Q1 and P1 terms cancel out of equation completely, there is no calculus required as there is no theoretical second offset point required to approximate elasticity.

Foundations of Integrative Thinking with Dean Roger Martin

What a way to start your MBA career. My first class, Foundations of Integrative Thinking was graced with a lecture from Dean of the Rotman School of Management, Roger Martin.

In his introductory session, he introduced the idea of conflicting models from his book, The Opposable Mind. The central idea of integrative thinking, the hallmark of the Rotman School of Management and Dean Martin, is that opposing models should not be considered mutually exclusive, but rather as each offering a potentially new piece of the puzzle which can improve the overall model to have a better understanding of "reality".

He introduced the case of A.G. Lafley, recently former CEO of P&G, who was introduced at a low point in P&G's history who need to turn around a large global company who had issued two quarters of profit warnings and who needed to build a new model for turning the company around. In his interview with Dean Martin, A.G. is noted as saying "Anyone can do 'or'", refering to the idea that decisions that assume models are mutually exclusive are common and typical. The implication is that what is common is not often the best solution ('the higher the fewer').

Roger continues by building on his model: Salience, Causality, Architecture and Resolution.

Salience: What features do I see as important?
Challenge of Conventional Thinking: Limited consideration of features

Roger Martin goes on to poke a little fun at linear regression (Personally, I don't even really like polynomial regression) what he characterizes as an atrocious standard dependency relationship model.

Causality: How do I make sense of what I see?
Challenge of Conventional Thinking: Simplified consideration of causality

Roger continues by pointing out that specialization based focuses will create localized (piece meal) salience. He emphasizes multi-directional and non-linear causality considered.

Architecture: What tasks will I do in what order?
Challenge of Conventional Thinking: Sequential / independent consideration of piece-parts

Recognizing the whole while working on the individual parts.

Resolution: How will I know when I am done or not?
Challenge of Conventional Thinking: Ready acceptance of unattractive trade-offs

Searching for creative resolution of tensions.

In Roger Martin's model, he points out that in CT, the thinking is linear both in process and thinking, however, he mentions that IT requires conflict (the idea of the opposible mind).

For more information and a primer on IT, check out the definition page at Rotman.