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Markets for the Digital Generation

JP is leaving Dresdner Kleinwort and the crowds are lining the route, some throwing flowers and some throwing broken bottles…anyhow reminded me of one of my favorite (among many) Kathy Sierra posts on the “physics of passion”:

The most popular and well-loved companies, products, and causes have the strongest opponents.

You’ll know when you get there, because the buzz goes from pleasant to polarized. Moderate, reasoned reviews and comments are replaced with stronger language and more colorful adjectives on both sides. Those who speak out against you will be referred to as “brave” or “having the balls” (see the comments on Scriven’s review) for daring to criticize. They’re hailed as the smart ones who finally call the emporer on his buck-nakedness.

Should you ignore the detractors? Diss them as nothing but evidence of your success? Should you just wave them off with a “just jealous” remark? Absolutely not. Somewhere in their complaints there are probably some good clues for things you can work on. But if you start trying to please them all or even worse, turn them into fans, that could mean death. Death by mediocrity, as you cater to everybody and inspire nobody.

It is physically impossible to have everyone love what you do. And the more people do love it, the more likely it is that you’ll have an equal and opposite negative reaction. X = -Y the physics of passion.

Anyhow good luck JP, I’ve enjoyed working with you and I have no fear that you’ll be able to stay well clear of the zone of mediocrity, even if that means ducking a few bits of flying detritus. Then again, don’t drink too much of your own kool-aid, otherwise you really will end up looking (and acting) like this:

…and that can’t be good…

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Following up from this post last week, the following headline from the FT caught my eye:

Fewer storms please hedge funds

By Andrea Felsted, Insurance Correspondent
Published: September 24 2006 21:59 | Last updated: September 24 2006 21:59

Hedge funds that have piled billions of dollars into reinsurance are poised for bumper returns, amid increasing expectations of a benign hurricane season.

Hedge funds could still be hit with heavy losses as the Atlantic windstorm season does not finish until the end of November, while an earthquake could happen at any time.

…um I guess she didn’t interview Nick and Brian for this story…

Then again, the readers of Dealbreaker.com didn’t think you should ‘blame it on the weather’ (actually 21% blamed ‘Canada’…they must be watching too much South Park! )

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I was pointed towards this post in Telco2.0 by Doc; it picks up the ‘because of’ rather than ‘with’ meme that Doc, JP and others have been successfully promulgating (through the blogosphere at least, maybe one day it will make it past the Fortune1000 boardroom gatekeepers…), here’s an excerpt:

There’s a huge body of economic literature on vertical integration of industries, and Coase did his seminal work on the structure of the firm based on analysis of internal and external transaction costs. This horizontal federation of adjacent businesses is not so well studied. The crashing co-ordination costs driven by hyper-abundant and cheap technology and communications is fairly new. It shouldn’t come as a surprise to find it confusing and hard to react to: they don’t teach it in business school yet.

So, what are the because of businesses that you should be considering as a network operator? We suggest three growth areas:

* Data assets. Google made billions out of the latent value of hyperlinks. Telcos are also sitting on a goldmine of digital social gestures in the form of call detail records, network address books, text messages and voicemail responses. With the user’s permission, you can mine the value to create new businesses.
* Platform APIs. The really hard-to-replicate parts of the business are all the call centres, logistics, servicing, tax remittance, and so on: a long list of non-network assets, each somewhat dull, all deeply profitable if milked by allowing third party access. Amazon do it, Google do it, and a Telco 2.0 will do it too.
* Advertising and attention. You’ve got that little screen in the user’s hand at great, subsidised expense. Shame there’s so little for sale. Buying stuff makes people feel good: empowered and in control. It’s almost as good a dopamine buzz as getting a text message. Fix the missing links to telco-assisted commerce and ads.

Basically if you understand ‘because of/with’, my arguments with respect to aligning the appropriate capital structure to the type of business/activity, can be boiled down (in an admittedly reductionist way) to:

‘With’ businesses should be funded by debt (and if/when natural monopolies - which is often the case - regulated with fixed target returns)

‘Because of’ businesses should be funded by the (more traditional) blend of equity and debt, with the amount of debt depending on the maturity/visibility of cash flow in the given business and/or company

So I guess I’m possibly slightly disagreeing with Telco2.0 in that I think that “horizontal federations” need to become or remain at most just that, ie federations. Trying to put them together in one organisation causes not only cultural and strategic issues but also results in necessarily sub-optimal funding. And worse, the capital structure will inevitably contribute to driving strategy, leading to a vicious circle where incompatible businesses are kept together with the justification articulated in terms of driving necessary returns on the capital employed. ie ‘As a telco network operator, I need to get into producing entertainment because ‘just’ selling network access won’t provide the return on equity that I need (to justify having equity capital…) And being in the entertainment industry, I need to be financed by equity given the uncertain and lumpy nature of cashflows (that the entertainment business generates…) [Repeat loop infinitely, create unwieldy suboptimized conglomerate. ]

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Over-the-counter vs. exchange-traded. A more emotionally charged debate than crunchy vs smooth. (peanut butter for non-North Americans) Or Chicago vs New York.

That’s why the only deal that could top Icap’s acquisition of EBS for smartest financial services deal of the year, would be for Icap to acquire the LSE. From an industrial point of view a dead obvious trade (and fully cogniscent that I will be accused of Monday morning quarterbacking, literally!), this was a combo (not necessarily Icap/LSE but OTC broker/exchange) that I always felt was missing from AmazonBay. And indeed one of the reasons I have avoided subsequently writing about such a deal was that in the back of my mind I harboured the possibility of personally trying to get in the middle of some such combination in one way or the other. Well now the cat is out of the bag. (btw this link could have been to the FT but for their dumb paywall policies…)

The papers report that there is no deal on the table (for now at least) due to financial considerations and the large blocking Nasdaq stake, although the Times makes the obvious point that perhaps a three-way deal could be arranged (clearly always very tricky from a practical point of view but in principle why not?) and valuation issues sometimes resolve themselves.

I’d be interested to see how Betfair would price the probabilities of a 2-way and a 3-way deal happenning in the next 12 months…I’d be surprised if the odds ended up being much longer than 3-1 and 8-1 respectively. (based on a completely unscientific 10 second long ’stab-in-the-dark’ reflection…)

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Phil points to a 4-part series on management techniques articulated by Joel Spolsky:

At the risk of becoming a Spolsky link blog I wanted to point people toward a recent series of articles which look at different management styles. Joel disects each with respect to managing high tech, knowledge-oriented teams.

Introduction

1) The Command and Control method

- Shout at people

2) The Econ101 method

- Incentivise people with rewards

3) The Identity Management Method

- get workers to identify with the problem by telling them stuff

Joel frames his thesis in terms of managing highly educated software developers but if you ask me his framework is equally relevant for any “knowledge worker”, say for instance professionals working in an investment bank.

Obviously - at least to me - he comes down in favour of method 3 - the Identity Management Method. Not always easy to implement but who said managing (or doing anything well) was ever easy… It boils down to treating people as responsible and intelligent and helping them find something they are passionate about (see the collected works of the great Kathy Sierra.) I think this is probably a universal truth with respect to the human condition, but if earlier generations were prepared to put up with methods 1 and 2, I’m pretty damn sure the digital generation won’t. Anyhow the funny (peculiar not ha ha) thing is anyone who has worked in investment banking for any length of time will find a predominance of methods 1 and 2. But wait a second, investment banks have generally been extremely successful and have made many of their employees and shareholders very wealthy and happy. Ok wealthy. So 1 and 2 work.

To this I would say two things: has worked (ie in the past) and just imagine how well these organisations would succeed using method 3! Indeed perhaps Goldman Sachs is at the top of the class because they have the biggest proportion of method 3 in their management mix? (I can’t say for sure having never worked there but anecdotally it does seem so from the outside…)

This thread reminded me of a book I read a few years ago called “The Paradox of Control in Organisations” (great insightful ideas, awful writing), here is the synopsis:

…the author takes self-organization and emergence as central themes in thinking about life in organizations. He focuses on the tension between spontaneously forming patterns of conversation and intentional actions arguing that the order of organizations emerges through a combination of collective interaction and individual intentions. In today’s organization, managers find that they have to live with the paradox of being ‘in control’ and ‘not in control’ simultaneously. It is this capacity to live with paradox, and to continue to participate creatively in spite of ‘not being in control’, that constitutes effective management.

Anyone with a bit of self-awareness who has ever managed an organisation will immediately identify with this paradox.

Anyhow, Spolky’s thesis is by definition a bit reductionist but nonetheless pretty accurate and taken as such is an excellent primer/refresher on how to manage knowledge workers, especially in this digital age. Definitely worth the 10 minutes of your life it will take to read.

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The FT this morning reports on a new search/news aggregation service aimed at the financial trading community aka ‘hedge funds’ (is it just me or are pretty soon are we going to be referring to any business involved in trading assets as a hedge fund?…) I won’t bother to link to the FT (too bad for them, change your paywall policy folks) but basically it is touted as a revolution in information gathering, digging out the nuggets that exist below the radar screen of the conventional or mainstream press.

Sounds like they have some smart people and decent technology so I’m sure it will be useful however I suspect the really smart money traders who have known how to search blogs and use RSS readers and tagging and social-bookmarking services etc. will be a bit annoyed that any old dinosaur trader will be (in theory) able to find the same gems of information buy paying up for Monitor110’s services. And to be absolutely frank, the ground Monitor110 is breaking isn’t completely virgin; firms like Clearforest and Relegence have been offering similar services for some time now and digital generation traders can mash-up their own intellingent news filters either from scratch or using tools like Netvibes.

Edward Hadas over at breakingviews.com (another paywall, but really good analysis site founded by Hugo Dixon) likens it to using the ‘wisdom of crowds’ to trade. I’m sorry Edward but actually I think you’ve got this one wrong. ‘Wisdom of crowd’ - mining would be things like Marketocracy and SocialPicks. Monitor110 in my opinion is all about finding the needle in the haystack; finding the individual voice or nugget that escapes crowd amplification. Finding the kernel before it becomes a snowball. Where I do agree with him however is the paradox of diminishing returns: the more people find the needle the more difficult it will be to monetise. Or paraphrasing Dash - ‘if everybody is special, it really just means that nobody is…’

I don’t want to sound too negative however; if it does what it says on the tin, I think it could be a very useful tool and if they have smart technologists and market savvy management which definitely seems to be the case on the face of it, they should be able to continue to innovate incrementally and stay ahead of the obsolescence curve at least for a few more years. One to follow for sure.

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…outside of the Northern California and no one in the Valley had already thought of it is it still a disruption?

Don’t get me wrong, I’m a huge admirer of the entrepreneurial and innovative and generally open-minded spirit that reigns on the West Coast but I’d be lying if the implicit belief of its denizens that everything is thought of first or done best in the ‘valley’ isn’t a just a bit exasperating…

Ross and JP simultaneously sent me a link to Mr. Arrington’s breathless post entitled: “PicksPal Could Disrupt Sports Betting Markets.” Pul-lease… The sports betting market was well and truly disrupted (in the Google sense of the word) 5 years ago (!!!) when the world (ahem…except for the US, bless) was introduced to Betfair. In the United Kingdom. I guess I shouldn’t be too harsh as Betfair has chosen to take a very conservative approach and has never accepted any business from the US, but follow-on competitors like TradeSports have so he shouldn’t be ignorant to the whole idea of a sports exchange. And given the wealth of predicition market sites and ideas (however hobbled the actual markets themselves might be by the luddite American polity), his wide-eyed appreciation of PicksPal is at best a case of post first, search later.

I am saved the effort of a technical critique of the relative merits and/or lack thereof by the wise crowd that has already contributed a large number of concise and accurate criticisms in the comment to the original post, but I would like to take the opportunity to (once again) highlight the blatant hypocrisy brought forth by this example.

Am I the only one who finds it ridiculous that sites like PicksPal are obliged to play for points and prizes instead of money? Here’s a happy customer quote on their homepage:

“It came down to the last field goal banging off the left upright, but I bagged an HDTV. Awesome.”- GoodLow, Dallas

Hello? Anyone ever hear of eBay? So does old GoodLow need to sign a waiver promising not to take his HDTV and monetize it on eBay? I hope the folks at PicksPal give me some shares in the company for giving them the idea to tack-on an eBay selling service onto their site and automate the process for their customers, taking a nice commission along the way. Also implicit in their business model is the ‘fact’ that tens of millions of Americans bet on sports often (think March Madness, Super Bowl, etc.) in office pools and amongst friends but do so illegally. I guess there is no appetite to throw half the country in jail, probably not a big vote-winner… As far as I can tell the fabric of American society has yet to be irreparably destroyed by Marge taking Pittsburg and the points on Sunday…but perhaps the fact that much of this illegal trading - oops sorry betting - happens in the office and not while people are “in their bathrobes” is of huge comfort to Congressman Frank Wolf and his colleagues.

If you haven’t clicked through to read the TechCrunch post (linked to above), it highlights that PicksPal will be selling the picks of their best predictors. Aside from the problems of randomness (see the TechCrunch comments for explanation) assume there really are people that are expert at picking winners and losers. Unless they move to Las Vegas, the US does not allow them to make a legitimate living from their expertise. Because they are knowledgeable about say,basketball rather than interest rates or precious metals or natural gas (sorry couldn’t resist!), the US government doesn’t allow them the opportunity to start a hedgefund, live in Greenwich and live happily ever after on 2 and 20.

Hey it’s not just the US either, France is getting into the prohibition game too, arresting the joint-CEOs of Bwin a couple days ago.

Of course it’s all about money. Incumbents wanting to keep their rents. Governments wanting their vig. Legalize, regulate and tax. It worked (-ish) for financial and commodity markets. It will work for these markets. The faster it gets done the better off all will be. Hell, the tax take from legitimizing March Madness alone might close the US budget deficit!

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First Direct’s new CEO Chris Pilling gives a great engaging and friendly interview published as a podcast on their website. Despite being part of the giant HSBC group, they seem to manage to keep their unique cultural and organizational identity and remain leaders in bringing innovation to retail banking.

Podcasts are useful but don’t really constitute a new paradigm for banking. It’s a good start, but will be interesting if the new guy can build on this foundation and stay out in front of the pack.

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Ok hindsight is obviously 20/20 but from reports coming out over the past couple days it would seem that the reason that Amaranth has lost billions of dollars (yes billions) in the natural gas market is because their traders decided to make the same bet that last year made them hundreds of millions. ie That supply disruptions caused by hurricanes in the Gulf of Mexico would cause the price of gas and certain calendar spreads to soar.

Aside from it being a crowded trade - who wanted to be short heading into hurricane season this year? - this would seem to be a good example of bad basis risk. If the goal was to speculate on the number and strength of hurricanes in the Gulf, there should be a better way.

Of course then again if you look at it that way, you might be loathe to pay a manager 2-and-20+ , would be easier and cheaper just to place the bet yourself.

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I believe in the Wisdom of Crowds. And I also believe in the value and importance of leaders and leadership. In fact in many contexts good leadership is what allows the crowd to be wise (as opposed to idiotic; see JP’s critique of Freedman’s article here.) The problem is a paucity of good leaders, or at least good leaders who can be bothered to wade through the venal and cynical thicket that all to often surrounds positions of power or influence. History is littered with disastrous outcomes due to poor leadership, we’re not just talking about a bad quarter or a bottom decile share price performance…

In his excellent book Collapse, Jared Diamond quotes from Barbara Tuchman’s book “The March of Folly” :

Throughout recorded history, actions or inactions by self-absorbed kings, chiefs, and polticians have been a regular cause of societal collapses…Tuchman put it succintly: “Chief among the forces affecting political folly is lust for power, named by Tacitus as ‘the most flagrant of all passions.’ ” As a result of lust for power, Easter Island chiefs and Maya kings acted so as to accelerate deforestation rather than to prevent it: theur status depended on their putting up bigger statues and monuments than their rivals. They were trapped in a competitive spiral, such that any chief or king who put up smaller statues or monuments to spare the forests would have been scorned and lost his job. That’s a regular problem with competitions for prestige, which are judged on a short time frame.

These are leaders that got caught up in their own press - that believed that the sun rose and set because of their genius and charisma. Leaders that eliminate dissent and fear change. Leaders that end up breeding a madness of crowds, crushing the wisdom under their iron determination.

I’m just in the process of re-reading Surowieki. And I can tell you I don’t really see him expounding on the virtues of blindly, and in all circumstances and contexts, trusting the ‘crowd’; and explicitly he underlines the fact that the wisdom arising from a crowd is not the same (indeed often just the opposite) as consensus.

(from “The Incredibles”:)

Helen (Dash’s Mom): Everyone’s special Dash.

Dash: [muttering] Which is another way of saying no one is.

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