What Baseball has to Teach Us About Business Success - a Review of Michael Lewis' Moneyball

I’ve just finished reading Moneyball by Michael Lewis, a writer made famous by his banking classic ‘Liar’s Poker.’ One of the modern classics of sports writing, Moneyball follows the story of a baseball team, the Oakland Athletics, which employed the unorthodox tool of statistics to pick players and win games.

The way Lewis describes it, the vast majority of the baseball industry relies on experience, intuition, and tradition to make these choices. In a sport that generates a vast trove of statistics on players’ and teams’ performances, only a small group of fans, known as ‘sabermetricians,’ used to bother subjecting the data to hard analysis. This changed in the late 1990s when Billy Beane, general manager of the Oakland A’s, realised that to stand a chance against wealthier teams he would have to organise his team differently. Together with Harvard graduate Paul de Podesta he set about analysing baseball to determine, amongst other things, how you can use historic performance statistics to value players (and work out which attributes are underpriced in the market), and which tactics help you win games. On both these questions the conventional wisdom was wrong, and using their analysis Beane and de Podesta put together a successful team on a low budget.

I myself am not a big baseball fan, but I was drawn to the book by references to it in a number of modern business books. The story Lewis tells has some wider messages that resonate far beyond the baseball diamond.

1. When used properly, statistics can be a goldmine

The rest of the industry were not ignoring statistics. They were simply focussing on the wrong ones. They had never subjected the raw data to a statistically valid analysis using the tools of probability, hypothesis testing and regression analysis. This attitude – taking basic statistics such as means, medians and ranges – leads to simplistic conclusions and overlooks the value of deeper analysis. Proper use of statistics can give a business an advantage over its competitors. It can also have great effect in non-competitive sectors such as public services or international development.

2. When a competitor is being unexpectedly successful, don’t dismiss this as an aberration

This is a mistake big businesses make all too often. They assume that a competitor’s success is down to luck, temporary trends, or the unique success of a single initiative or product. While this might be true, a competitor which consistently outperforms is probably doing something substantially better than you. There is no denying that baseball contains a strong element of luck. So when the Oakland A’s had a couple of good seasons, competitors were not too concerned. However even when the A’s continued to outperform year after year, with ‘winning streaks’ of historic length few competitors stopped and questioned how they did it. Even after Moneyball was published, much of the industry remained in denial about the power of statistics.

3. Don’t just accept the conventional wisdom – and don’t be afraid to look for a new way

The conventional wisdom in baseball was that you need to hire star players to make a team better. Billy Beane did not have the budget to hire stars – but he didn’t accept the conventional wisdom either. He looked for another route to success – one his competitors would have overlooked – and he found it. This is a step that many successful businesses, investors and entrepreneurs have taken, ranging from Toyota reinventing the way car production is organised to Apple’s launch of the iPad, a product in an entirely new category overlooked by every other electronics firm in the world.

As a book Moneyball has a great deal to offer sports fans in general and baseball fans in particular. But it also contains lessons that are useful to a wider audience, namely: look to the numbers, and if they conflict with the conventional wisdom, then the conventional wisdom is probably wrong.

Why I'm a fan of 'The Seven Habits'

A few weeks ago I had dinner with an old friend. Having noticed my reviews of several business books, he asked me to recommend my favourite ever book on ‘personal effectiveness.’ I didn’t have to think for long before responding: the book I have found most compelling has been ‘The Seven Habits of Highly Effective People’ by Stephen Covey.

I’m not an expert on the ‘success’ and ‘self-improvement’ literature, but I’m not a cynic either. Several of my friends would never pick up a book of this genre, believing that they’re aimed at people who have low self-esteem, who lack confidence or who otherwise feel that they are in some way flawed. While some proportion of self-improvement books is aimed at this kind of audience, I have found many titles with a lot to offer readers who are already confident and well-adjusted individuals.

‘The Seven Habits’ is one of these. It has several great things going for it:

• Stephen Covey is an expert in what he is writing about. He has a thorough knowledge of the existing success literature which he has studied at length. His depth of knowledge shows through in what he writes.
• Covey acknowledges up front the low quality of much of the self-improvement literature. He has a clear disdain for books that promise a ‘quick fix.’ This honest approach make much of what he recommends that bit more compelling.
• His writing style is very accessible; he illustrates all his points with anecdotes either from his own experiences of those related to him by others. This puts all of his ‘Seven Habits’ into context and prevents the book becoming dry and overly theoretical. He includes some ‘thought exercises’ which engage the reader, but not to the point it reads like an instruction manual.
• The content itself makes a lot of sense, but without coming across as something obvious. Each of the ‘Habits’ stands up by itself as useful advice. Added together, they mesh into a sensible structure giving an overall picture which is more than the sum of its parts.

The one thing I can see putting off some readers (particularly English ones) is Covey’s earnest tone. To quote Kate Fox’s classic, ‘Watching the English:’

“At the most basic level, an underlying rule in all English conversation is the proscription of ‘earnestness ’… seriousness is allowed, earnestness is prohibited. …To take a deliberately extreme example, the kind of hand-on-heart, gushing earnestness and pompous, Bible-thumping solemnity favoured by almost all American politicians would never win a single vote in this country.”

With this health-warning aside*, I would highly recommend ‘The Seven Habits.’ Even if you have never thought of reading a ‘self-improvement’ book in your life, I think you would find it accessible, practical, stimulating and altogether a worthwhile read.



Notes: *In writing this I realise that this blog is sometimes guilty of excessive 'earnestness' (!)

How a Trip to the Pub Reminded Me, ‘There’s No Such Thing as a Free Lunch’

I’m always on the look-out for articles that educate, stimulate and generally challenge my view of the world. This week I found one in an unexpected place: the JD Wetherspoon pub chain’s company magazine. Sitting in the pub, leafing through the magazine, I was anticipating finding commentary on their latest pub openings and newest real ales. Instead I found myself reading an intelligent editorial piece on the troubles in the Eurozone by Tim Martin, Chairman of JD Wetherspoons.

While criticising the Euro is now in fashion due to the sovereign debt crisis, Tim Martin has long been opposed to the idea of the single European currency. He recounts in his article how he campaigned, in his capacity as a business leader, against its introduction in the UK. At the time, the accepted wisdom in intellectual circles was that the Euro would strengthen trade with Europe and would be an asset to the UK economy. He came up against politicians, economists and financial journalists all clamouring for its acceptance. But, along with hundreds of other citizens who rejected the idea of surrendering more powers to bureaucrats on the continent, he vocally rejected the Euro.

He characterises the debate over the Euro as pitting the intellectual elite, with their neoliberal economic agenda, against the ordinary citizen who values local freedoms (such as the control over our own currency) more highly than the theoretical benefits of global integration. And in the case of the Euro, his side appears to have won.

This got me thinking whether simple, unsophisticated, folk wisdom might triumph over complex theorising in other areas of business and finance. For example, how much management theory applies in real life? Do economic models include too many assumptions to really reflect reality? Is all the effort we spend making quantitative forecasts really much better going with your gut feeling?

One piece of folk wisdom that the world of business and finance would do well to learn from is “you can’t get something from nothing” (or, more familiarly, “there’s no such thing as a free lunch”). This simple maxim seems to have been forgotten in the pursuit of quick profits – but the profits prove illusory when the hidden costs are taken into account. For example, in business, switching to a cheaper supplier might seem like an easy win – but no switch comes without risks that might end up costing you. In finance, increasing your leverage is an easy way to flatter your return on equity – until a crunch arrives and you wind up with nothing. In economics, keeping interest rates low seems like an easy win in terms of stimulating the economy – but excess credit sows the seeds of the next bubble.

How the Eurozone debt crisis plays out will be fascinating and potentially terrifying to watch. As such, I am thankful to Tim Martin and others for opposing the Euro in the UK. And I am also grateful to him for reminding me that even the best theoretical ideas frequently fall flat on their faces when confronted by reality.

The Trouble with Financial Services: Why Regulators Fail

Last year I wrote about the difficulties inherent in organising healthcare services. Another industry with in-built instability is financial services. Several characteristics of this sector make it especially difficult to regulate effectively. I have explored some of these below.

Financial regulation is in a constant state of tension between two approaches. The ‘Laissez-faire’ (i.e. hands-off) approach advocates minimal interference, based on the assumption that the best interests of society are served through free markets. The alternate approach (‘interventionist’) suggests that free markets often act irrationally; they require close supervision and restrictions to avoid damaging financial crashes, amongst other problems.

The decision of where in the regulatory continuum between these two extremes a particular regulator should sit is fraught with difficulty. I’d like to draw attention to four particular problems.

1.) Complexity
Financial systems are full of feedback mechanisms that we don’t completely understand. The actions of millions of market participants combine to set asset prices, provide capital and transfer risks. What happens in the markets affects their behaviour, which in turn has an effect on the markets. George Soros calls the feedback patterns ‘reflexivity’ and blames the recent financial crisis on it.

Complexity in the markets might be seen as a good reason not to intervene, as regulators’ actions are liable to have ‘unintended consequences’. However it could also justify interventions which prevent increases in complexity (such as restrictions on derivative products). Regulatory rules may also help companies deal with the unexpected (such as capital requirements for banks). Market complexity is a double-edged sword that makes regulators’ jobs extremely difficult.

2.) Revolving Doors
The Oscar-winning documentary ‘Inside Job’ highlights how top roles in financial regulators are frequently filled by ex-bankers. This isn’t surprising, given the specialised knowledge these roles require. However it can reasonably cause concerns about conflicts of interest. Social ties, political contributions, and the ‘revolving doors’ between jobs in regulation, banking, and lobbying create strong disincentives to individual regulators taking hard line.

3.) Race to the Bottom
Financial services firms can base themselves where they like. As a result, some countries try to attract them by offering low regulatory burdens. The risk that firms will flee financial centres such as New York or London is a major disincentive to regulators in the US and UK from tightening up their supervisory regime.

4.) Financial Innovation
As Merton H. Miller explained in his 1986 paper on Financial Innovation, “the major impulses to successful financial innovations have come from regulations and taxes.” More specifically, financial institutions use new products as a way to get around regulatory restrictions, rendering them ineffective. (As an example, the US withholding tax on interest payments remitted abroad triggered the creation of the market for Eurobonds, to allow US firms to raise money outside of the US.) In addition, continuous financial innovation makes it extremely difficult for regulators to stay up-to-date with the latest financial instruments being created.

This is a very cursory treatment of a subject that could inspire whole volumes. I am sure I have missed out other important reasons behind the difficulty of regulating financial services. Ultimately, it will be the widespread recognition of these potential roadblocks to effective regulation that allows us to make progress overcoming them.

Too Big To Fail - The British Brains Behind the US Response to the 2008 Financial Crisis

I’ve recently read Andrew Ross Sorkin’s book on the Global Financial Crisis, “Too Big To Fail,” often described as the definitive account of how the events unfolded. It starts with the emergency rescue of Bear Stearns in March 2008, then plots the series of decisions which ultimately led to the collapse of Lehman Brothers, the takeover of Merrill Lynch by Bank of America and the bail-out of the banking system.

While I lived through these events and followed the press coverage eagerly at the time, the book sheds a fascinating light on the behind-the-scenes manoeuvring of the Wall Street CEOs and the government regulators. It has changed my perspective on some of the decisions that were made and reminded me of the magnitude of the task that was asked of the leaders in the banks, the regulators and the government.

One of the biggest changes in my view on the matter is a new-found respect for how effectively the British regulators reacted to the crisis, in comparison to their American counterparts. On a long list of issues, the British government and regulatory bodies took decisive action that the American regulators would not stomach – yet in many cases were later forced into copying.

• US regulators were strongly resistant to a ban on the short selling of financial companies’ shares, until they saw the positive effect it had in the UK.

• In the weekend before Lehman Brothers collapsed, Barclays was in negotiation to take it over. I didn’t realise before that this was blocked by the UK government. If a deal had gone through, Barclays could ultimately have been jeopardised, so it seems in hindsight to have been the right call.*

• In late 2008, when it became clear that wide-scale action was needed to help banks survive the write-downs on bad debts, the US government was planning to buy the poor-quality loans directly from the banks. This was the plan that was ‘sold’ to Congress. However, in practice it is barely workable – the government just does not know how much to pay for the loans. The solution was instead to make capital injections directly to the banks in exchange for an equity stake: the US chose this route after it had been successfully implemented in the UK.

• In a twist of irony, the UK bail-out was optional and several banks (including Barclays) were sufficiently strong they did not need to take government funds. In the US, which loathes government interference with ‘free enterprise,’ the top nine banks were forced to take bail-out funds (so that the weaker among them didn’t look bad).

The UK has a long history of showing leadership in the fields of economics and finance (I’m thinking in particular of the great economist J.M.Keynes). Reading this book made me realise that the UK still has an edge in these fields – one that will be required going forward as the country faces continuing challenges from fiscal tightening at home, the Eurozone debt crisis, and many other problems on the horizon.

Note
*Barclays later acquired the US broker-dealer unit of Lehman Brothers out of administration, getting the bit of the business they wanted at a knock-down price

Why we shouldn't follow America's lead, as far as "justice" is concerned

A series of pieces in the media have focussed my attention in recent weeks on the shockingly high proportion of US citizens who are incarcerated. It started with an article in The Economist about high rates of repeat offending:

“One in every 100 American adults is in prison or jail, one in 31 is under correctional supervision – and after their release, most will find themselves back behind bars. According to a new Pew report, 43% of American offenders are returned to their state prison within three years of their release.”

The article goes on to describe a number of programmes which are having varying degrees of success at cutting re-offending rates. It also points out the enormous cost of the prison and jail system - $60 billion per year: “a year’s stay at a state prison costs about $45,000 – Harvard would be cheaper.”

A few weeks later I noticed this fascinating documentary by Louis Theroux, in which he visits Miami’s biggest jail and interviews several of the inmates. This is the establishment where alleged criminals are held prior to trial, so from a legal standpoint every inmate is innocent (until proven otherwise). Nevertheless they are subject to abysmal living conditions with twenty people to a cell, and a brutal dog-eat-dog culture where beatings are an everyday occurrence. Those convicted then face a further stint in prison. Given the casual aggression which is part of the daily life in jail, it is easy to see why parolees trying to re-enter society have trouble fitting in.

Another facet of the ‘prison dilemma’ was described in a cover article in last weekend’s Financial Times. Economist Martin Wolf wrote about a new report by the Global Commission on Drug Policy which calls for an end to the escalating, destructive war of drugs and adoption of a policy of treatment rather than criminalisation.

“The policy on which the world has engaged for decades, at the behest of the US, is a disaster. While failing to reduce the ills of drug use at which it is addressed, [the ‘war on drugs’] has created massive collateral damage: the spread of avoidable diseases; use of drugs in dangerous forms; mass criminalisation and incarceration; a gigantic waste of public resources; corruption; creation of a cross-border network of organised crime; and the subversion of states.”

Prohibition, he points out, simply doesn’t work: where there is demand, there will be supply, and waging a war against the supply chain is pointless when the root of the problem is in your own back-yard.

Clearly something is amiss with the American system of so-called justice. As Martin Wolf, Louis Theroux and the Economist make clear, the system which the US has constructed is not one which the rest of the world ought to imitate. And it is one that, over time, most Americans will surely realise is economically and socially unsustainable.

Sunk Costs, Trashy Novels and Good Behaviour

Anyone working in finance is likely to be familiar with the concept of a ‘sunk cost,’ but the idea has some interesting wider applications.

The term describes an expense that has already occurred and should therefore not be considered when appraising the costs and benefits related to a possible investment or project. For example, if a pharmaceutical company has spent £500m developing a drug which would then cost £100m to manufacture and generate £400m in sales, the decision over whether to manufacture would be based only on the latter two figures: £400m sales less £100m costs would give a £300m profit. The £500m spent on development is considered a ‘sunk cost’ and so doesn’t form part of decision over whether to proceed. While in this example the outcome is clear, the concept of a ‘sunk cost’ is somewhat non-intuitive.

Outside of finance, the idea gets little recognition, but it can be just as useful in making decisions. Often people ignore the fact that an expense already incurred is a sunk cost, and as a result may not make the best use of their time or their cash. Have you ever done the following?

• Been to a show or event or on a holiday just because you had bought the tickets, even when you didn’t feel like doing it anymore?
• Sat through a movie you realised was rubbish or finishing read a book you weren’t enjoying, just for the sake of getting to the end?
• At an ‘all-you-can-eat’ buffet, eaten so much you felt sick?

A clear indicator of someone ignoring a sunk cost is when they say, “but… I want to get my money’s worth.” But this is a logical fallacy if it means continuing with something you wouldn’t otherwise do.

On the flip side, the concept of a sunk cost can be used to encourage positive behaviour. In fact by realising that we feel compelled to “get our money’s worth” we can manipulate ourselves into healthy or beneficial activities. My favourite example of this is my monthly gym membership. Based on my average attendance at the gym twice a week, it would cost the same to either pay a monthly subscription (with unlimited use) or pay individually for session I attend.

From one point of view, paying ‘per session’ gives me added flexibility by not being tied into a monthly contract (in economic terms I have “option value”). However, I know that if I pay a marginal sum for each session this gives me a disincentive to go to the gym. And if I pay a monthly subscription, I feel compelled to go, in order to “get my money’s worth,” and so I'm using this little behavioural bias in my favour.

So next time you go to a buffet, just remember it’s “eat as much as you like” and not “eat as much as you can:” it’ll save you the indigestion and won’t cost you a penny more…