Ascription is an Anathema to any Enthusiasm

I’ve been trying to think about the financial structures around processes that exhibit highly skewed distributions.  The insurance industry is a great place to find the examples.  We buy insurance to hedge against the small but awful.  Most of our houses don’t burn down, but it does happen.  The chance of a fire is scale free, the insurance company protects it’s clients at the scale they care about, but who protects the insurance company against the rare event the burns down the entire town.  There are three ways the insurance industry handles that scenario: they don’t cover it (excluding acts of god for example), they reinsure into a yet larger pool, or they avoid it by not insursing in certain venues. Over here at Bronte Capital is a posting arguing that Warren Buffet, who moved into the insurance industry in a big way over the last few years, has been working this third angle.

When process with a highly skewed distribution delivers it’s rare but powerful shock into the system, it’s black swans, everything designed to work with the median shocks is blows up.  I’d be interested to know how the insurance industry handled the New England hurricane of 1938.  I’d be interested to know how the insurance industry in Thailand handled the AID’s epidemic.

Another place I’ve been musing about exceptional, but inevitable, events is where you situate your career planning.  I’ve a friend who likes to say that almost all the people he knows who made a fortune in their life “fell of a log into a pile of money” thru no special merit of their own except in some cases they consciously picked a good log to sit on.  On the other hand a lot of people just fall off a log sooner or latter.  It would be nice if, as you plan your career, you had a better sense of what the chances are in the trade you pick, in the economy at large.  The fetish people have for presuming that career path probablities are entirely a matter of personal merit seem wreckless.  I was quite impressed when an acquantance of mine with a degree in biology explained he was moving into lawyering because, well he didn’t put it this way, the climate was more predictable.

Recently I’ve been trying to explain how wily US cell phone pricing is.  They sell monthly plans with N minutes and then when the exceptional crisis comes down the pike, you fall in love example, they charge you huge over charges.  The typical plan delivers minutes at about five cents each and forty cents a minute.  Better, at least for them, is that as little crissis come and go your start changing your plan to buy more minutes, which in the absense of a crissis you don’t use.  That in turn raises the real cost of even you noncrisis minutes.  It’s a very impressive pricing scam isn’t it!  I recomend prepaid (t-mobile for gsm, pageplus for cdma on verizon).

If we ignore prepaid cell phone service, the cell phone contracts with a bundle of minutes every month are a bit like lousy insurance policies. You buy the option to use five hundred minutes, not because you need them, but because your insuring against the risk that you’ll run over and get stuck with the over charges.  That’s great, and I mean that sarcasticly, they are selling you insurance against a risk they created.

It amuses me to wonder what would happen if everybody in the country could be coordinated into using all those free minutes one month.  I very much doubt the phone companies can fufill that promise.

The options contracts implicit in those monthly cell phone contracts are analogous to the insurance pools.  If we could coordinate the month of the phone it would be the analogous to a hurricane or a plague, at least from the point of view of the phone company.

That scenario has been playing out with the internet service providers, at least for the incompetent ones.  For example Comcast sells me a package with certain assurances about what bandwidth I get into the Internet.  Unsurprisingly the consumption patterns of their customers is highly skewed, and I’m one of the higher users since this site runs over that connection.  Inspite of 20 plus years of history showing that Internet consumption grows extremely fast and quickly grows to fill the pipe provided Comcast was suprised when more users actually exercised the option they had bought.  It is not relevant what these users are doing with the bandwidth (P2P, video, voice over IP, spam) because if it hadn’t been one of those it would have been something else.

This last example, the ISP’s problems, is not actually an example of pricing design in the face of a highly skewed distribution.  It just looks like one at first blush.  The real problem the ISPs face is the rapidly rising tide of usage.  They thought they had a slower growing usage situation, something more like what is seen with the cell phones, but they were wrong.  When they discovered some of the users were consuming all the bandwidth they thought they had purchased the ISPs presumed those users were little trouble makers rather than early movers.   But that’s a mistake, soon everybody will consume all the bandwidth they can get.

Michael Heller’s new book looks interesting.  Heller was, for the last decade, been working to introduce a bit of balance into the discussion down stream from the idea that goes by the name “Tragedy of the Commons.”  He originally called his idea “The Tragedy of the Anticommons.”  Those who public goods coming to tragic ends often prescribe a dose of property rights.  Heller is interested in situations where too many property rights create grid lock.

His Authors@Google talk is a good introduction.  About a half hour long it touchs on various coordination failures with substantial social costs that arise from an abundance of property rights: Drugs that don’t get developed, families displaced from their legacies, urban development frustrated, air traffic congestion, foul ups in the post soviet privization programs.  Good stuff, and he is reasonably straight forward about how societies should be more aware about the balance they strike when they architect their property rights schemes.

That last point is of particular interest to me, since it goes to the question of how you shape the power law curves.  Is the single property owner who frustrates the urban developer the hero of the long tail; or is he just the worse case of ground cover strangling urban vitality?  Guess I’ll need to read the book.

I’m bemused, or confused, by the realization that both these tragedies arise because some coordination problem blows up when too many parties have simultaniously have rights.  I guess you might say the anticommons goes down the tubes when one player says no (or more often just lies silent) while the commons blow up when too many people say yes.  After a bit I can’t see these as really different, it’s back to the group forming coordination problem.

This talk by Clay Shirky is a basicly the first bit of his book performed live.

He cut from the book the suggestion that the phase transition we are going thru is going to lead to chaos.

I don’t recall hearing before the delightful idea that Institution rely of carrots and sticks, but that if you want to tap into the the long tail of one off contributors you can’t do that, making the long tail a no carrots, no stick zone. That is very line nice. While it’s probably not true, since systems that work by filtering value out of that thin soup of long tail contributors can to a lot to manage their incentive structures, it is a very good rough approximation of the right mindset.

Sitting in the small Vietnamese restaurant in Western Massachusetts an ominous dark cloud slowly delivered one of those marvelous downpours that sometimes end hot summer days. For the woman at the next table the sky was bright one moment; the next the windows were sheeted with water. A young man walked across the square, hood up, jacket unbuttoned, tee shirt glued to his chest.

The woman spoke of global warming to her companions: a friend and a husband. She mentioned that she thought such storms were becoming more common. She mentioned hurricanes. His counter point was that we don’t know much about hurricanes, maybe a few decades. No doubt this was only idle conversation; but I quietly leaned across my table and whispered to my wife. “This is important. Somebody is wrong on the Internet!”

I’ve been haunted by this conversation. He’s wrong. She’s right.

Finally the ghost of the stairwell was sufficiently frustrated to manifest himself, at least in virtual form. Fresh off the presses “Weather and Climate Extremes in a Changing Climate” - From the Brochure: “More frequent and intense heavy downpours and higher proportion of total rainfall in heavy precipitation events.” - “Very Likely.” From volume 3, chapter 2 of the final report: “Paleotempestology is an emerging field of science that attempts to reconstruct past tropical cyclone activity using geological proxy evidence and historical documents.”

Ah, if only. I could have leaned over and said “Paleotempestology!” Well, as we like to say around my house “Oh, tell it to the blog!”

I have sighted a new urban myth: Electric heating is cheaper than oil heat! Here in Boston people heat with both gas and oil, and the cost per unit of heat between the two has diverged rapidly over the last few years. Those who heat with oil are looking for ways out of their plight. Apparently the rumor making the rounds that it is cheaper to use electric. That’s not true.

In related news Martin brings my attention to a company EnerNoc that sells negative energy, i.e. load shedding, to the utilities. They use telecom and widgets to shift power consumption from high demand time periods into low demand time periods. Martian’s example is the fridge. You chill when power is plentiful and let it coast when others are paying higher prices.

I assume that EnerNoc’s role in all this is to aggregate small power users into a large enough pool to be worthy of selling to the utilities. It’s a interesting example of a coordination problem. There are of course other ways to approach the problem; ones that are less dependent on a thicket of contracts and ongoing coordination signals controlled by a middleman and enabled, as Martian, points out by the telecom infrastructure.

The obvious alternative is to just broadcast signal; and let the demand side react to the signal by selling some simple technology that responds to the signal in reasonably simple ways. That alone would enable substantial contributions from the demand side. But you can improve the incentive structure either thru regulation or by using statistical sampling to tell which customers have gotten with program; and then reduce their tariffs.

The amount of signal that needs to flow from the grid operators to the consumers is small, in the sense that you can broadcast it. A signal only needs to flow back the other way sufficient to assure that the incentives play out right. It is stupid to presume that the only incentives that are available are monetary or that they need to be executed with fastidious accounting. Most social systems have very fuzzy accounting and they work just fine, thank you!

The puzzle to be solved here is how to draw more of the peripheral demand into a load balancing system. Reading about EnerNoc’s approach isn’t the first time I’ve seen discussion of this. For example Bruce Schneier mentioned a regulatory attempt at something similar. I liked that one a lot, it provided a way to signal household thermostats. He was concerned that the resulting system would attract hackers. I presume he’d be just as sanguine about the security of the EnerNoc system; probably more so since it’s a closed system.

Such concerns are appropriate, but for heaven sakes I wish smart people like Bruce would stop pretending that these cases are somehow unique. It is the very rare large scale system that doesn’t have vunerable choke points. Hubs who’s failure can bring the entire system to it’s knees. Telling designers not to build large systems because of those risks is lame. Helping them know how to build them so they are safe and robust is hard, yes. But these systems get built because they generate mind boggling amounts of value. So it’s better to do the hard job and forgo the short term pleasure of a bit of hysteria.

Speaking of load shedding: turning your car’s engine off when you stop is more efficient than you thought.