Category Archives: business modeling

de novo branching

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banks.pngIf I tally up all the retail businesses with in a mile of my house one category stands out. Retail banking offices are an invasive weed on the local landscape; a persistent weed. Presumably rational business men over the last year have built quite a few new branch offices in my town. Demand for banking services certainly hasn’t increased. Our economy and demographics is very stable and looks likely to stay that way. The reasons for this blight must lie elsewhere.
But where? Here’s my guess. There is tremendous pressure on firms to grow, and to take risks to enable that growth. The rules of the game are, oddly, structured so that on average these bets don’t work out very well. For the investor this is a statistical curiosity, a lot of risky bets plus some diversification creates higher return. For the firm’s employees and neighbors it’s an offputting realization.

In the days when banking was closely regulated business banks expanded by building new branches, and enticing customers to open accounts. The classic enticement was a toaster.

When society discarded the regulations against bank consolidation the route to growth was acquisition. Growing companies by acquisition is risky; it creates a slew of coordination problems to be solved. If your lucky you get some economies of scale. Modern IT has made banking pretty efficient. Bank acquisition was one way that IT efficiency spread through the system. So I’ll buy that there was some cost and efficiency drivers for the rollup of banking over the last few years.

I gather that’s pretty much played it’s self out. The banks that were available to be acquired have become a scarce commodity. No doubt this has created demand for more. Some of the new branches are tiny banks building additional branches, and I think they are dressing up for acquisition.
Banks are now returning to their traditional growth strategy; i.e. opening new branches. I doubt there are powerful technological drivers for this; but there are regulatory ones. Citibank, which recently announced plans to build numerous new offices around the Boston area, can do that because of regulatory change and when you combine it with the scarcity of banks available for acquisition it’s their cheapest route to growth.

Apparently all the largest banks are playing this game, which goes by the name de novo branching (note that link is 2003). What’s a bit disturbing is the realization that mot of these giants are not yet on the ground in my town; so it seems not unlikely we are going to get a lot more banks real soon now. Their investors demand that they grow; they don’t care that my town is way over banked;

miscreant market

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Schneier points out this paper (pdf) reporting on patterns the researches found by listening on on the IRC channels where evil-hackers buy and sell credit cards numbers, bot-net rentals, and the other commodities of the spamming and identity theft industry.  The authors refer to the actors in this market as miscreants.  I guess I can’t really call this a miscreant market; since we usually name markets not after their participants but after the commodity exhanged; as in meat market.

This market is interesting as a case study.  Since it’s commodity is illegal it has a harder time condensing out hubs for the exchange to rendezvous around.  They use IRC channels because that medium is a bit more peer to peer than other choices.  I presume that this community is the one that will finally build a real anonymous peer to peer IRC network.  Well pseudo-anonymous because like any market they need to have a reputation bank of some kind to keep the books of the repeating prisoner’s dilemma.

Had to write this.  I couldn’t reisist getting the word prisoner, miscreant, and evil-hacker all together in a posting about market structure; mentioning peer-to-peer is desert.

Tax collecting

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Bridges make great venues for collecting a tax.  They are a bottleneck. As soon as people find a route around that bottleneck then your power to collect the tax weakens.  Income taxes, for example, work only because firms have rich accounting systems that it would be hard for them to route around just to avoid the taxation.  Of course the rich can route around them.

As technology changes the bottlenecks move around; and tax collectors slowly follow along behind.  Slowly because people don’t like taxes, but inevitably because people dislike the absense of government a lot more.

So the question arises where in a highly globalized information economy are the bottlenecks where taxes might be effectively collected?  At the emerging hubs.  For example a tax on search would work.  A tax on eBay, Amazon, and Windows would work as well.  I’m surprised I didn’t see this before.  What triggered it was it appears that China sold their search franchise.  I don’t think what your seeing there is censorship; it’s about revenue, regulation, and as usual who’s cronies are in favor.  That firewall of theirs looks like a real money maker!

Micro-utility Coops

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gasmeter1.jpgThere is a certain fantasy, at least among Americans, that they might go off-grid. Grow their own vegetables, keep a some live stock, heat the house with wood from from their own wood lot, a yurt, a windmill, some solar panels. Of course a the satellite TV and Internet connection would be nice. Off grid is one thing, but no TV or Internet – that’s crazy; I mean “there are more World of Warcraft players than farmers.”
The grids fascinates me; including the utility grids.

I contemplated my gas bill (google spreadsheet, the onion). Broadly the gas bill has two parts; one part is the cost of the gas and the other part is the cost of tapping into the gas distribution network. The gas distribution network is a classic two sided network; they buy from assorted suppliers and sell to assorted consumers. Here’s the formula, a function of C and T; where C is their cost to buy the natural gas, and T, the number of therms of gas I use.
Bill(T, C) = $14.72 + .34*min(0,max(T-3,47) + .053*min(0,T-50) + (1/45+C)*T

For me $300 a year, about a quarter of the bill is the cost to access the local distribution network.

I could go half off the grid, saving $150 a year if I could coordinate my purchase with a neighbor. We agree to form a gas purchasing micro-coop. One of us cancels our service and we run a pipe over to his house from the remaining service. You can buy a gas meter so the bill is split equitably.

Schemes like this are all about coordination costs. I think you could do a lot to lower those coordination costs by providing a bit of innovative technology and IT to help. For example. Consider the micro-gas coop outlined above. A vendor might offer a kit for setting this up. The kit would include a gas meter for each member which reports usage back the vendor who then bill the members. This reduces the coop’s coordination costs to signing up, setting up, and occasional maintenance of members. Reducing an on going coordination cost to mostly just a plumbing problem.

Of course there are other utilities that this makes even more sense for. Internet access and cable TV access for example. The CATV installer, some years back, told me about some guy in a small city north of here who had his entire neighborhood running off a single CATV subscription. At least at that time the rules were such that you could do that; and even today there is plenty on the CATV cable that you can view just by plugging your TV into it.

Meanwhile, flickr has a great pool of gas meter photos. Where you can see there are plenty of apartment buildings a coop housing estates were a micro-coop wouldn’t be that hard to plumb.

Banking Concentration

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This is called burying the lead, in the ninth paragraph of an eleven paragraph article.

Nationwide, perhaps the most significant point in the FDIC reports was figures showing Bank of America’s total deposits account for 9.9 percent of all US deposits, including assets it is acquiring with its purchase of LaSalle Bank in Chicago, according to analysis by research group SNL Financial in Virginia. This moves the bank up against the federal limit of 10 percent, beyond which it cannot grow by acquisition.

The nominal headline of the article was that smaller banks in Massachusetts appear to be taking market share away from the larger banks.  On that topic the article appears to be mostly hearsay: “… she’s heard anecdotal evidence that frustration is driving the growth of midsize institutions. “They’re gaining on having lower fees, some higher interest accounts, and perhaps better service”.  My impression is that there is some very aggressive efforts by some area banks to drag customers in; and it appears to me this is in service of making them more attractive acquisition candidates.  For example DanversBank is both 6% interest on your checking account (with very complex rules) while at the same time it is going public.  Going public is, I think, a precursor to selling the bank off.

Presumably Bank of America will now be lobbying for loopholes so it can get yet larger.

Expensive Eccentric

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Markets are the friend of the plutocracy. In the market the votes are per dollar rather than per person. Which is, in passing, one reason why “market choice” isn’t synonymous with democratic freedom. Progressive governments do assorted things to counter the pro-plutocracy tendency of markets, for example creating public goods that raise the foundation the entire economy stands upon, but that’s not what this post is about.

Tibor Scitovskyin his book “The Joyless Economy” points out that mass production can act as a countervailing force. Mass production, which can lower unit costs tremendously and that empowers the masses to draw out of the economy goods which raise their standard of living and fulfill their desires. The market aggregates their dollars and mass production leverages those dollars. These pseudo public goods are leveraged by both rich and poor.

This arguement is analogous to the change the subject argument made whenever the distribution of wealth becomes the subject of attention; e.g. that rising standards of living have raised all boats. I don’t have much patience with those arguments, but that’s not what this post is about.

Economies of scale create a well known perverse effect; they tend to make the largest producer in an industry the cost, quality, and profit leader. That’s is good for the plutocracy and bad for the health of the market. What Scitovskyin highlights is a perverse effect on the consumer side.

Scitovskyin uses an older term for the consumer, he calls them the mob. The mob is the complement of the plutocracy. The mob can only benefit from economies of scale if a coherent demand signal emerges in the market about their desires. In the absence of that signal the producers don’t know what to make. That creates a yearning for both producers and consumers to rendezvous, standardize, on achievable desires.

It is perverse that mass production creates incentives for everybody to be more conventional. Advertisers pour money into the market is their yearning to accelerated the forming of this or that consensus. It’s parsimonious to argue that when they succeed it’s their desires, rather than the mob who’s desires really being fulfilled. One is tempted at this point to call them the herd. In any case, economies of scale act encourage normative of behavior in the mob.

Markets make it expensive to be eccentric. What ever goods and services the eccentric desires are substantially less likely to be produced by the market. Of course if your rich you can bear that expense. If your poor these market forces pressure you to extinguish your abnormal desires. There is a long tradition of plutocrats fearing the mob, see French revolution. Early propagandists felt it was in their brief to help keep the mob in line. It probably says something about American education that I’d not previously noticed that the market works to normalize the mob’s behaviors.

It is amusing to note that the rich, while probably not born more or less abnormal than the rest of us, are less likely to have their rough edges worn off.

But there is another point I want to draw out here. As I’ve only just begun this book I don’t know if he goes onto make it. The economies of scale also work to extinguish some goods and services. Mass production is not a universal solution. It is not effective across all goods and services. It works well for something thing, e.g. lawn furniture, but much less well for others, e.g. live music.

So a second perversity of markets is that they work to extinguish goods and services that are resistant to scaling and this happens even if there is substantial demand for them. Thought provokingly, by the force of habit the market will label those activities as eccentric; and when members of the mob signal their demand for them they the market’s return signal will be “mind your manners.”

Bribing the Pirate

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This is kind of fun.

In the October/November issue of the Academy of Management Journal, the authors note that the basic purpose of options has been to promote managerial aggressiveness in top executives, even if they sometimes led them “to undertake large-scale risky investments that tended to deliver extreme company performance.” What was not envisioned, they write, “was that the extreme performance delivered by option-loaded CEOs was more likely to be in the form of big losses than big gains.”

I’m not sure of their premise, i.e. “the basic purpose of options has been to promote managerial aggressiveness”. The purpose of options is and was to create improved alignment between the employees and the shareholders. A shareholder may want a more agressive management, i.e. higher risk and increase volatility, but only if that shareholder is well diversified so he can temper that with the rest of his portfolio. Options tend to create higher risk taking since the option holder, unlike the shareholder, doesn’t actually have capital at risk.

It’s fascinating to me how capital/shareholders may be perfectly happy to have their managers take risks that will kill the company; since limited liability shelters them from the full magnitude of the down side while they are likely to get much of the upside. So the pattern seen above maybe what the owners want.

Update: Paul Krugman makes an analogous moral hazard argument.

See also the pirate metaphor as applied to limited liablity.

Do you feel lucky, Punk?

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Brad DeLong picks up some postings arguing that Google destroy’d the garden wall revenue model that the New York Times was using for Times Select and that others (e.g. the Financial Times and the Wall St. Journal) aren’t long for this world.

My first nit to pick here is that it wasn’t Google, but the tsunami of disintermediated content that blew up that business model. If you looking for the institution to blame it was the internet and it’s end-to-end design principles. Google had nothing to do with it. Well maybe it had a tiny bit to do with it; but it pains me how people are unable to distinguish the value of Google from the value of the content it is now the intermediary for.  This is like confusing the card catalog for the library, or Sony for the Shastakovich.
Brad then goes on to say something much more interesting to me.

I suspect we are headed for a winner-take-all situation here as well: journalists who acquire reputations as experts will do very well as they become draws for advertisers. Institutions–not so much. Anybody who trusted the New Republic under Michael Kinsley and then encountered the New Republic under Andrew Sullivan, Michael Kelly, and Peter Beinart learned a very painful lesson about focusing on institutions rather than people.

That is indeed the pattern. Winner take all maybe a bit exaggerated, but the pattern is clear; and this is the yet again the question of what the highly skew’d distribution of economic entities will look like going forward. As we skew more severely we end up with fewer intermediaries and everybody else cast into the role of a solitary player. Institutions fail, certainly, but it is ironic that in a single paragraph Brad can suggest that we should expect a single institution, Google, to win it all and then advise us not to focus on institutions; just on the solitary players.

Sharing Cell Phones

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In Yochai Benkler’s essay “Sharing Nicely” about large class of institutions where people solve problems by sharing rather than market clearing or regulatory frameworks he blocks out a rough model of what enables that them; e.g. a large pool of excess capacity (empty seats in the car, idle cycles on your PC or your head) and ownership at the periphery.

With that model in hand you can begin to look for them.  And there are lots and lots: in the ride share space; the community wireless movement; around the P2P, mesh networking, craig’s list, freecycle, leave-one/take-one book exchanges, etc. etc.  There are lots of little examples of which the pool.ntp.org is a great one.  And given that you start to see them you can try to get to the next level and see if you can find opportunities to create new ones; e.g. entrepreneurial opportunities to create new sharing institutions.

This is fun! It’s like three other periods in my life when I developed an eye for a new pattern.  For example at one point I started to realize that marketing people had an eye out for empty niches in your house and tried to slip products into them: the fridge door, the medicine cabinet, your pockets.  That each of these was a competitive landscape.  For example at one point I noticed that there were components which were so widely used for one function that they created a near discontinuity in the price curve for things of their kind and that they then created options to repurpose them: the magnets in disk drives, or the motors and lasers in cd players are both examples.  The sharing nicely examples are analogous to both of those.

So, it looks to me like wifi/bluetooth equipped phones are an almost perfect example of a substrate for Yochai’s sharing systems.  If they were sufficiently open and sufficiently dense upon the landscape it should be possible to route around the Telcos.  That would be fun.  I don’t doubt this idea has already brought a smile to a lot of engineer’s eyes inside of the handset manufactures.  Makes me wonder, is Apple planning on doing just this to escape the relationship with AT&T?  Makes me wonder if you couldn’t to this today with some of the Linux based cell phones.