Ironick

A great article on modeling risk

I finally got around to reading Risk Management in the New York Times Magazine. It is one of the best articles on

• Wall Street
• Modeling
• Risk
• How people game models
• How all models eventually fail

that I have ever read. It is must reading.

All risk management systems, all (complex) models for that matter, are examples of robust yet fragile systems: robust in the face of expected events, yet extremely fragile in the face of unexpected events. Of course we will "fix" our models and rebuild. But remember Hawkins Law:

Progress does not involve replacing one theory that is wrong with one that is right, rather it involves replacing one theory that is wrong with one that is more subtly wrong.

And that more subtle error will one day cause the edifice built upon it to come crashing down. And so it shall always be, since there's no such thing as a free lunch.

Take a free ride or be nickeled and dimed--it's up to you.

Good article in the Sunday times on vendor's strategy of "shrouding" costs, aka to "nickel and dime": "Why That Doggie in the Window Costs a Lot More Than You Think". The article is based on the paper "Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets".

What I like about the article is the interaction among sophisticated consumers, myopic consumers, and vendors: sophisticated consumers are subsidized by the profit that vendors make from myopic consumers. For example, credit card companies offer no annual fee credit cards, which give sophisticated consumers free credit because myopic consumers foot the bill with late fees and interest charges.

It reminds me of a New York Times article from a couple of years ago: " It Adds Up (and Up, and Up)". The "Adds Up" article discusses how information services vendors break up costs into lots of small charges to make it difficult for consumers to see the Total Cost of Ownership.

The nice IT implication is that the TCO for a product or service will depend very much on whether the ITO is a sophisticated consumer or a myopic one.

Dissolving the paradox of decades long disruptions.

[This is an excerpt of an email discussion we are having regarding the pace and effect on incumbent carriers of the migration to VOIP. In a previous post I had stated that, "While I agree that the disruption of and eventual replacement of ALL forms of wired communications with wireless digital communications, as all good disruptians know, "disruptive technology" can sometimes take place over decades." Of course, this generated the standard objection: how can a technology evolution that takes decades be called "disruptive." Since this happens so frequently, I'm posting this answer to this FAQ on my blog so I can just link to it in the future.]

Both "disruptive innovation" and "sustaining innovation" (Christensen's terms) are kinds of evolution. And both may happen relatively quickly or relatively slowly. What distinguishes disruptive innovation from sustaining innovation is clearly laid out in Christensen's book. I highly recommend EVERYONE read it. There are many aspects that distinguish the two; most of which I highlight in my Disruptive SOA Trends pitch--an homage to Christensen, which I'd be happy to send to anyone.

But the easiest way to tell if an innovation is disruptive (and hence the reason Christensen calls it by that name) is to examine its impact on the market, i.e., whether the dominant companies in a market remain the dominant companies after the transition to the new technology. If they are, then it was "sustaining" technology because it "sustained" the common business model of the dominant incumbents. But if most of the dominant companies are wiped out by the new technology, then it was disruptive technology because it disrupted the common business model of the dominant incumbents.

That is why Christensen's research on the excavator market is much more interesting than his research on the hard drive market. In the excavator market, the dominant incumbent cable-driven excavator manufacturers had thirty years to adapt to the new hydraulic excavator technology and they still failed to do so. Thus virtually all of them disappeared when the cable excavator disappeared from the market.

Christensen's fundamental question was to understand why seemingly well run companies that dominated a technology market would often be unable to adapt to new market conditions and as a result, cease to exist, or at least lose their dominance. His theory of the two different types of technical innovation and their differing impact on dominant business models was his answer. And one of his fundamental insights, often overlooked, is that adaptiveness, is NOT about being able to change quickly; it's about being able to change at all. Some companies have plenty of time--decades--to see a new technology growing in the market, and yet they fail so do what is necessary to adapt their business model to it!

Thus, the adjective "disruptive" is not being applied to the technological innovation itself, but to the impact it has on the business models of the dominant firms in a market. When you hear "disruptive technology" think "disruptive-to-the-business-models-of-market-leaders technology". If you look at it this way then the answer to your question ("If a change in technology occur [sic] over a period of say 30 years can it really be called disruptive") is a definite yes. And vice versa: a technology change occurring in five years can be sustaining.

So as to Telstra, the question is whether or not after the decades it takes to migrate the market to VOIP, Telstra will end up dominating that market, or cease to exist because of it.

Cards surpass cash and credit.

Apparently in 2003, for the first time, checks and cash were used for less than 50% of all consumer in-store payments, according to 2003/2004 Study of Consumer Payment Preferences sponsored by the American Bankers Association. They were displaced by card-based payments, with debit cards being the fastest growing type of payment card.

I think this is a watershed event, yet I only read about it in a recent Boston Globe article on layoffs at the Federal Reserve check processing centers: "Check volume at the Fed has been falling faster in recent years. In 2003, check volume dropped nearly 5 percent, compared to 2 percent in 2002 and a half percent in 2001. The Fed handles about 40 percent of the nation's checks; the rest are processed by big banks and private clearinghouses."

What's also intriguing is that the number of consumer payments has doubled in the past thirty years. Obviously, some of the growth is due to population growth, but it would be fascinating to know what caused the doubling: more frequent payments of less value? did the value of consumer payments double as well (doubtful)? The report on the study did not go into this statistic.

The study also had interesting statistics on Internet payments and bill payments (the only two other types of consumer-to-business or consumer-to-government payments?).

The dialectic between Standardization and Innovation is the fundamental source increasing returns.

I already got some great feedback from two law school friends (!) re my previous entry on standardization that has helped me to substantially clarify my thinking. (Leave it to those sharp lawyers to poke holes in arguments). First, let me just say that my entry title was a deliberate provocative poke at the conventional wisdom that innovation is the fundamental source of increasing returns.

Though I alluded to a "virtuous circle" in my entry, I did not clearly understand the details of that circle. I think I have a better understanding now. First, I am using "standard" and "standardization" in a very broad way. As Rorty would say, I am redescribing them, and the test of my redescription is how useful it is in thinking more clearly about things. A "standard" in my vocabulary is nothing more than some degree of coordination among two or more systems (or one system with itself across time). If you think this an unreasonably broad definition, see the ASTM definition of standard, which is almost as broad: A standard is a common language that promotes the flow of goods between buyer and seller and protects the general welfare. Note how this definition is circular to the degree that common implies standard.) Clearly there is a dialectic process going on between system and environment involving standardization and both are being standardized by the dialectic. It is not just the system that changes, the environment (in the sense of the extended phenotype) changes as well, e.g., the dam built by the beaver.

But a much more important dialectic is going on as well: a continual transition from standardizing (coordinating) to innovating (disrupting the established coordination). It is this dialectic (or dynamic equilibrium?) of standardization/innovation, stasis/change, or solidarity/irony (for you Rortians) that is the fundamental source of increasing returns. Thus the speed with which a system can shift from a standard to an innovation, and the range of innovations it can generate both determine its evolvability, which is the source of increasing returns.

Once again, I see dualities where once I saw opposites. Perhaps the most satisfying duality is the solidarity/irony duality. I never found Rorty's exhortations to embrace solidarity very convincing. I now see clearly that irony, which has intrinsic appeal to me (and most everyone) cannot exist without a "solidarity" to react against.

Standardization is the fundamental source of increasing returns.

This is a pretty profound statement:

Notice that, in the case of organizations and institutions as in the case of technology, standardization is arguably the fundamental source of increasing returns.
Richard N. Langlois, Knowledge, consumption, and endogenous growth

I'm going to have to reconcile this with my prioritization of my four "economic forces:" commoditization, virtualization, integration, and innovation. I'm also going to have to reconcile this with my prioritization of "modularity." I'm thinking that modularity is a means, and standardization is the end. Thus, contrary to some opinions (perhaps even my own at times): standardization is not a means of increasing modularity; modularity is a means of increasing standardization. This includes such forms of modularity as "division of labor."

The reasoning behind Langlois' assertion is I think captured in part by the following quote:
Consider the example of printing. If one is going to run off a few copies of a memo, a photocopy machine will do the trick. If one needs several hundred copies of documents on an ongoing basis, it might be worth investing in a small offset press. For even larger predictable production runs, it would pay to have a more serious printing press. As volume and predictability allow greater "durability of dies," unit costs decline. This is an effect of growth in the extent of the market distinct from the division of labor narrowly understood. And the reason that costs decline as dies become more durable is not because the knowledge itself leaks out but because the knowledge – created once – is spread over more and more units.

This means that increasing predictability in the system's environment (a market) favors increasing standardization of the system (the printing press). Even more generally: the behavior of the environment shapes the behavior of the system. But note that the system itself is part of the environment, so this creates a virtuous circle of environment shaping system shaping environment. And this shaping is in the direction of ever greater predictability and standardization.

(Is standardization then just a type of predictability? Is the direction of evolution then in the direction of organisms with ever greater predictability, including "predictive power"? Is the direction of evolution in the direction of ever greater standardization? Are ever greater predictability/predictive power the same as adaptability? How does this fit with increasing entropy?)

The Lifespan of a Company.

From The Living Company by Arie De Geus

The average life expectancy of a multinational corporation-Fortune 500 or its equivalent-is between 40 and 50 years. This figure is based on most surveys of corporate births and deaths. A full one-third of the companies listed in the 1970 Fortune 500, for instance, had vanished by 1983-acquired, merged, or broken to pieces.1 Human beings have learned to survive, on aver-age, for 75 years or more, but there are very few companies that are that old and flourishing.

I'll bet the lifespans of companies forms a power curve, not a normal distribution.

The Internet Book Race.

"When it comes to books, Internet selling has not led to uniformly low prices. By Virginia Postrel."

Interesting analysis. When Amazon raises prices by X, it loses a smaller percentage of customers than Barnes and Noble does when it raises prices by X. This implies there is something besides price that users value about Amazon. Let's call it "BRAND."

Rapid Diffusion is the Key to Success

An expensive resource (exres) that is essential to only a few will be displaced by an inexpensive resource (inres) that is essential (or very useful) to many, even if the inres lacks some of the features of the exres. Examples: Internet, Web, Ethernet, IA-32, Linux. The inres will diffuse more broadly and rapidly, and the larger market will drive down costs of production. The unique features of the exres will then be ported to the inres, when the cost of the exres exceeds the cost of the port plus the cost of the inres. Visually this looks like a stovepipe in the first frame and in the second frame, a wide base with a shorter stovepipe (both which reach the same height as the first frame). How to represent the lower cost of the second frame? Since market size and cost are highly correlated, use the horizontal axis for both.

The Lever of Riches: Technological Creativity and Economic Progress

Is a good book by Joel Mokyr, which I found through a reference to it in David Landes magisterial "The Wealth and Poverty of Nations." Both books have lots of concrete examples of the evolution of technology and its economic impact. It is chock full of great quotes:

[The dynamic forces of technology and the conservative forces of ceremony and ritual] oppose each other in dialectical fashion, and what is required for technological creativity is the right blend of accumulated knowledge of past generations and the ability to shed the stifling burden of past institutions. pg 190