Markets, unintended consequences and the spam in the Feudal System

Ok, so the title will only make sense within the context of Blizzard’s hugely popular (and financially successful) World of Warcraft. WoW is, very simply, a multiplayer online game (and by multiplayer we’re not talking of 4 players here, but rather millions of players around the world) where players interact with other players and the virtual world of the game.

A key component of the game is that special items can be purchased. The currency is “gold” and gold can be earned in a variety of ways. The least interesting of which is by performing basic tasks and completing basic quests. These are, in general, not very difficult or challenging, but do still take a fair amount of time. The other piece of the puzzle that is relevant to this post is that gold can be transferred from one player to another.

Without too much difficulty, it should be clear that players with lots of time and little money are incentivised to spend their time earning “in game currency” to sell to time-poor and money-rich players for real world cash (i.e. as in US Dollars). The sale of in-game currency in the real world is a free market, so free-market economics forces act on the allocation of resources (time and money) in a way as to more optimally allocate resources.

Picture if you will the far-eastern sweat-shops manufacturing shoes. Now replace the glue and sewing machines with computers, and replace the shoes with in-game WoW currency. Cheap labour comes to the fore and a business is born. In-game currency is the product, salaries (and a bit of computer, WoW and internet expenses) are the Cost of Sales, and real hard cash from time-poor First World teenagers and adult is the revenue.

Two problems:

  1. Is purchasing vast quantities of in-game gold with real-world currency (presumably earned from applying one’s particular real-world skills and talents in gainful employment) cheating? Is there a moral or ethical angle here? What is it?
  2. How do the “entrepreneurs” boost sales? They advertise! How? By spamming in-game players with messages.

The first point is interesting, and worthy of a blog (and quite likely a UN commission as well). The second point that has seen some recent action from Blizzard, who are suing one of the companies behind the in-game spamming. Will be interesting to see how that develops. Slashdot also picked up the story.
But, understanding how the problem arose is clear with the benefit of hindsight. However, I am quite certain that with some basic analysis of the economic forces in the game, and an understanding of consequences, these problems should have been anticipated by Blizzard. Seems like they have fallen one step behind the spammers, which could also be interpreted as the power of the free market.

Oh, and the Feudal System? The company being sued is “peons4hire”.

Aftermath of 20 May 2007 bomb in Beirut

This is a different sort of post, but given the huge impacts the recent (and not so recent) events all over the Middle East have on people’s lives, countries’ economies and business decisions, it is worthwhile to recognise the very real problems that exist in these markets.
A few photos of the damage and tension after the tragic bomb blast in Ashrafieh, Beirut on Sunday evening, 20 May 2007. Several people were injured and one woman was killed when the force of the explosion caused a wall to collapse on top of her.

Sweeping up broken glass in Ashrafieh, Beirut after explosionLow light photo of Lebanese Army maintaining security near ABC mall after explosion in BeirutGarage door at ABC mall damaged by bomb-blast in BeirutStreet near ABC bomb location in BeirutThe Lebanese Army assisting and protecting at the seen of the 20 May 2007 car-bomb in BeirutBroken window in Ashrafieh near when one woman was killed after carbomb explosion in Beirut

Useful commentary on a useful tool – MySQL

I mostly use MySQL for ad hoc analytical work for specific projects – the sort of work where Microsoft’s Access product just doesn’t cut it because of the size of the data-sets involved. However, this is really just the tip of the ice-berg for MySQL, which powers a large proportion (I don’t really have any idea on the actual stats) of the web’s sites and more.

There are competing products, free and open-source. For some of the analysis that I do, a more specifically oriented statistics package like R or SAS (which is particularly good for large datasets) may also be worthwhile considering.

However, if you’re interested in finding out a little more about MySQL, you can visit their homepage or their developers’ zone. Also, the following two links provide brief pros and cons of using MySQL.

  1. Five Reasons to use MySQL
  2. Eight Reasons not to use MySQL

For those of you who complain that Excel only has 65535 rows (although I hear rumours of more rows in the latest or upcoming version?), perhaps you should consider using the correct tool for the job? Give MySQL a look.

Mbeki points to rand volatility for hurting exports

President Thabo Mbeki made reference to the adverse affect that volatility of the South African Rand has had on South Africa’s export manufacturers. I’ve posted quite a bit about hedging recently, but it seems that the issues just won’t go away.

Volatility hurts planning capabilities. Hedging can restrict the impact of volatility for certain durations. Maybe the exporters need to reconsider the “evil” that is hedging?

With a detailed, technical analysis of the financial and other risks inherent in a business, the appropriate risk management strategies can be defined. Value can be created through the application of these business tools, but only after the application of some sense and knowledge on the damage that volatility can do to a business and sensible measurement of the costs and benefits of alternatives.

Pricing and promoting businesses

David Maister’s blog has an interesting post about the pricing and promotion strategy for a small home-based business. In this case, it’s a pre-school looking for a pricing and promotion strategy. As always, David Maister has some useful suggestions and no doubt his wealth of readers will add some real gold in terms of suggestions soon.

The case involves the pricing and promotion of a pre-school in an area where there are “informal” preschools with little or no qualifications, and formal preschools with highly qualified teachers. The different schools have different prices and demand levels.

I approached the problem by applying a model. In this case it was the “4 P’s of Marketing” model. It is by now an old model, but grew out of a very different time when it was assumed that if you have the best product, customers will beat a path to your door. This was followed by the idea of price competition and price being the all powerful tool to sway consumers in their decision to open their wallets.

Most people now realise that these ideas are too primitive. The 4 Ps are:

  1. Product
  2. Price
  3. Place
  4. Promotion

Some people add a 5th P called “packaging” to the list, which may or may not be useful, and could probably be added under product, with the idea that the product purchased is the full basket of utility attached to buying the item, or added under promotion as part of the more traditional selling process. It’s just a model after all.

I like to apply models to problems as it provides a framework to generate ideas. No doubt there are good models and bad models, and models will sometimes restrict thinking and options as well as freeing up the mind to think of new options. (I am also a big fan of brainstorming and other structured lateral thinking methods to generate creative ideas.) But without a model, it can be difficult to get everybody speaking the same language, and it is easy to look at a problem from only a single dimension. In most cases, applying more than one model is even better. Too many models and you don’t spend enough time applying your mind to the thought patterns under each model.

I mention “models” quite a bit on this blog. Here I am describing mental models for approaching problems, rather than computer-based models for figuring out the numerical answer to a problem. Different application, but both useful.

Here’s my response to the pre-school post:

The question was posed about both pricing and promoting, but then it seems that the rest of the comments all related to price. The 4Ps recipe is an old one, but is still a worthwhile place to start for an initial structure.

Product, Price, Place and Promotion

1 Product

A good product is important, but it isn’t going to sell itself. The analysis presents some information on pricing and supply / demand levels for various “products”, but it is unclear to me whether this analysis is systematic and representative or not. As tough as it is, this is something you need to look at through dispassionate eyes at times. Do other parents want qualified teachers? Or do they prefer a less formal approach. Maybe (and without children myself I am purely putting this out as a possible point of view for discussion) parents feel that they are not handing their children over to an institution if the teachers are less qualified and the setup less formal.

2 Price

Price has been given more airtime than the other components so far. Coming from outside the States, I have no feel for absolute levels of pricing. However, maybe this is an area to brainstorm a large array of pricing possibilities (and get David’s readers to suggest many more!). Maybe you offer reduced rates for the first 5 kids to sign-up, or a discount for upfront payment for a 3 or 6 month period. This could help finance the cashflows early on, encourage some interest and early adoption, but also make it a seamless process to go from discounted prices to a premium-priced service. I do agree with David’s point that it sounds like a tough ask to get a full house in a short space of time, but I suppose a preschool with 2 children isn’t much of a fun place for the children to play and learn.

3 Place

Is the place to which you’re moving right for a preschool? How much has the desire to start a preschool affected the choice of area? Are there other areas that meet all the other criteria (the writer’s own workplace, nearby schools, other amenities and “feel”) but are better suited to start a preschool? What sort of catchment area do you envisage? If the children’s homes are spread around, maybe some form of transport service could transform “place” into something more workable. This again needs a firm understanding of real demands of prospective customers (both the children and their parents).

4 Promotion

How you go about promoting the preschool will be crucial. Flyers placed on cars may be successful (I’m not convinced) but face to face visits to families in the area might add a personal touch, a relationship and trust-building touch that will go a long way to settling anxious parents’ minds and showing that you are serious about a quality, professional product based on whatever mix you are after. If your wife believes in a mostly play-based preschool, then that is what you must show. If it is going to be desks and chalk boards and 18 hours per day of advanced mathmetics lessons, then that is what you convey. Personal selling will allow time for the parents to ask questions and get to know the people who will be looking after their children. If the service fits, I expect the price will be less of a sticking point.

If you use a personal promotion strategy, it also gives you the opportunity to receive instant feedback early on, which you can use to adjust your promotion, pricing and even product strategy. Started early enough, it will advise you whether the “place” you have chosen is going to work to. This goes back to my allusion earlier on that you may need some more hard data and careful analysis before you set everything in motion. The odd discussion with friends over at a dinner party (I don’t mean to suggest you haven’t done more serious research than that, but hopefully you understand my point) does not replace carefully considered homework to make the launch a success.

Because the number of successful promotional visits is quite low (20 or so I gather) it is more sensible than if you needed to fill 5,000 seats for a convention!

A 5th “P”?

There is an occasionally added 5th “p” – Packaging. Unless you’re planning to wrap the kids in bubble-wrap to keep them safe, I think we can safely skip this one!

South African Airlines and hedging

Moneyweb falls into the same trap that many others have stumbled over time and again. David Carte mis-titles SAA loses as oil price falls and makes the mistake worse with the subtitle “A hedge goes the wrong way”. Mr Carte doesn’t belabour the point in the article, but his perspective on hedging is clear. I’ll repeat my comments attached to the story below:

The article reflects a common misunderstanding of hedges. This comment doesn’t necessarily support hedging (since they are good arguments for and against hedging) but it attempts to point out why hedging is not “taking a view” and therefore must not be judged with the benefit of hindsight as to whether the commodity involved (oil in this case) increased or decreased in price.

It isn’t a question of getting the hedge “wrong”. SAA is exposed to the risk of high oil prices. In order to remove this risk, they can hedge against the cost of rising oil prices. This way they are free to concentrate on the operational aspects of running an airline, rather than trying to guess the oil price of tomorrow. In this case, the oil price decreased. The “loss” they have made on the hedge isn’t really a loss – it is offset by the lower cost of fuel for their operations. Similarly, if the oil price had increased, they would have made a profit on the hedge, which would have been offset by the higher cost of fuel in future. The final impact is that changes in oil prices don’t impact them as much as they would have without the hedge.

Now, there are other risks such as “basis risk” and, more broadly, trying to estimate their future fuel needs (i.e. what exposure they need to hedge) but these technical points don’t negate the position that hedging is not about getting it “right” or “wrong”. It is about not wanting to take a view on oil and thus removing the exposure in a company.

Hedging is risk management, it is not taking a view. Having said that, there have been examples of misuse of hedges through mistake, lack of understanding, or trying to use derivatives to take a punt and still calling it a “hedge”.

Appropriate timing for a follow-up to my follow-up on WAR and hedging future gold production. The world of financial risk, hedging, derivatives and risk management require careful analysis, strong technical skills and an understanding of some fairly complicated mathematical models in order to generate value. Throwing a few ideas around because they seem popular does not fit this bill.

Follow up on gold hedging: Western Areas, South Deep and GoldFields

Gold Fields purchased Western Areas (through a share swap) and thus inherited the notoriously “toxic” hedge-book of Western Areas. This event is worth considering in the light of my previous blog on hedging. Let’s apply some analysis and critical thinking here.
First, some real-world imperfections. The hedge book was created in the time of the equally notorious Brett Kebble’s involvement in Western Areas. The structure, the banks involved and the behind-closed-doors-dealings that went into it are not the subject of this post. Definitely scope for some difficult questions here though.

Ok, but what about the hedge itself? Why was it terminated? Ian Cockerill, Chief Executive Officer of Gold Fields said:

  1. “We terminated the Western Areas hedge book because we believe in gold. “
  2. “The hedge book was significantly under water and was a crippling liability to the South Deep mine. Now we can bring the asset to account in a transparent manner.”
  3. “Gold Fields is of the view that the price of gold remains firmly in a long-term upward trend and, with that outlook, it does not make any sense whatsoever to be hedged.”
  4. “It also ensures that Gold Fields remains fully transparent to investors, and that its balance sheet remains simple to understand.”

Let’s take each of these statements in turn.

  1. So Mr Cockerill is stating quite clearly that Gold Fields view is that gold is a good investment, that they expect to make profit about increases in the price of gold over time. Fair enough. And since they are in the gold mining industry, perhaps they will have a more informed view than the average Joe. However, since they are in the gold mining industry, maybe they have a biased view of gold. Most management teams are notoriously optimistic about their company, their industry and can never understand why their share prices are so far below fair value! Also, this doesn’t address my major point that shareholders can easily adjust their exposure to gold in any case. This doesn’t present any arguments for operational improvements or similar efficiencies from terminating the hedge book.
  2. A crippling liability? Raising cash to pay off a liability simply accelerates the cost to now. Not necessarily a bad thing, but not clearly a good thing either. This probably makes sense within the context of point 4 below.
  3. Hmmm, a rehash or point 1 then. Except Mr Cockerill takes it further. “It makes absolutely no sense to hedge”. Well, as I described before, there is more to the decision to hedge than a simple view on the prospects of the gold price. One wonders whether Mr Cockerill couldn’t have expanded on his logical thought process that helped him conclude that there was absolutely no sense.
  4. Ah. Yes! A very valid point, and possibly the only valid point we’ve seen so far. Hedge books are complicated derivative structures and an excellent mining analyst should know about mines and mining and minerals and prices and not necessarily a thing about fancy derivative structures. Fully agree on this one.

So this leaves us with 1/4 or 25% relevancy score. Ok, this is a bit harsh, but it does support my view that hedging decisions are made more on emotion and rhetoric than on rationality and facts.

Now, there is another side to the story. From http://www.mineweb.co.za:

Western Areas also stated that “the hedge banks may be able to terminate the derivative structure as a result of existing circumstances or as a result of an acquisition of control of Western Areas by Gold Fields and in that event, Western Areas may need to make a material payment to the hedge banks and would seek to raise this amount from shareholders, in proportion to their shareholdings. If Gold Fields acquires 100% of Western Areas, then Gold Fields will need to deal with this issue with Western Areas and the hedge banks?.

So, in other words, regardless of what Mr Cockerill and his management team think about gold, they were probably close to forced to close out the hedge book in any case. Let’s hope this was a happy coincidence and not pure spin.

Some more background on the story:

yahoo business
www.mineweb.net

Gill Marcus on Moneyweb in early 2006

Botoxing a bling deal, also from Moneyweb

The place of analysis for entrepreneurs

Entrepreneurs are hailed as saviours of modern society. The current international paradigm (and one which is growing ever stronger in South Africa) is biased towards the idea that career success requires one to create something new and build up something from scratch – head out on one’s own and conquer the earth.

OK, this doesn’t apply to everyone, but the start work at a large company, rise within the ranks to senior management then retire and die doesn’t have the same allure as it used to. I was discussing this with some very bright friends recently. We agreed (in our pop psychology way) that probably one of the causes of this change in attitude was the decrease in loyalty offered by large companies to its employees over the last 30 years. It might be simply a matter of survival that has created this idea that you’ve only made it once you’ve made it your own way.

So increasing numbers of engineers are heading out on their own to form small engineering consulting businesses. Even actuaries are departing the safe and comfortable world of life insurance or pensions for the wild wastelands of “entrepreneurial world-saving activities”. These are entrepreneurs with extensive theoretical training, rigourous mathematical and problem-solving abilities, and (particularly actuaries) a huge array of analysis tools and a deep-seated understanding of risk. Are these skills of benefit or hindrance to these professionals in their new-found living-on-the-edge lives?

Jawwad Farid (an actuary in Pakistan with extensive education in the States, including an MBA) takes a view on this in his blog on the new Image of the Actuary site. (The tagline for the Society of Actuaries is “Risk is Opportunity”, which I quite like as a slogan for actuaries, since we are used to using risk rather than just getting rid of it.) I get the impression that Mr Farid is not a typical actuary in his risk-taking exploits, but he does explain the twin concepts that reduce actuaries’ willingness to take risks:

  1. Possible higher risk aversity (the obvious, but not necessarily all-powerful factor)
  2. Higher opportunity cost of taking risk (more to leave behind in terms of virtually guaranteed good income)

Factor 1 comes from several possible areas. Maybe only risk averse people are attracted to studying actuarial science. Maybe only the risk averse ones make it. Maybe the very process of writing (and passing…) the exams kills off part of the soul of actuaries, leaving them nervous shells of their former beings in the process. While I’m sure these all make a contribution, there can be no question that virtually all actuaries start out as risk averse. In their career choice (at school-leaving age now, mostly) they choose to study a course that is difficult (has a high cost) but reasonably certain rewards (provided they make it). Thus, they are paying a high price to reduce risk. This is a classic definition of risk aversity. As it turns out, many probably underestimate the amount of risk involved in actually getting through the exams. Let it not be said that actuarial students don’t back themselves to meet challenges! Overestimation of one’s abilities is one of the important components of Behavioural Finance and related behavioural studies. (Interestingly, many of these studies show that the extent of overestimation of one’s abilities increases as one’s abilities increase. The frightening fact may be that as actuaries and other “experts” become more qualified, they are more susceptible to overestimating their skills.)

But all those last few paragraphs are something of a digression. The point of this blog is to pose the question: “Does analysis have a place for entrepreneurs?” If it does, then actuaries (and similarly other analytical professionals) should have an advantage, even if it is muted by the dangersr of analysis paralysis. If, on the other hand, the advantage of analysis is so slight in the face of huge uncertainty and the need for brace, gut-based decisions, then actuaries should do well to stay clear.

There is no doubt in my mind that analysis is key to success in business, but I’m an actuary after all.