Too Many Cooks Spoil the Myth -Hidden Hypotheses Syndrome

You likely have heard many of the maxims like the one about cooks and broth – Too many cooks spoil the broth. And likely used it without realizing it and even though you and your colleagues are not cooks or when your work does not really involve making broths. But I can say with high certainty that you never asked,

“Do too many cooks really spoil the broth?”

Thankfully humorist Joe Queenan did. As he set out to question this and many other maxims, Mr. Queenan wonders why they are never true. He offers us some infinite wisdom like,

The English language abounds with hoary maxims—tidbits of putative wisdom that, upon closer examination, prove to be completely idiotic.

The list of time-honored, moronic maxims is by no means tiny.

Folk wisdom is equally cretinous.

The best part is his line of question on the maxim on cooks and broth.

Do too many cooks spoil the broth? Was there a control group with a smaller number of cooks and different broth?

What was likely a humorous take is actually asking relevant questions when rest of us have suspended disbelief and accept these as enunciated truth. Our suspension of disbelief and acceptance of inanities extend beyond broths and watched pots into business realm.

Take a closer look at his line of questioning. A simple question on evidence and the method of analysis that opens wide upon the veracity of the claim.  This simple question we fail to ask when we see, read, listen to Gurus and charlatans presenting their pet theories in bite sized chunks and colorful TED speeches.

Mr. Queenan’s simple question bring out the issues you and I need to worry about when we read, “women in board led to better share performance“. Or “women who play video games have more sex“. Or when a popular Guru sees a movie and writes up business lessons.

The issues are

  1. How was the hypotheses developed in the first place?
  2. How was it verified to be stated as a claim – the experimental design and data collection?
  3. What hidden hypotheses are at play? (As he asks, will the result be different with different broths?)

We seem to be longing for the the comfort of Gurus walking down the mountain with simple business maxims for us to Retweet (and follow). All it takes is one visit to a store or a cab ride for them to come up with sweeping prescriptions for all of us, regardless of the variations. One instance of a chaotic kitchen with cooks milling around and someone tipping over broth pot lets them declare universal theory about cooks and broths.

You cannot place all the blame on them. More than 70% of the blame should be on us – the willing audience that has suspended disbelief. And our failure to recognize the simple fact that it is not enough to know that data fits one hypothesis and we need to look for falsifying evidence.

Here is a simple message – No one can be trusted so verify and trust with reservations.

 

Bigger than Bigger Profits

A while back I wrote an article about brands finding a way effective product versioning to get customers to willingly spend more, happily part with more of their cash and consumer surplus and hence able to drive up their profit.

The principle is not new. The examples were there just to illustrate the power of effective pricing and versioning. None of those examples come close to the scale of what Apple was able to achieve with its iPhone 6 and iPhone 6 plus.

I wrote about long term profit potential of Apple’s iPhone 6 versioning. As customers lined up for hours and miles over the weekend to buy the new phones we have some early survey numbers that points to Bigger than Bigger profits.

In my last article I predicted increase in Average Selling Price just from not offering a 32GB version and making the cheapest version stay at 16GB. With that change and the introduction of iPhone 6 plus we did see a huge shift in product mix sold over the weekend. According to Wells Fargo analyst,

Most notable was shift to 64GB and 128GB models versus prior launch surveys and greater popularity of 6 Plus. Of those surveyed, 67 percent intended to buy the 6 Plus versus 33 percent the 6. Additionally, 33 percent planned to purchase the 128GB versus the last two launches for the highest-end model of 22 percent and 17 percent.

In the end what does the net new profit for Apple look like? Crunching the numbers with data from Wells Fargo analyst and treating COGS increase as negligible here it is.

iphone6-opening-weekend

That’s Bigger than Bigger indeed!

Price Increase By Any Other Name

Increasing price is not easyIt requires careful review of customers you want to serve, their needs and alternatives available to them. Increasing price of an extremely popular product is even harder. When hundreds of millions of people buy your product and repeat that at least every two years increasing price is the hardest task. There is the reference price concern, customer backlash, unpopular social media outbursts and many other risks.

And yet Apple recently increased price of its iPhone 6. Did you notice?

Price increase or shall I say pricing right after a not so right price has to be done if a business wants to increase its share if value and grow its profits. There are many ways to do this – many wrong ways and many right ways. All the wrong ways start with the product and the business interests. All right ways start with the customer.

One naive approach would be to simply increase the price points across the board – say by a preset arbitrary percentage – and hope the customers won’t notice. Customers always notice due to reference price effect. Reference price is the price customers are used to paying for a product and expect to pay next time. Any increase from this level will be felt by customers and perceived as pain. You can see examples of this from a food truck arbitrarily marking up its prices to a tablet maker thinking their products deserves higher prices.

All the right ways start with the customer, base it on current revenue mix, be selective in increase and focus on scaling value more than the price increase. You have seen examples of this with Starbucks and Netflix. Starbucks increased prices only on its cheapest drink. Netflix limits options available on its lowest monthly subscription option.

Then there is product or price unbundling. Separate out the value options that used to be included and charge for them like airlines did. This of course has its challenges and requires careful execution.

Most successful approaches give customers reasons for the increase. It is never, “we want to increase our profits” or “our products deserve it”. There are always other reasons, like cost increase and regulations.

Of all these successful and right approaches one stands alone – how Apple did it. Its approach and expected results are far superior to anything else we have seen before.

They didn’t change any price points – they are exactly same as before. They did’t unbundle. They didn’t take away value customers used to get. They actually gave customers more value than they use to get. How is this a price increase or how is this going to help their profit?

Customers don’t make their choices in isolation or on absolute value. They have options. Even when a customer is a diehard stand in line for 12 days Apple fan they have 3 to 6 iPhone options. For each option customers perceive different value and are willing to pay different prices. When the net value they get over prices they pay (consumer surplus) is highest for an option, they will choose that over others. Price alone is not a factor and lowest price does not win always. If increased value in next higher price point delivers more consumer surplus than the lowest priced option a rational customer will choose the higher priced version.

That is exactly what Apple did. It kept the price points the same, the value of lowest priced 16GB iPhone 6 the same but significantly increased the value of two higher price point versions. They essentially gave customers higher consumer surplus with 64GB and 128GB versions.

This results is many (if not all) who otherwise would have chosen the 16GB iPhone willingly pay $100 more to buy the 64GB version. Effectively a price increase!

This is pricing beyond excellence.

What Apple Gains By Not Offering 32GB iPhone6? $4 Billion?

If you are reading this you already know about Apple’s iPhone 6 launch. One thing you may not have noticed is there was a price increase. Even professional Apple product reviewers did not notice the product versioning change first. Usually Apple releases three versions of the product that are separated by the storage dimension. In the past it was 16GB, 32GB and 64GB. And the versions increase in price by the standard $100.

That changed with iPhone 6. A careful review of the versions will show you this

iPhone 6 versions

After looking at this you may wonder where is the said price increase. Read on.

There is no 32GB version. For $100 more instead of getting just 16GB more or 32GB for another $100 you now get lot more. Instead of 100% more for $100 more and 300% more for $200 (more than base version) you now get 300% more for $100 and a whopping 700% more $200 more than the base version.

However the fact that the base $199 version has stuck in 16GB has caused considerable heartburn to many. Many argue Apple should have offered the base version at 32GB instead of 16GB. Sure they could have and could have done so with no impact on profit. After all their flash costs are so low at the volumes they get.

Wouldn’t customers be delighted to get 32GB at $199 (contract price)? Yes. That is not the point. What Apple would say to these naysayers is, “we are offer far more value than before for $100 and $200 more than we did before”.

What Apple is doing is a simple case of price discrimination done right. It is an effective lever for them to get customers to self select themselves to the version that is most profitable to Apple.

Think of it this way. Let us say the 16GB, 32GB and 64GB versions of iPhone 5 are like 3rd class, 2nd class and 1st class service in a train car. In the early days of American railroads the operators did offer three classes, with the 3rd class at really affordable prices. But the operators wanted those who can pay higher prices to willingly do so. So they removed the roofs in 3rd class cars. People who can afford second class were no more tempted by cheap prices of 3rd class tickets.

In case of iPhone 6 Apple didn’t remove any roofs or cripple it. They decided to add free extras to 2nd and 1st class car passengers for the same money. You can choose to remain in 3rd class but you are not getting free drinks or umbrella.

A customer looking at the base version and the middle version will see lot more value for $100 than if they bought the 16GB version. Many who otherwise would not have chosen the middle 32GB version (had it been there) or chosen base 32GB version (if Apple heeded the advice of tech bloggers and offered it as base version) will pay $100 more.

That is the price increase I referred to before. That is customers will willingly give pay more and still get to keep more of their consumer surplus. So Apple will see an increase in its Average Selling Price (ASP).

What does this do to Apple’s bottom line?

Look at past four quarters of iPhone sales and ASPs.

iphone5-sales

Let us say the unit numbers stayed the same (likely will be higher given the unprecedented demand we are seeing). Let us assume a conservative rate of 25% to 30% of people will willingly choose the 64GB version. Let us give a high end cost of $16 for the additional 48GB storage. Just for this limited and conservative scenario the new Apple profit for the next four quarters look like this

iphone6-sales-forecast

That is close to $4B in new profit just by keeping the base version at 16GB.

Any questions?

Slide7

Seven Deadly #PowerPoint Sins

Here are what I consider to be the most annoying mistakes I have seen in PowerPoint presentations.

  1. Showing a slide filled with words – like word vomit, then half-apologize for that by saying, “I am not going to speak to all the points in this slide”.Slide1
  2. A close cousin of Sin#1, asking audience to read through the word vomit. Slide2
  3. Adding a random picture haphazardly in the name of visual presentation.Slide3
  4. Rushing through the presentation to make every point the presenter already decided to make regardless of relevance to the audience.Slide4
  5. Showing a perfectly crafted eye-candy slide deck, impressing the audience with design skills and hoping no one will ask for data or question the analysis.Slide5
  6. Using meaningless chart constructs like reusing a bubble chart when there are only two variables. Slide6
  7. Hammering a trivial and irrelevant aspect of the slide because the audience didn’t right away appreciate the finer details.
    Slide7Have you committed any of these?

How to build the future in 224 pages?

0-1-peter-thiel-best-seller-startupWeekend Journal ran an excerpt from  PayPal Founder and Venture Capitalist Peter Thiel’s upcoming book,  Zero to One: Notes on Startups, or How to Build the Future. The book is not released yet but is already number one bestseller in Amazon in at least two categories.

Startups is one category and there should be no surprise about that. I have no doubt this book will be extremely popular among those who religiously follow tech blogs, want to run startups or call themselves founders.

The second category is Economic Policy which should come as surprise.

0-1-peter-thiel-best-seller-econ-policy

Standing at 224 pages with no footnotes or references (you can check the content page in Amazon) one cannot help but wonder how this can be a definitive work on both startups and economic policy let alone a bestseller in both those categories.  Its startup credentials come easy, the author founder PayPal and funded many. The economic policy credentials likely come from a provocative chapter that calls for monopoly market power over competition and avers its take on capitalism.

And it does all that with no references to previous works on capitalism, competitive markets or the unavoidable market market move toward market concentration with few powerful players. Not only it ignores any previous works (which there are many, just see the length of references listed here) it goes on to paint a picture that entire branch of economics as antiquated and stuck in 19th century.

Economists copied their mathematics from the work of 19th-century physicists:

Economists use two simplified models to explain the difference: perfect competition and monopoly

 

There is no mention of who those economists are. They are all labeled and addressed as one group – economists.

After several such putdowns of all economists as single class of people, attributing to them what is only taught in introductory coursework the author claims superiority by dismissing these simple ideas easily. It is a time tested ploy to take an already refuted claim, make it sound like widely accepted truth, attribute it as commonly held belief of a vast majority of people and then offer author’s own antidote that causes that belief to come crashing down. For good measure present author’s position as the only possible option with no room for another possibility.

A curious reader with iota of skepticism left in them will find this treatment disconcerting. But there are not that many and the book will continue to remain a bestseller for a very long time. Whether people read this or not they will continue to rave about it, quote from it and will claim this changed everything.

Here we must ask how anyone can opine on such broad and complicated topics of capitalism, competition and monopoly without as much quoting single supporting work or alternative viewpoint. For this we have an answer from my favorite economist, John Kenneth Galbraith,

affluent-society

Now let me end this with a look at what other powerful and popular people are saying about this book. Since these are the blurbs you can get they say nothing but the best. Here are the blurbs from Amazon.com and my annotations.

This book delivers completely new and refreshing ideas on how to create value in the world.”
– Mark Zuckerberg, CEO of Facebook

Careful choice of words by Mark. He does not say these are correct or relevant, he just says “new and refreshing”. Of course if we look at the econ lit even those are highly questionable descriptions.

“Peter Thiel has built multiple breakthrough companies, and Zero to One shows how.”
– Elon Musk, CEO of SpaceX and Tesla

The statement is ambiguous at best. Musk ends with, “shows how”. How what? How Thiel built his multiple breakthrough companies? How to build one such company? How to write a book?

” Zero to One is the first book any working or aspiring entrepreneur must read—period.”
– Marc Andreessen, co-creator of the world’s first web browser, co-founder of Netscape, and venture capitalist at Andreessen Horowitz

The first book? What if we have already many books? Really?

“Zero to One is an important handbook to relentless improvement for big companies and beginning entrepreneurs alike. Read it, accept Peter’s challenge, and build a business beyond expectations.”
– Jeff Immelt, Chairman and CEO, GE

I honestly don’t understand this blurb. I wonder if Immelt even read the book let alone write this blurb. Why should any reader accept the challenge?

“When a risk taker writes a book, read it. In the case of Peter Thiel, read it twice. Or, to be safe, three times. This is a classic.”
– Nassim Nicholas Taleb, author of Fooled by Randomness and The Black Swan

Is NNT calling the readers slow on the uptake? Should they be spending time reading the book three times or spend the time in critical thinking to find alternative explanations for author’s observations?

“Thiel has drawn upon his wide-ranging and idiosyncratic readings in philosophy, history, economics, anthropology, and culture to become perhaps America’s leading public intellectual today”
-Fortune Magazine

If this is indeed true the readings must come through in multiple footnotes. You are only left guessing about author’s readings on these complex topics.

“Peter Thiel, in addition to being an accomplished entrepreneur and investor, is also one of the leading public intellectuals of our time. Read this book to get your first glimpse of how and why that is true.”
– Tyler Cowen, New York Times best-selling author of Average is Over and Professor of Economics at George Mason University

Tyler Cowan gives a circular argument.

“The first and last business book anyone needs to read; a one in a world of zeroes.”
– Neal Stephenson, New York Times best-selling author of Snow Crash, the Baroque Cycle, and Cryptonomicon

Neal goes one step further than Andreesen who stopped at, “the first book”. Neal adds, “the last book”. So just this book is all you need to start and run a business. Nice play on words, using zero and from title of the book to praise the book.

 

Question to you, where do you stand?