Compromising Values for Profit

If you want to stay true to your morals and values, stay small. That’s the lesson from Nate Silver’s successful FiveThirtyEight blog/platform for election predictions.

There may also be a second major issue with FiveThirtyEight, which we will describe as one of economy. We start this part of the discussion by noting that every one of us who is writing about politics this year benefits from a horse race. “Things are the same as they were yesterday” is not a story. “Clinton extends her lead” and “Trump makes up ground on Clinton” are. Similarly, we also benefit from finding things that are new and different to talk about. Sen. Bernie Sanders (I-VT) and his rallies tended to get relatively little media coverage; not because of any particular bias against him, but because they were all the same. You can only write, “10,000 young, mostly white people show up to cheer Sanders” so many times. Hillary Clinton, evenhanded and cautious as she is, also tends to give us relatively little to talk about much of the time. With Donald Trump, on the other hand, it’s several new and outrageous and previously unheard of things almost every day. Hence his dominance of the headlines.

Point is, all the political sites have a certain bias towards “dog bites man.” However, there is reason to believe the bias is unusually strong for Silver and his crew. Many political sites and prognosticators—NBC News, the Wall Street Journal, Fox News, Bloomberg Politics—are part of organizations for whom political coverage is part of their core mission. Others—Sabato’s Crystal Ball, the Harvard Political Review—are part of (and are supported by) universities. Still others—HuffPo, Breitbart, Politico, The Hill—are already stable, self-sustaining businesses. And a few—this site, Sam Wang’s Princeton Election Consortium—are side projects of academics who already have day jobs. The point is that while we all like page views and clicks, none of these sites is—as far as we know—facing an immediate existential crisis. Page views could go up or down by 50%, and most or all of the above would keep on trucking.

In short, the article accuses Nate Silver of selling out for money rather than maintain purity of form with insightful and articulate wonky coverage of elections. This is why the most profitable ads that you see on sidebars of major sites are Outbrain specials with outrageous sounding taglines like: “The cameraman kept rolling when she did this” and a picture of a half naked woman. Or how about, “You won’t believe what Donald Trump’s daughter looks like now.” Unfortunately for humanity, insightful blogs like this one and Marginal Revolution can only hope to get half the number of clicks and views, because we cater to the intelligentsia rather than to the lowest common denominator.

Unfortunately, the business mantra of know your audience and know your customer apply to online as well. Just like in the real world, sex, celebrities, and controversy are what draw customers and eyeballs. Eventually, in order to make money, businesses have to bow to reality and cater to this crowd. The alternative to retain control is to remain small and niche (and by extension less profitable), without an overlord or owner to dictate content based on productivity.

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A Profitable Protected Franchise

Surprised to know how profitable auto dealership are? So was I.

Franchise laws include prohibiting manufacturers from terminating existing dealers without “good  cause,” requiring the manufacturers to sell through franchised dealers, and protecting dealers from competition by awarding exclusive territories.

These laws favor the dealers so much that when General Motors GM, -0.22% eliminated its Oldsmobile brand it coughed up $1 billion to compensate dealers, and still couldn’t avoid becoming embroiled in lawsuits. Adding to the dealers’ advantage, some states make it illegal to circumvent the dealers by selling cars online.

Dealers are profitable even when manufacturers are floundering because the dealers make money on servicing old cars and selling used ones. One reason servicing cars is so lucrative is because dealers mark up parts by as much as 80%. For example, a dealer may charge $1,800 for a turbocharger that costs around $1,000. So the dealer pockets $800 before adding labor expenses.

Yeah, there’s a reason Warren Buffett wants to get into this business. When you generate a big proportion of state sales tax revenue, you have incredible leverage to get your favoured bills through to protect your business, at the expense of the average man. How can the rest of us avoid paying tax to this cartel? Move to a place with better public transportation and never drive again.

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New Media vs Old Media

Just read this article about ESPN and how it’s contributing to a drag on Disney’s bottom line. Funny thing is that for the last decade, it was a major profit guzzler while Disney’s other divisions were dragging it down. But now, due to cord cutting and gradual aging of people used to paying for cable, ESPN is finding that even live sports can’t hold the attention of the masses. Their viewership is declining relentlessly.

What should you do when there are fundamental technological changes destroying your customer base? Adapt and disrupt yourself before someone or something else dose. What specifically can the cable giants do? Move their operations online, where more and more consumers are. Rely on advertising or charge minimal paywalls (like HBO) for gated access to premium content. Hulu is a viable medium for archived episodes, while Youtube can stream live shows. Accept lower profits for higher market share in a dwindling industry. Are they likely to implement these changes? Doubtful. Large businesses are by nature conservative, and CEOs are more likely to be fired for rocking the boat than by riding a dying business model to the grave.

Coincidentally, another example of an industry that’s facing rapid technological change is that of computer chips. Whether it’s Intel, AMD, or Nvidia, they’re finding that fewer people have need to upgrade their computer and buy faster chips. We’re so far from being bottlenecked by the CPU today, while we get much more bang for the buck by upgrading the RAM, hard drive to SSD, or broadband internet speed. So what are these chip makers to do when people are slowing the upgrade cycle and some opting out by relying on mobile devices? They go on a quest to find a new must have product or technology that requires more computing power. Gaming was historically the big driver over the last few years, but the next big advance that everyone is betting on is virtual reality.

Herein is an opportunity for up and coming developers or aspiring entrepreneurs. Just like the mobile revolution unleashed a market for gaming apps, so can talented programmers plan for creating worlds in VR. One need that I’ve identified – creating a simulation program for surgery trainees to practice doing surgery, with all the unanticipated complications along the way. It will take a major team of programmers, visual designers, and surgeons to create, but it has the potential to revolutionize how surgery training is done.

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To Make Money in Real Estate, Follow Millennials

One big theme I harp on is that the new demographic bulge of millennials reaching adulthood (their peak spending years) will drive the success or failure of companies. Those who can adapt and cater to changing tastes stand to do well, while other who fail or cling to dying cohorts will be relegated to the dustbins of history.

Real estate has been one of the things on my mind in recent days, and it is without a doubt that millennials are influencing how future communities and properties are designed. Take this for instance:

“What millennials want are places that have a vibrancy, where you … can shop, go out to bars, walk, and bike,” says Lynn Richards, president and CEO of the Congress for the New Urbanism, a Chicago-based advocacy group for more pedestrian-friendly neighborhoods.

(…)

“For a very long time we built up our towns and villages and cities to drive” in, says transportation consultant David Fields with San Francisco–based Nelson/Nygaard Consulting Associates, adding that even drivers like to park their cars and walk around. “People ultimately want choice.” He says demand for biking-accessible communities is currently the highest he has ever seen.

Developers are taking note. Communities in the suburbs that chose to design for driving (I’m looking at you, Orange County) will suffer in the future as the new generations choose to live in walkable high-density places with plenty of amenities. This means that forward-looking cities like Portland, Denver, Austin, and Vancouver will reap the rewards (and they are, in terms of skyrocketing real estate prices)

As the article notes:

Developers and builders are taking note. They are offering bike storage facilities, valet, repair service, and even wash stations in fancy apartment and condo buildings to lure younger buyers and renters.

Crescent Communities, which builds subdivisions, homes, and apartment buildings across the Southeast, looks for cities and towns whose streets are lined with sidewalks and dedicated bike paths.

That’s because the No. 1 thing potential buyers of all ages want in their communities is walkability, the builder learned through surveys it conducts regularly. So Crescent looks for communities that already have those amenities in place to which it can link up its new buildings and developments.

While those hot areas are already expensive now, they may still have room to grow. What’s more rewarding is to look for communities that are still relatively affordable but which have the potential to be the next “hot” city where millennials flock to. I like to look for college towns close to large cities with good public transportation, a fun pub culture, and close to the outdoors (or at least with biking trails and green spaces).

Some potentials:

  • Fort Collins, CO
  • Madison, WI
  • Asheville, NC
  • Salt Lake City, UT
  • Bend, OR
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Millennials Just Hustling to Survive

One big theme in my book is how everyone, especially millennials, have found ways to compensate for the rise in living costs without a corresponding increase in wages. One big way to do this is unfortunately to work a side job. Traditionally, this was limited to low-wage service industry workers. I remember hearing stories from my patients waking up at 4 AM to drive to work in Los Angeles from the outer suburbs, only to return in the evening and work a second shift at a local restaurant. Mind you, all this is to just cover the bills – it isn’t even about making extra spending money.

This practice has now slowly but surely engulfed millennials, many of whom are recent graduates from university who can’t find any meaningful well-paying work in their fields. Many of them choose to monetize hobbies. As the article describes:

The 31-year-old Torontonian makes adult Sailor Moon outfits and sells them on Facebook, a gig she estimates brings in about $800 a month on top of what she earns in her full-time position at a mascot manufacturer.

(…)

Covering everything from teaching English over Skype to driving an Uber, the term has even found its way into Urban Dictionary, where it’s defined as “sideline that brings in cash.”

It’s a tough time out there. Regardless of whether extra money is a need or a bonus, you can monetize your talents in one of these ways. See more details on side gigs in my book on wealth, as well as ways to turn your hobbies into highly profitable businesses.

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Disrupt Yourself in a Declining Industry

A friend sent me this article about the plight of the diamond industry, namely that they can’t appeal to millennials.

This is a frequent problem faced by many different industries, who have failed to adjust to changing consumer tastes. This is why a favourite Silicon Valley expression is: “disrupt yourself or be disrupted”. Namely, stay ahead of the curve, innovate, and shape consumer preference rather than be the laggard clinging to a dying product.

One great story of adaptation that I’ve seen is with Nvidia. They saw many years ahead of time that the market for PC graphics cards was in decline (due to consoles and lack of new groundbreaking games). As a result, they leveraged their expertise into the burgeoning field of mobile device SOCs (chips and chipset). This became a smashing success. By licensing the underlying technology and IP from ARM, Nvidia’s top chip engineers (from their graphics side) could fine tune the SOC to be more power-efficient and powerful than the competition’s.

What if you’re in resource extraction like coal or oil, threatened by the next generation of clean energy? Why not disrupt yourself by investing money in those technologies? That way you can dominate the new industry even while your old products become obsolete.

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How the Wealthy Became Rich

The answer? It’s mostly through slow and steady investment.

The article defined wealthy as those with at least $3 million in investable assets, which is easily within reach.

According to the survey, more than three-quarters of the wealthy investors surveyed came from middle-class or lower backgrounds, and earned their wealth mostly through income from work and investing.

They took one of three basic paths to wealth: earning it; investing to get it, or becoming an entrepreneur. Only 10% attributed their wealth mostly to an inheritance. In short, the wealthy have worked their way to their enviable portfolios, and took a long time getting there.

Regardless of the asset (preferably stocks or real estate), diligent saving and investing over time will let anyone achieve great wealth.

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There’s a Reason They Promote Active Management

Just saw this ad on Morningstar:

marketwatch ad

Investors have started to wake up to the high fees and poor performance seen with active management, and as a result, big financial service firms are trying to stem the flow of money away from active funds to passive funds. As a result, they’ve ramped up advertising trying to sell potential customers with fear. “Now is a turbulent time,” they say. “In an uncertain world, it’s not good to be passive.” “Have an expert guide you.”

But really, if they have to work that hard to sell you on something, it’s probably a bad investment. Just remember: they’re worried about profit, not about working in your best interest. They (apart from Vanguard) have little incentive to sell you on low-margin passive products.

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Why Boring is Best in Investing

Are you a solo investor trying to imitate the big boys? It may not be such a good idea. You may have seen hedge funds, institutional investors, and big university endowments delve into “alternative” investments, meaning esoteric low-liquidity products that ordinary people wouldn’t have access to. Financial service providers, hoping to capitalize on a trend, created mutual funds and ETFs allowing ordinary people to buy into these supposed hot new strategies. Warning: they just want to charge high fees.

The performance has been dismal. As the chart on the link shows, a boring tried and true approach with stocks and bonds has outperformed all of these newfangled products.

The article goes on to explain the reason for the discrepancy:

Ben Johnson, Morningstar’s director of global ETF research, says many alternative ETFs have serious flaws. “Those guru-type portfolios are just equity strategies taking the long side of some well-known hedge-fund managers’ positions and following them on a lagged basis,” he told me.

“Oftentimes what you see in these ‘mimicking’ strategies is the derivative of the underlying asset that is many times watered down or is otherwise not directly connected to the…real asset.”

In other words, the ETFs are very poor substitutes for the real thing. Institutions like Yale get to pick the best private equity and hedge funds, and can buy, say, actual timberland rather than the WOOD ETF.

So yeah, if you can buy and operate an acre of farmland and know how to run it profitably, you may do ok. But for the rest of us, just stick with a diversified collection of stocks and bonds.

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What is the Goal of Your Business?

A friend sent me this article about the future of entrepreneurism in the world. In short, the central thesis is that the giant companies are entrenched in their industries, and it’s harder to compete with them given their incumbent status. Thus, it’s far better to stay small, keep costs low (the key theme in my book!) and make “subsistence” level wages that replace a day job. For example, a local plumbing business is like this. At most, it may grow into a handful of employees and service the surrounding cities, but it doesn’t want to scale up and become a national presence (is there even a comparable national business that provides plumbing?). That’s too much investment, hassle, work, and time before the eventual payoff. That’s not to mention the bureaucratic headaches in providing benefits to employees, building up marketing, HR, and legal departments. In the face of this, it’s quite logical that many a business owner is quite comfortable pocketing $200,000-$1 million in yearly profits from operating a small business.

Side thought: this is a workable theme for a business concept. Uber’s premise is that it provides a single app that links service providers (taxi) to customers anywhere in the world. One could argue that independent taxi drivers and companies could have preempted Uber’s rise by banding together and making an easy to use and interoperable app. In any case, we can extend this concept by applying it to things like plumbing services. Imagine if you can access a worldwide network of plumbers at your call on the app, without having to fumble through the local Yellow Pages.

Going back to building a successful business these days, the alternative is to be high growth and low profit and eventually cash out in a sale to one of the big boys. Threaten them enough with disruption and then whisper into their ear that it’s better to head off a rival early with a manageable buyout than to face the loss of their entire business. Facebook did this to Instagram, paying a high price but preserving their business model. This is arguably easier to do in the fast-moving world of tech than in other industries.

Ultimately, is it a bad thing that so many businesses are now focused on the modest goals of profitability and sustainability? I’d argue no. For many people, there’s no need to grow big. Having fun, creating something, and being mildly profitable is surely enough to live a comfortable life.

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