Archive for November 5th, 2009
Buy low, sell high is sage advice. But what is low and what is high? Certainly if you look at the cost of buying shares of a company, they are lower now than they were a few months ago, but are they as low as they are going to go? What is the real value of a share of stock, an automobile, a house or a pearl? The short answer is that the share of stock, the car, the house or the pearl is worth whatever someone is willing to pay for it, and what they are willing to pay for it is often based upon the demand for those goods or services and the perception of the buyer that what they are purchasing has value. The perception of value is partly derived by demand, for if everyone else is buying one it must be desirable and hence of value, but also partly by the context in which the product or service is placed in your mind.
I had to smile the other day when I received an ad inviting me to attend a sale of “watches of importance”. Nice positioning. I have to admit a certain weakness for watches, as I own three rather than just one. I don’t think I can tell time any better by owning three rather than one. I don’t think having more watches rather than fewer makes me any more punctual, or efficient, but in certain moments of weakness ranging from about 20 years to about 8 years ago, I went out and bought a couple of nice watches (a Breitling, a Movado and a Muhle Glashutte). But I never met an important watch before, I wonder if an important watch gets a glass case all to itself or if it needs to bunk with other watches, maybe, heaven forbid, resting next to a Timex? Clearly the phrase “watches of importance” is just positioning to let you know that “we are going to charge a lot for these watches, and we are trying to shape your thoughts, making you feel that these watches are valuable and rare”. They are only as valuable to you as you allow them to be. It is incredible and a tribute to watch manufacturer’s marketing savvy, that even though quartz watches that can cost just a few dollars and are many times more accurate than mechanical watches which can cost thousands, that there is still a very large demand for expensive mechanical watches – especially the automatic ones. Apparently as odd as it sounds from a rational viewpoint, the accuracy of the watch is not the feature of overriding importance in determining its value. Why did man invent watches? Oh yeah, to accurately tell time.
In the creation of the market for black pearls lies an interesting story. In the mid-1970s there was no market for black pearls. People did not particularly attach any significance to them and there was no demand for them, hence they were not considered valuable and you could not sell these pearls for any significant sum. James Assael owned a source of black pearls and was interested in making some money from them. He went to Harry Winston, a friend of his, and convinced him to display them in his famous jewelry store window on 5th Avenue in New York City with extremely high price tags attached – you can almost hear their logic, “do not think of them as valueless, something that no one wants, think of them as rare and affordable only by a few fortunate ones”. Assael took out ads in fancy magazines showing the strands of black pearls next to diamonds, emeralds, rubies, comparative references and gems that people attributed value to, creating worth for the black pearls by association. Relatively soon black pearls festooned the necks of the rich and famous in New York and a niche market for these gems was born. Once the “market leaders” adopted the black pearls they became more widely desirable and a robust trade in black pearls ensued. Are black pearls inherently worth any more than they were when no one wanted to buy one? Were they all of a sudden found to cure horrible diseases? No of course not, they were worth more only because people were willing to pay more for them, people who were skillfully manipulated into creating a market for black pearls. (Predictably Irrational, Ariely 2008)
The human mind is drawn to basing the value of an object or a service by making comparisons to benchmark items of known worth (or at least generally recognized worth). If you put your house up for sale, the realtor assigning value to your house will begin by showing you comparisons to other houses in the neighborhood. You might see hidden value in your house that makes it one-of-a-kind, but potential buyers will be comparing your house to other similar ones nearby. This process is not simply due to the secret guide realtors use on how to price a house, but also due to the fact that the human mind looks for comparators and context in order to place a value on something. I just read about a house being built in Greenwich, Connecticut that is about 85-90% complete. The asking price for the house is close to seven million dollars, which by Greenwich standards makes it a nice but certainly not an over-the-top kind of house. Given the current housing market the builder indicated that he cannot find anyone who has any interest in buying the house. He stated that there is no point in finishing up the house if it is just going to stand empty and so there it stands with its door ajar and leaves blowing into the entry foyer. As it stands, there is no one who sees the house as being worth seven million and once the market turns, the builder stated that it is his feeling that the house will likely be torn down, only to be replaced by a new one according to the tastes-of-the-day. For instance the builder speculated that new houses that are viewed as “valued” in that price range, after we get out of this economic downturn, will be those with a zero carbon footprint, and can operate off-the-grid. So this perfectly good, almost completed house will be torn down to build a new one with a zero carbon footprint that will make it attractive to a potential buyer. I could not help but think how much carbon is being squandered by tearing down a perfectly good house.
When employee surveys are conducted, of intense interest to the management team of the surveyed organization is how they compared to normative data, the aggregated average of how employees respond across other organizations to similar items. The management team is simply being human, looking for comparators and context to help them interpret if their own survey results are positive or negative or simply typical. They often have a difficult time in looking at survey results in an absolute fashion, without any comparators and judging their results. One item often asked for instance is about pay satisfaction. When you look across a large number of organizations, the average score regarding pay satisfaction is about 48% favorable, meaning that 48% of the population feels on average that they are paid fairly. The other respondents are either neutral or unfavorable. Given that context then, it is not unusual for a management team to indicate that, “well we scored about 50% favorable on pay satisfaction, which is similar to other organizations, so I guess that is pretty good’. In an absolute sense, 50% favorable means that 50% were either neutral or unfavorable, but the result is more easily dismissed because of the natural human tendency to compare to others who responded to a similar item. (It is a myth that no one ever rates their pay favorably. Those who feel that they are paid well, surprise, do rate their pay favorably). If I were to change the item however, and ask about quality and got a similar response, 50% favorable, all sorts of alarms bells would go off and efforts would be made to improve the quality of the products and services being produced. We can dismiss one area of concern, because of the comparators used while being alarmed about another similar scoring item with different comparators.
Whether or not people view themselves as being paid well depends completely on who they are comparing their pay to and whether their level of pay meets their minimum needs. Over the years in an effort to control the spiraling salaries of CEO’s there have been efforts to have their salaries publically disclosed. The thinking was if they were publically disclosed that the CEOs would be embarrassed by their pay levels and become willing to take lower amounts. Well, guess what, exactly the opposite happened. Once CEOs were able to compare their salaries to other CEOs, which they felt were the appropriate comparison group, CEO pay shot up enormously for they could then see what other CEOs were making and so began a salary competition, allowed by compliant boards, to have comparable pay levels for “their” CEO. Management intuitively knows what is going on. Ask a senior HR person or a CEO if the idea of publically disclosing all pay and bonus levels for each person in the company is a good idea and you will see the blood drain away from their faces.
If we go outside of our materialism and try to place values on things without true comparators the resulting challenge can be great. What is the value of an education, an open mind, being able to spend time with and provide for your family, making someone else feel good about themselves, having time to pursue a hobby, helping those in need, doing what you can to preserve our planet, or just feeling good about your priorities? These are things that are much harder to place a value upon because their worth may be very specific to each individual and hence non-comparable. Some may value these things beyond all, while others may view them as incidental, most of course will fall somewhere in the middle of the continuum.
What does all this comparative valuing mean to our current economic situation? I got into a discussion a few weeks ago regarding how quickly we could pull out of the economic downturn we are now in. I was among the more optimistic in the group saying that within the year while we may not have completely recovered, we could be well on our way to recovery. On what basis do I make that statement? While a lot of what is going on is in fact structural, for instance housing loans being made to those who could not pay them, intricate financial dealings being thought of that have no comparable basis for valuation, organizations that leveraged themselves with debt that could only be serviced with unrealistic growth, a good chunk of how people view the health of our economy is perceptual. I don’t think we could have just continued to go on the way we were, but I also don’t think that things need to be as bad as they currently are. What needs to happen? There needs to be a shift in the perception of how bad things are and that the right things are being done to address the issues. Why did the current Treasury Secretary, Henry Paulson, change gears and not invest in the banks as he thought he original should? It was clear that the investment would not have significantly changed the situation from a psychological perspective among the investing public and the investment would not have the needed impact to shift the perceptions of the economic climate.
Without getting into politics, from an apolitical standpoint we are very fortunate at this moment in time to have elected a new President who is clearly a break with the past, for in that lies opportunity, the opportunity to change the psychology by which people are viewing this economic climate. If over the next few months President-elect Obama can create a new psychology, then we will be able to turn the corner and pull out of this mess faster than we would have, but the next few months are critical. Confidence has to be, if not restored, then pushed significantly in the positive direction. A balance between installing people who have proven track records that instills confidence broadly needs to be struck with those that represent a break with the past and a fresh approach and so far that is exactly what is being done. So I am cautiously optimistic.
And what does all of this mean in terms of future bubbles of one sort or another that we will experience and the likelihood that our economy will churn though additional up and down cycles? Simply put because of our human nature these cycles will continue, some cycles worse than others, for the basis for how we view value, how we determine the worth of various things, which is relatively arbitrary, will continue.
© 2010 by Jeffrey M. Saltzman. All rights reserved.
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