Saturday, February 28, 2009

Fixed Costs vs. Variable Costs

Colleges unlikely to cut financial aid, because they need enrollment to bring in money
Students considering a wide range of private schools, as well as those who are already enrolled, can expect to get more aid this year, not less.

The increases highlight the hand-to-mouth existence of many of the nation’s smaller and less well-known institutions. With only tiny endowments, they need full enrollment to survive, and they are anxious to prevent top students from going elsewhere.

Falling even a few students short of expectations can mean laying off faculty, eliminating courses or shelving planned expansions.

This makes sense, I suppose. Most of your costs at a college should logically be relatively fixed: it's probably a lot harder to lay off your professors than it is for non-unionized companies to lay off line employees. And that labor cost likely is a big portion of the budget: then you have your normal fixed costs (like buildings).

But what's surprising is that these students receiving aid, on the margin, are not costs to the university...they are actually assets, because the marginal cost of adding a few more students isn't very significant. What's the extra cost of moving a lecture from 100 to 101 students, after all? Sure thing, we'll take $10,000 per year in tuition for that!

It's a result that surprised me, anyways.

Friday, February 27, 2009

And US Growth revised downwards!

Remember when I mentioned that Europe was falling faster than the US? Turns out that was wrong!

From the BEA:
Real gross domestic product -- the output of goods and services produced by labor and property
located in the United States -- decreased at an annual rate of 6.2 percent in the fourth quarter of 2008,
(that is, from the third quarter to the fourth quarter), according to preliminary estimates released by the
Bureau of Economic Analysis.

And in other news, more free money for Citi

Swap Data on European Bank

Via the Baseline Scenario

It's costing a lot to insure debt at some major European banks. This isn't surprising because, as is commonly known by now, European banks are highly leveraged compared to major American banks.

Obama's Savings

Health Care Savings -$316
Limit Tax Deductions for High Earners -$318
Carbon Permit Auctions -$646
Close Tax Loopholes -$354
End War in Iraq -$1,490
Allow Upper-Income Tax Cuts to Expire -$637
Deficit-Reducing Policies -$3,761


I commend President Obama for his plan to cut the deficit, but the War in Iraq savings are partially inflated. As has been mentioned many times over the past couple days:
Assuming that war spending will continue at FY2008 levels (adjusted for
inflation) – an amount even beyond what President Bush’s policy would have
required – strikes us as a gimmick to build up the spending amount in order to
reduce it and claim “savings”. We believe the Administration should have
included war costs at the levels they are proposing.

Thursday, February 26, 2009

New Treasury Plan: Just as bad as the old one?

Well, we all know what a total cluster**** TARP turned out to be. $350 billion doled out with virtually no strings attached, not even the requirement that banks actually be able to account for the money that they took. Several months later, we learn that banks paid out large bonuses, acquired other banks and financial services companies, and didn't really increase lending at all.


Well, the new Treasury plan, hopefully, would have gotten around some of that.

Unfortunately, it doesn't. Rather than giving the government the right to convert the preferred stocks into common shares, the new program seems to actually give banks the right to convert government equity into common shares, opening up the possibility for all sorts of shenanigans.

Of course, I'm not overwhelmingly concerned...the goal of the plan is to recapitalize banks by giving them money after all. I'm increasingly wondering whether there is a point to that strategy anymore, though.

GM sacrifices to the Money God

Or at least that's what the headline should read.

General Motors lost $31 billion last year, a much greater loss than was expected, largely due to a truly horrific 4th quarter. That shouldn't be surprising to anyone, after Japan posted a more than 10% drop in GDP (annualized) for the same period. But the magnitude of GM's issues is a bit concerning. Consider the following:
Output at GM’s European plants was 53 per cent lower in the fourth quarter than a year earlier

Demand really is plunging. And worse, GM's pension is now underfunded by $12.4 billion, which the US taxpayer is probably going to be on the hook for.

Another bad year like this and it wouldn't be surprising to see $50 billion in cash being devoted to keeping GM afloat. GM's market cap, for comparison's sake, is presently $1.45 billion.

One wonders if there is even a point anymore, and whether we should just go ahead with full-scale nationalization.

Monday, February 23, 2009

Europe falling faster than the US

EDIT: Picture removed
From the Atlantic Business Channel

Some in the past were suggesting that the EU would be able to scoot past this crisis, but unfortunately it looks like they've been tangled up even worse than the US.

Looks as if I copy-paste, the picture directly links to the Atlantic Business Channel display graph on their site.


Sunday, February 22, 2009

More on Required Classes

The last post was to address what the professors seemed to concern about. This post is what I think needs to be improved.

First, I thing there needs to be more emphasis on risk management, especially in light of recent economic events. We don't actually deal with a whole lot of risk and uncertainty in our business classes. The most the business core ever really requires students to understand is the concept of "standard deviation" in our advanced quantitative classes (to you non-UIC people, that means math classes!) with a bit of sensitivity analysis in IDS 355 Operations Management.
I had never heard the term "Sharpe Ratio" before my Finance 472 real estate class.
Business majors need to have an understanding of how to handle uncertainty, because no plan survives first contact with the enemy/the economy. UIC should pay some more attention teaching us that. I would suggest some more effort in looking at risk in different ways, much like finance classes look at profitability of projects in different ways.

Second, Econ 221 Intermediate MacroEconomics should be a required course. Business majors should have a more solid understanding of macroeconomics than what it is offered in Econ 130. Specifically, they should be more aware of the debate between Neo-classical economists and Keyensian economists, since both have arguments that apply at different points in time. Econ 221 provides a higher level of analysis than Econ 130, and pays attention to these debates. Understanding the arguments should lead to a better understanding of the economic environment underlying the business environment, hopefully beyond "tax cuts=higher growth!" and "No, government spending=higher growth!" kind of thinking.

Third, it seems the business core pays little attention to ethics. It is rarely mentioned beyond the passing phrase "ethics are good" and "don't be Enron!" with some attention paid to the subject in Management 350 (which mostly seems to be a Business Law course, so ethics are not exactly the topic of the class). Perhaps a 1 hour per week class on ethics with a workload similar to BA 100 would be a good idea, or requiring every student to attend to an ethics workshop prior to graduation.

Finally, I would reevaluate IDS 200. This is not meant to offend the professors, but I remember so little about the class that I wonder how much it actually accomplished. This may be a result of my own bias (I have never taken an IDS course beyond the required curriculum). However, from what I recall, it seems that the topic of the class was the effect of digital technology on the business environment. This is a topic that is hammered to death in every class, and I think discussing the effects of the Information Revolution is better addressed in those general classes than having a class specifically devoted to the Information Revolution. Eg: I think I can learn a lot more about the role of IT in marketing while attending a marketing class than studying it in IDS 200.
Of course, there ARE some aspects of the class that aren't covered in other ones...there was a lot more specific information on types of networks and different programming languages, for instance. To be certain, students lose something if we don't teach them this, but I am not sure what it is.
I'm not saying we should drop the class. I simply think it needs to have some more attention paid to it.

Friday, February 20, 2009

Core Business Classes

Summary and Recommendations at bottom

Our Finance professor, Mary Brown, commented in class yesterday that she was on a committee responsible for reviewing the Business core curriculum.

A core curriculum consists of the classes that every business major must take. The idea is to ensure that every student has a good understanding of every field of business, so he/she can make good business decisions in a management capacity (or just from a business perspective). Professor Brown specifically mentioned two things:

1. UIC students apparently aren't performing well on case presentations. This is when someone gives you a big file about a problem a company is having, and you have to make a recommendation

2. Teachers wonder how much UIC students are actually retaining of the core curriculum.

2 makes sense if 1 is a problem. After all, maybe the reason that students can't analyze a business case is because they don't actually remember anything about business! That would be very disappointing, and would cast some doubts about UIC's current teaching style.

Now I can't really SOLVE the problem, in part because I don't know the problem fully. I would have to obtain a lot more information if I was going to try to make UIC students astoundingly better. I have some ideas which I like floating around with Alpha Kappa Psi members sometimes (because I can more directly influence AK Psi than I can UIC), but nothing very concrete and well-researched.

Still, Professor Brown asked for thoughts. And there is no such thing as a BAD thought, so I figure I'll give it a go.

If they think retention is a problem, they are probably right. Information learned but not used is not retained very well, especially when it is only studied for a test. That's not to say that it is totally lost: for instance, I took psychology 3 years ago, and if I took a psyc test on the spot right now, I'd fail. But I can still talk about positive reinforcement a bit, and since I once learned "shaping" back then, I can pick it up faster now.

The problem is that business majors can't immediately access all of the information they have because they don't use it often enough. But they probably still have the fundamentals down to some extent, so they can relearn quickly if they need to.
On a case, though, they need to know it RIGHT NOW. They don't have time to relearn it all. So the thing we want to do is increase their understanding more than right now, preferably through making them use it often.

Another possibility: it might be the case that 2 is not really the problem. Rather, the issue might be that students can't think very well. They UNDERSTAND how marketing works, they understand how finance works, and they understand how accounting works. They just can't put it all together, and they can't analyze information put in front of their face and put what they know to work.

While I think retention is a problem, I also think this other problem, which I will call "critical thinking," is a major one. First, cases can be extremely intimidating, especially if you have never ever studied one.
For example, if you've spent your entire life writing essays and giving lectures, you might be thrown totally off-guard when you take a test for the first time. Just as you can learn good test-taking skills, so can you learn good case skills.
UIC, though, has pretty much NO case studies. All my experience in them comes from two sources:

1. AP tests in high school, which had things called Document Based Questions. They weren't business cases, but somewhat like them.

2. Consumer Behavior (Marketing 462, I believe) with Professor Rosa. The entire class consisted of one Mid-Term, two case studies, and a consumer interview.

UIC business classes, on the other hand, teach a lot like other academic classes. You are lectured 2 or 3 days a week, and have an exam once every few weeks. You have homework assignments in some classes, you have papers in a lot of other classes. My gut instinct is that this is a bad approach, and generally leads to our students being unable to do cases because they are trained more like professors than decision-makers.

There are two counter-arguments to this:

1. The Document Based Question-item, which is something that non-business people do with ease, is a lot like a case.

2. The papers students do in class should train them to think critically.

The first is very true, but those types of questions were rather difficult for high school students, enough so that our history teacher, Matt Whipple, gave us an example question before the exam so we should be prepared. It wasn't something that came naturally to us, because tests are about converging on a right answer, while cases are more about diverging, analyzing, and choosing. You need to think of possibilities (diverging), figure out the merits of each one (analyzing), and pick the best one (choosing).

On the second, papers HELP, since they are much less about convergent thinking than tests are. A student can, if he/she chooses, dazzle a professor with brilliance. However, papers tend to be graded a bit softly for my tastes. I can remember writing numerous papers on the night before a due date and getting near-perfect scores. The only teachers that have actually graded harshly are Professor Thompson (who I had for Compensation Management) and Professor Rosa (who I had for Consumer Behavior, as previously mentioned).
We need to grade tougher if we want students to develop better writing skills, and we need MORE. Just like other skills, writing improves when practiced. My own writing skills have been honed through countless hours of posting on internet forums and internet blogs, something that most other students simply don't have.
Another problem with papers is that they aren't really integrative. Writing a paper for my management class doesn't usually require me drawing upon my marketing and finance knowledge, which doesn't make much sense if we want our students to understand business as a whole.

The other aspect of "critical thinking" is that students just don't seem to have good reasoning abilities. Their arguments are SOMEWHAT sensible, but they are not really good enough or developed enough. So...all they really have is an idea, not a truly defensible position, and it would crumble upon closer inspection. See, for instance, my remarks on my experience with the bank simulation.

If students can't construct logical arguments because they simply don't have those skills, then they will fail even if they are trained in cases and retain knowledge. So UIC needs to be more concerned about developing those skills.
I find the best method to doing this is taking a student's position and simply pointing out all the logical flaws and why they are logical flaws. Learn through experience.

So...if we want our students to do better...we actually have three different problems:
1. Students retain knowledge, but not well enough to access it on demand.
2. Students do not have much experience putting different business ideas together.
3. Students do not have strong reasoning abilities.

There are a couple different approaches we could take, but as my time is running out, I will simply say what I would do.

First, I would require case competitions every year by UIC students, to be done in very small teams (2-3 people max). They will be required to come up with some sort of product idea and explain how they would sell it. This would be graded and put on the transcript, like any other course. Guidance would be minimal: sink or swim on your own.
Hopefully this will keep students integrating and using new knowledge every single year. That helps out with problems 1 and 2. Small teams are a must to ensure that there are no shirkers (which occurs in every group, but especially among any group above 4 people in my experience at UIC).

This may be difficult to accomplish, so I would be perfectly happy with an addition to 495, but a class devoted entirely to case studies of actual strategic management. These case studies would be done individually.

Second, to address problem #3, I would make a new, required class (BA 250?). Every day, a different student will be required to give a presentation on a topic that the professor assigns. The other students will then be required to agree or disagree, with the professor facilitating discussion towards the "disagree" side. The onus will be on the presenter to both identify the weakness in his/her own arguments and be able to address any questions or counter-points other students would have. I imagine a 3 hour, twice a week course would be sufficient for this.

Wednesday, February 18, 2009

Margins and Profit

Before you go any farther, going to let you know up-front: This isn't economics or politics. It's business.

But it's a simple business concept that everyone should understand.

Let me explain the situation. Around a week ago, I met up with some group-mates from my finance class in a lounge around campus. After munching on some delicious Wendy's burgers, we got down to work: we were responsible for running a bank through a simulated economy against the other groups in our class. And we planned on taking it seriously, for a couple reasons.

1. The project is a large portion of our grade. It doesn't matter if we LOSE money, but we need to explain how we arrived at the decisions we did.
2. The winner (IE, the group with the highest stock price at the end) will not have to take the final, and will get to meet the head of the Finance department...hopefully leading to some job connections!

I had spent the previous day staring at the financial statements of the bank for the previous two quarters. And, believe me, it was confusing for a long time. Even if you know the basics of the financial statements, new parts that you've never seen can confuse you if they aren't explained properly. Considering we were just handed statements with numbers on them, yep, I was confused.

But I managed to figure out what was going on with the statements. Our bank didn't seem particularly strong (we were hemorrhaging deposits, losing 5% every quarter. Those are basically personal bank accounts people put in your bank that you use to make money elsewhere), but there was a good opportunity for growth in retail banking by creating mortgages. This basically meant that we will have to open more branches, shift effort away from appealing to business customers, and start focusing and trying to get customer deposits back to get more money to invest,

The story we were given was that consumers are not price-sensitive, so I naturally said that we should advertise a lot, tell our bankers to spend more effort on getting more residential customers, and charge higher rates so we could have better margins.

My friend asked me "So we're going to advertise that we have higher mortgage rates?"

There ain't nothing wrong with asking the question and thinking like a businessman, which includes thinking competitively. It's so common sense that people all across the nation can think like this: cut prices, and that way you can attract more customers and beat your competition. But there are limitations to this kind of thinking.

For example, the most obvious one is that customers might not care about price very much. Starbucks can charge $4 for a cup of coffee, when I can make my own at home for 30 cents. Obviously, price isn't the biggest factor.

Scale can also be a big factor. Sure, by reducing your prices, you might get more customers. What happens if your store or bank cannot handle all those customers? Just as there are economies of scale, so there are diseconomies of scale. Once you are producing beyond a certain point, your costs actually start to rise.

For a bank, you might not have enough employees, so your quality of service suffers. That's REALLY bad if customers also care more about service than price, so you are driving them right in the arms of your competitors. You might also lose the ability to exercise due diligence on loans: you can't spend 6 hours vetting every single person asking for a mortgage when you have one guy to approve them and 1,000 people begging for loans because you are charing 6% whereas everyone else is charging 10%.

And you can't hire more workers either: your bank is only so big! Buying another bank? Extremely expensive, and can't do it because you can't make money when you are charging 6% for a mortgage and giving out 5% on savings accounts. Or, if you CAN make money, it's extremely risky...if you don't get as many loans as you want, your stuck with two banks. Which means you might very go well bankrupt. Plus, hiring more employees means you lose your own personal control. You can't watch over 30 managers as easily as you can watch over 10.

So, if your company is running into trouble, the idea of cutting your prices seems very attractive. Often times, though, it's really a trap and might put your company even more into the dumps.

Monday, February 2, 2009

On Moral Hazard

Thoma rounds up an excellent series of articles describing how concern about moral hazard is overrated.

From a psychological perspective, at least some of the argument about moral hazard seems fundamentally overstated: you will be more likely to undertake risky behavior if you are rescued by someone else, true. However, two points:

1. These banks are not really getting "bailed out." Rather, TARP gave money to the banks in return for preferred stock, most of which, I believe, carried rather high interest rates (10%). So, if BofA receives $50 billion from the feds, they will be paying out $5 billion to the federal government every year for the rest of time. It's not costless. And this is at the expense of other stockholders, because those dividends COULD have been going to the common stockholders.

2. We tend to focus a lot on our own personal losses. For instance, you might say that having rescue helicopters picking up hikers from mountains is "moral hazard" because they don't have a high chance of dying. Well, having a 20% chance of dying is still pretty high to me, and spending a couple months in a hospital isn't fun at all, either.
Some people suggest that we value gains only half as much as losses, meaning that we would need to gain $100 to off-set a $200 loss (in terms of making us happy). If true, that means most people are risk-avoiding, and perhaps a bit of "moral hazard" to encourage risk-taking isn't such a bad idea.