Category Archives: Business

An ethanol glut?

From Business Week:

BW ethanol

Lobbying for a Better Blend

The ethanol industry is about to hit a wall—the “blend wall.” U.S. biofuel factories now have the capacity to make about 12 billion gallons of ethanol a year, and the U.S. market can’t use much more than that. That’s because annual U.S. gasoline consumption is about 137 billion gallons, and gas isn’t allowed to contain more than 10% ethanol, a blend called E10. If every drop of gas actually met that limit, the ethanol market would be 13.7 billion gallons. But for logistical reasons, a portion of the gas sold will never contain any ethanol.

The looming blend wall is making it harder to get new ethanol plants financed, so corn growers and ethanol producers are lobbying to increase the blend to allow up to 15% ethanol (E15). Opposing them: a coalition of oil producers, food companies, and green groups, which complained to the Environmental Protection Agency that raising the quotient may lead to higher food prices and other woes. In April, the EPA agreed to review the issue.

Nathan Myhrvold in Shanghai

Nathan Myhrvold, the former chief technology officer of Microsoft, now running Intellectual Ventures (which describes itself as “the invention company”), guest-blogs on Freakonomics. Here’s an excerpt:

The infrastructure is all new, from the airport to the expressway leading into the city (or you can take an ultra-high-speed maglev train and be there in 12 minutes). The downtown section of Shanghai is called Pudong, and it is full of gleaming new skyscrapers. The other side of the river has the Bund, the center of Shanghai’s 19th-century economic boom. It too is replete with interesting architecture, albeit smaller and older. Amusingly, none of this architecture is Chinese. The closest thing I found to ancient Chinese culture was a fast food-chain called Kung Fu. Maybe that is the point of the place; Shanghai has long prospered by embracing and adopting the foreign.

Pudong is clearly a work in progress — cranes hover over building sites everywhere. Most places that have tall buildings do so because they first had shorter buildings. The only reason to build high is that you’ve already exhausted the possibilities for building low. The economic value of density forces buildings up, because out is not an option.

The only places in the world that violate this rule are “instant” downtown areas that connive to jump the queue and go straight to the super-tall stage, for some artificial reason, rather than follow land-density economics. The Century City section of Los Angeles is one example, but the real classic example for this sort of instant development is the Las Vegas Strip. Vegas builds high, not because of economic pressure for building density, but for its own sake.

Shanghai has no casinos, but Pudong is the office-tower equivalent of the Strip. Giant skyscrapers erupt from the river bank in myriad forms, one more architecturally extravagant than the next. Like Vegas, they sport outsized gimmicks: the Aurora building transforms into a giant video billboard at night, the Pearl Orient tower is a science-fiction fantasy, and the Shanghai World Financial Center (SWFC) — the second-tallest building in the world — has a 105th-floor observation lounge with a glass floor looking down onto a giant hole in the building. It is spectacular.

I was curious what all of this splendor and view cost, so looked up the rent: the SWFC is charging $76 per square foot per year. By comparison, my company pays $25 for a second- or third-tier building in Bellevue, Wash. The good buildings in Bellevue are $40; downtown Seattle commands $45 to $50 (although I understand there may be some space coming available in the Washington Mutual building rather soon). At the other extreme, the warehouse space we rent in Kent, an outlying industrial suburb of Seattle, is a whopping $3.60, which is fortunate for me because rocket engines and dinosaurs take up space.

Our Singapore office costs us $73: about the same as SWFC, but for a much less impressive building. Our Tokyo office is the worst at $96, and it is definitely second-tier. I don’t have an office in midtown Manhattan, but my broker tells me that those average about $88 per square foot per year. So the coolest, newest office space in Shanghai at the SWFC is about the same price as mid-range Singapore, and a bit cheaper than midtown.

We have no plans to open a office in Shanghai. Plus we’re cheap, so we’d never pick that building (our office in Palo Alto is upstairs from a nail salon). However, I find it interesting that despite our frugal approach, we already pay 26 percent higher than SWFC in at least one place. Of course, all this proves is a rediscovery of the old real estate maxim: location, location, location.

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Sean Masaki Flynn explains author’s compensation

Sean Masaki Flynn, author of Economics For Dummies, answers a reader’s question on Freakonomics:

Q: Roughly what does one make for writing a Dummies book, and is it a more lucrative endeavor (in terms of dollars per hour) than the textbook route?

A: Author royalties are very paltry — both for textbooks and for other books. A typical royalty rate would be 6 percent or so of what the publisher can sell the book for at wholesale. That amount is typically half of the cover price. So if you see a hardcover selling for $30, the publisher probably got $15 at wholesale. So then 6 percent of that $15 would be only 90 cents. Then your literary agent will take 15 percent of that. So you are left with just 77 cents per copy.

And a book is considered a good seller if it sells 5,000 copies. Most sell far fewer. So basically, there is no money in publishing unless you can sell a lot of books.

Sadly, I am not J.K. Rowling.

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Opinions on SOX

From Euromoney Online:

Execs Lose Faith In Sarbox

Jul-22-2008 | Source: Compliance Reporter

Company executives are taking an increasingly dim view of some effects of Sarbanes-Oxley. According to new research by IT firm Oversight Systems, just 10% of officials think that complying with SOX has strengthened investors’ views of their company, down from 20% four years ago. Similarly, fewer (29% compared with 33%) respondents believe that compliance has reduced the risk of financial fraud. The firm interviewed roughly 100 CFOs, audit chiefs, controllers and internal auditors in May and June.

By contrast, SOX has won increasingly glowing reviews among executives for its impact on financial reporting. More than two-thirds (69%) of respondents said compliance has ensured accountability of those involved in financial reports and operations, up from 46% in 2004. Almost half (45%) said the law has improved the accuracy of their financial reports, a marked rise from 27% four years ago.

Cutting compliance costs was still the top SOX-related goal, despite 80% stating that their costs were the same or lower than in previous years. Dana Hermanson of the Coles College of Business at Kennesaw State University told CR that the shifts in attitude can be attributed at least in part to the increasing distance from the last major accounting scandals and to budget pressures in a tough economic climate. “It’s a classic problem… [Compliance] costs are easy to measure; the benefits are very hard to measure.”

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Creativity in business

Just stumbled on this nearly three-year-old discussion in

There is much talk about the need for creativity in business. Is this lip service?

Of course it is. Creativity can be described as going outside existing protocols. The majority of business functions, however, depend on strictly following existing protocols. One obvious example is accounting; it is for a good reason that “creative accounting” has become a pejorative. Operations tend to have very little tolerance for creativity as well; how creative can (and should) one be when operating, say, an oil refinery or a nuclear power plant?

Creativity does have its place in business, but it is usually limited to strategy formulation and product development. There are businesses where creativity is a part of the production process (music, motion pictures, etc.), but those are few and far between… There are instances where creativity can help better organize a particular business function, but those quickly become best practices anyway…

Corrine Maier’s book Hello Laziness suggests that why business likes MBA’s is not that they have intrinsic knowledge, but that they are compliant

“Business” does not “like MBA’s”; rather, managers like to hire people who went to the same schools they did or, failing that, people who went to reputable schools… Education, as Nobel-winning economist Michael Spence pointed out, is merely a signal that a prospective employee sends out to prospective employers.

I recently had a conversation with a business school professor at Berkeley who teaches MBA’s. His frustration is that they just want tools to do a job that is clearly defined.

Of course. That’s why they went to get an MBA rather than a PhD in art history…

This won’t help them anticipate what is coming next,

Very few of today’s MBA students will ever be in a position where such anticipation (beyond obvious things like “if a worker quits today, we’ll need to find a replacement tomorrow”) is required.

or stimulate them to create new products and services.

And how many of those products and services will be accepted anyway? The world is filled with examples of new products and services that looked great in market tests but turned out to be major failures…

We learn from mistakes.

Yes, but we PROFIT from mistakes made by others…

A culture of fear kills creativity.

And a culture of responsibility severely limits it. Creativity is not a goal, it is a means to an end. It is also a convenient mask often worn by waste, fraud, and ineptitude.

Large corporations are political minefields.

Yes, but it’s important to understand why it is the case. Large corporations are owned by large groups of shareholders, but managed by small groups of executives. Executive creativity can be (and often is) perceived as taking undue risks with shareholders’ money. Executives, whose compensation is in many cases comes primarily from stock options, like these undue risks, since their options have no downside (the worst thing that can happen is options expiring worthless); shareholders, conversely, face quite a bit of downside, since they hold the stock, rather than options on it…

Does creativity come from the margin of the business world, or is there a place for it inside the corporate box?

In the end, it boils down to two questions: (1) whose money are you trying to gamble with? and (2) have the moneymen agreed to the gamble before you commenced it?

Wouldn’t you agree that creativity is necessary for business owners,

Only if you are trying to start a new industry… How much creativity should you expect from a person who owns a car repair place? A dry cleaning business? A bed-and-breakfast? More specifically, would you want your car mechanic to test new repair techniques on your car and your dry cleaner, to try new cleaning compounds on your dress shirts?

for sales people?

Hell no. Sales people’s creativity often takes the form of hyperbolizing, overpromising, or, in extreme cases, outright lying to prospects. Marketing people, on the other hand, do need to be creative, but not in the way artists or writers are creative; rather, they need to be creative in the way scientists and engineers can be: design experiments and interpret empirical data to identify underserved demographics, figure out cost-effective promotion strategies, etc.

The prime example of such creativity is Gary Loveman, a Harvard Business School economics professor who started out consulting for Harrah’s Entertainment, then got hired as their COO, and eventually ascended to the top spot when Harrah’s CEO Phil Satre retired in 2002.

Enhancing the value of a multinational company

A question asked privately:

What can a multinational company do to enhance its value?

Mathematically, the value of equity P is determined by earnings E and the “fair” (in investors’ collective opinion) price-earnings multiple P/E:

P = E * (P/E)

To increase its earnings, a multinational can do two things:

  1. Move its production to an area where prices of requisite factors of production (be it land or labor) are low, and
  2. Sell its products in locations where they can fetch the highest price (which in most cases means North America, Western Europe, and/or Japan).

As to enhancing the P/E, recall that the Gordon model:

P = CF / (kg)

can be modified:

P/E = (CF/E) / (kg)

to show that the P/E ratio is determined by earnings quality (CF/E), cost of capital k, and expected growth rate g.  The greatest enhancement potential usually lies in reducing k through achieving optimal debt load and raising capital only in major developed markets, where both interest rates and transaction costs tend to be lower than either in minor developed markets or emerging markets.  Sometimes, a multinational can also show unusually (and consistently) high g achieved by expanding into new geographic markets.

Presidential inauguration and the stock market

A question asked privately:

After the inauguration of Russian president-elect Dmitry Medvedev, the Russian stock market rose by 200+ basis poins over a single day. Was this a significant reaction?

Let’s look at it numerically. Here’s the daily history of the RTS index, Russia’s primary stock market index:

Average daily change in the index over its entire history was 0.14%; its standard deviation, 2.70%.  So the change in the index on the day of inauguration, 2.24%, was 0.78 standard deviations away from the mean, whereas a “significant” event is often defined as one located at least two standard deviations away from the mean.  For example, in August 1998, after the Russian government defaulted on its bonds and devalued the ruble, there were two days when the stock market fell by more than five standard deviations form the mean.

There’s also another way of looking at it.   As of the end of the inauguration day, the RTS index had 3,164 days of history.  Of all those days, 471 (almost 15%) saw a change greater than that posted on the inauguration day.  In other words, one out of seven trading days was more “significant” than the day of inauguration.

An ETF hedge fund?

From Institutional Investor:

Calif. Firm Preps ETF Hedge Fund
May-01-2008 | Source: Alternative Investment News

Hermosa Capital Management is preparing the summer launch of a long/short hedge fund called Hermosa Capital Fund to invest in exchange-traded funds, FINalternatives reports.

The firm will use proprietary analysis and a fund ranking system to choose from the selection of global ETFs It will invest in securities that trade in enough volume to allow for speedy execution of transactions. Positions in securities may be held for very short periods, even as little as a day, said Christopher Harris, a consultant to the fund.

“I traded individual equities and mutual funds so when ETFs hit the market, I was just excited. We’re at about 600 ETFs now, which is more than enough, and we’re seeing new funds from India and other country-specific ETFs, so we’re able to capture a lot of different markets at the drop of a dime,” said Harris.

The strategy will employ a proprietary system that will rank about 300 ETFs based on relative strength, momentum and total return. The firm will then choose the top three to 10 to invest in. The existing strategy is exposed to the U.S., China and South Africa.

According to Investment Company Institute, there are about 613 ETFs with a collective AUM of $572 billion.

I wonder what the fees for this strategy will be…