Problems of redundancy and systemic failure

Recently I was listening to a series of reports on failures in some key organisations, public and private. All had a common element, the way that costs had been cut to the point that the organisation lost the capacity to respond to the unexpected. The subsequent costs of failure far exceeded the savings made.

Don't get me wrong. The battle against costs is a constant struggle that must be waged on an on-going basis. But would you want to go onto an aeroplane where systems had been cut to the point that there was no redundancy, where a simple system failure might lead to a catastrophic outcome?

To my mind, our constant pursuit of productivity gains has reached the point where the costs exceed the benefits in many cases. Again don't get me wrong. My professional colleagues and I have generated a lot of fees out of productivity improvement advice. However, there is a question of balance.

Today we live in a world of performance agreements, KPIs, performance based contracts. To a degree, our technology defines us. If you look at those agreements etc, you will find that they are all linear. We have translated computer decision rules into a human environment.

We humans don't work this way. We are often messy, disorganised. We are creative. We have dreams. I sometimes feel that there is no place for humans in the current management environment. We would be better off with robots who just do as they are told.

The modern approach works fine in a straight line environment. It can collapse as soon as a challenge emerges from left of field.

My message. Simply, I suppose, cut your staff some slack.

Deposit bases, credit rationing and the Australian banks

Back in December in The Balance of Payments, Australia and the sub-prime crisis I discussed the reasons why a US financial crisis affected Australian domestic liquidity. Since then, the crisis has eased. However, in so doing it has created another interesting set of dynamics.

Reduced access to international liquidity increases the value of domestic liquidity. Financial institutions that can access that liquidity gain relative to those who cannot. In an Australian context, it is the major banks with their big relatively passive domestic customer deposit bases who are the real winners.

Despite the slowing economy, both households and businesses still need to borrow. With reduced availability of funds, the major banks with their control over deposits begin to ration credit and can also increase interest rates. This allows for reduced risks in combination with increased margins.

Of course, if the economy really slows even the big banks will be affected by the overall reduction in the demand for funds. But at this stage in the cycle, the immediate flow-on effect of the sub-prime crisis is increased bank profitability.

Funding Australia's private schools

Note to readers: I began this post in January, but then got swamped. However, it seemed sensible to finish it despite the passage of time.

Neil has already beaten me to this one, the problems associated with the way the Australian Government funds private schools. However, I thought that I might make a brief comment on the economics involved.

For the benefit of international readers, education is technically a state responsibility. However, over recent decades the Commonwealth Government has assumed greater funding responsibility. Now in the school sector it is the main funder of private education, leaving the states with public education. Herein lies a problem.

In funding private education, the Commonwealth Government uses as a funding benchmark the average cost per pupil in the state system. On the surface, this seems quite reasonable. Yet it is now creating real difficulties.

In recent years there has been a major drift of kids from the state systems to private education. Some parents are now paying up to 50 per cent of their net family income to have their children educated in private schools.

Pretty obviously, many parents believe that there are major problems in the state systems. The reasons for this are complex and beyond the scope of this post. My concern is the impact on the funding of private schools.

As children move out of the state systems, the average cost per pupil in the state systems rises. This happens for two reasons.

First, it reduces the ability of the state systems to capture economies of scale. The state systems still have to provide universal education available to all across large and varied geographic areas with dispersed populations. As children move, they lose some of the advantages offered by network economics, the fact that the cost of teaching an extra child is much lower than the average cost per child.

Secondly, and linked, it leaves the state systems with a greater proportion of higher cost pupils, higher cost schools. Higher cost pupils because problem children who require more attention tend to remain in the state systems. Higher cost schools because the state systems have to maintain schools in areas that the private system will not address because the number of pupils is to small to be economic.

As the average cost per pupil in the state systems rise, so does funding to non-state schools. This extra funding allows private schools to do new things, attracting new students from the state systems. Market disciplines are further reduced, because the proportion of costs covered by fees is further reduced.

In all, it is actually something of a crazy funding model.

Why markets are not always better

Well, it was a longer break than I had intended! Still, a lot has been happening while I was off-line. I have been jotting down notes in my spare time to provide a base for future stories.

I had to laugh today.

Eldest is doing economics at the University of New South Wales. Her latest assignment was to prepare one side in a debate. There were meant to be two of them in the team, but her partner dropped out of the course so she had to go alone.

Why did I laugh? The topic they were given read "the market always gives better results than Government action." Helen had to argue the negative.

How could she not win? Because of the use of the word always, she had only to provide one example to prove her case. The results of the sub-prime collapse are all around us. Of itself, that was sufficient for her to win.

However, while I laughed I was left with a feeling of unease. Irrational exuberance has always been with us. To illustrate her point, Helen gave tulip mania as an example. She could equally as well have taken the south sea bubble.

There have been many crashes. Today, or so it seems to me, we are especially vulnerable because of the sheer size of financial markets relative to physical markets.

Leverage is central to financial markets. If you are making widgets or mining iron ore, then what you do is subject to physical as well as financial constraints. In the financial world, you can leverage transactions far beyond the real value of the underlying assets.

We call this financial engineering. This is a misleading term because it implies a degree of precision, of safety, that is simply not there.

When a small number of institutions operating in a relatively small market by global standards can leverage to the point that they threaten the whole global financial system, then we have a problem.

In Australia where our major financial institutions are generally secure, we still have something of a funding drought because of the flow on effects. This hurts everyone.

Time for a Break

I am having a break from posting to allow me time to recharge. I expect to be back on-line end February or early March.

Google's growing market share

In October I carried a post discussing the dangers posed by Google's growing market dominance. Recently there was an interesting article in the Australian Financial Review - I cannot give a link - providing more data.

According to the US firm Hitwise, Google's share of the US search market rose from 58.3% in March 2006 to 61.8% in November 2006 to 65.1% in November 2007. Each one per cent shift in market share appears to be worth about $US100 million ($A113.8 million) in extra advertising revenue.

According to Scott Kessler from Standard & Poor's, Google's growth will slow in 2008 because of a maturing search market together with improved service from competitors. Mr Kessler also feels that there is a risk that Google might get distracted by its non-search projects.

I have always been fascinated by the way Google's business model fits together. Yes, Google search is the jewel in the crown, but there is more than that.

Bogspot is a good example.

By providing a free blogging platform, Google has attracted millions of bloggers. I tried to find an actual number, but without success. These provide a platform for Google products such as adsense, search and referral. In parallel, Google blog search provides an increasingly used tool for searching the blogosphere, one that has I think now over-taken Technorati in popularity.

Many of the blogs have very limited traffic, so the actual revenue to Google per blog from its products is low. However, the sheer number of blogs makes for high aggregate numbers. Further, Google does not pay its publishers until their earnings reach $US100. This provides a handy source of working capital.

Google is constantly fine-tuning its services to try to increase revenue from its existing base. This is not always successful - the company is withdrawing support for its referral product in Australia, presumably because of lack of profitability.

Low cost management of large numbers is critical to Google's success. I have not tried to analyse Google's accounts, but successful product management in the blogging environment requires a large base to spread fixed costs with very tight control of variable costs. So the whole system depends upon effective automation.

Introductory Blogging Tips

Photo: Will Owen Munupi Arts

Will Owen's Aboriginal Art & Culture: an American eye is one of the most interesting blogs I know dealing with the art of Australia's indigenous people.

Will wrote a post on Arts Centres and the Business of Blogging discussing in part the new use of blogs by Aboriginal arts communities as a promotional device. In it, he asked a couple of us whether we had any tips.

I decided to respond on this rather than my personal blog because over the last year or so I have been trying to get the message across about the important role that blogging can play in supporting business and community objectives.

I have kept the tips that follow as simple as possible, writing from the perspective of those with limited money and technical skills new to the blogging game.

Introduction

The blogosphere is a crowded place.

I am not sure how many blogs are out there now, although I know that the number passed 75 million some time ago. All these blogs compete for attention.

Do not despair, however. All blogs can achieve their place by following a few simple rules.

Rule One: Keep it all as Simple as Possible

I have put this as rule one because I know how hard it is to maintain a blog in the face of other pressures. The simpler you keep things, the easier it is to keep going.

Rule Two: Be Clear on your Objective

Rule two is to be clear on the purpose of your blog. Why are you doing it? What do you hope to achieve?

Write this down, because it determines your entire approach.

Rule Three: Be Clear on your Target Audience

Rule three follows from rule two. Who do you want to reach and why? Again, write it down.

Rule Four: What does your Target Audience need to know, What will attract them?

Now that you know target audience, what will attract them, what do they need to know? Write it down.

This rule guides what you write, what visual material you include.

An example to illustrate all this.

Assume that your objective is to promote local talent, to support art sales and to promote the community and encourage visitors to the community. So a mix of community and business objectives.

At broadest level, you want to reach all those who might buy your art works or come to visit. This is just too big. We need to break it up a bit.

One group might be those who have already bought a piece of art or who have visited. This group might include gallery owners, agents, tour promoters.

You know that they are already interested, may buy again, may come back, will promote your story to others. This group is likely to be interested in what is going on, new developments. Use your blog to keep in touch with them.

Then you have those who might be interested. I will talk about ways of reaching them, of attracting traffic to blogs in a moment. For the moment, just two key principles.

First, you have to write in a way that they will understand. Explain things. If you use local terms and refer to local things without any explanation, people will not understand what you are saying.

Secondly, give people the information they need. How can they buy? How can they come to visit?

Rule Five: Short but Regular Posts

With time, your blog will build four broad groups of readers:

1. those who visit on a regular basis because they are very interested
2. those who drop in every so often to check what is new
3. those who use your blog as a reference point for information when they need it. A tour operator might be an example.
4. those who come to the site via search engines or referrals, including referrals from other blogs. You hope that some of these will visit again.

Short but regular posts is the best way of building all four groups.

Why short? This links to purpose.

I often write very long posts on some of my blogs because I am exploring ideas, putting down material for later reference. But I do so knowing that this will reduce my readership.

Reading material on screen is harder than reading a printed page. People have limited time - they scan and move on. So if you keep your posts short people are more likely to read and, having read, come back. And that is what you want.

Why regular? We are all creatures of habit. We like to know what we are getting, when to come back. You cannot achieve this without regular posting. A good blog becomes a friend that we visit when we know that there is likely to be something new, to find out what is happening.

Okay, regular is fine, but how often should you post?

There is a fair bit of debate about this in the blogging community. Again, it depends upon purpose as well as your time.

I try to post daily on my personal blog because that blog is in part an on-going dialogue between me and certain of my regular readers. They expect daily posts.

However, there is no point in aiming for daily posts if you cannot maintain this on a regular basis, nor is it necessary or even desirable for a business related blog.

As a general rule of thumb, once a week is about the minimum if you want to build a consistent return readership over time.

Rule Six: Allow Time

Things don't happen overnight. It takes time to build a blog. It also takes time to learn about blogging. So if you are going to build a blog, you have to be prepared to keep going even when initial results seem slow.

This post is long enough. In a later post, I will provide some more advanced tips. In the meantime, if you follow these few simple rules you will get initial results.

Welcome to 2008

Welcome to 2008. I am looking forward to this year. Just so much is happening.

The above graphic shows traffic to this blog by country of origin. Australia still stands out first on 31%, closely followed by the US on 27%. Then come a range of countries.

This blog necessarily has an Australian focus simply because there are so many Ndarala Australian members. However, I do welcome the broad country spread because the world is a global place.

Sounds a bit silly I know put in that way. But we do need to understand the broader world if we are to operate and expand in a globalising society.

Season's Greetings to All

Christmas Eve

I am now signing off until after the Christmas break.

This has been a troubled year in many parts of the world. May you and yours have a very happy festive season and a peaceful and prosperous new year.

The Balance of Payments, Australia and the sub-prime crisis

One of the things that has been puzzling me about the US sub-prime crisis is just why it should have such effects on Australia. Our direct US exposure is minimal, while there is no evidence at this point that the local low-docs loan equivalents suffer from the same problems, yet the effects continue to reverberate.

I could understand it when local home lender RAMS struck trouble because this otherwise solvent firm depended directly on shorter term US borrowings. But why was the US crisis creating domestic liquidity problems, forcing Australia's Reserve Bank to pump funds into the economy?

Thanks to an article by Brian Toohey in the Australian Financial Review (17 December) quoting HSBC Chief Economist John Edwards, I now understand. The answer proved simple but, I think, very serious.

Australia has long had a substantial deficit on the balance of payments current account, a deficit funded by capital flows, mainly through international borrowings by Australian financial institutions. The sub-prime crisis has largely stopped those borrowings.

This created a ricochet effect.

Borrowers such as RAMS dependent on offshore borrowings tried to borrow locally, increasing local demands for funds. More broadly, reduced capital inflows meant that cash stopped coming in to fund the current account deficit, draining cash from the Australian economy. Then, too, there was a reduction in lending between local financial institutions, further reducing the supply of loanable funds.

In normal circumstances, this would have been accommodated in part by a rise in interest rates rationing credit, in part by a fall in the value of the Australian dollar thus choking of imports. However, because of the scale of impacts, the Reserve Bank chose to push liquidity into the Australian economy. This meant, among other things, that we were funding the deficit on the current by reducing the RBA's holdings of foreign currencies. As a consequence, the RBA's official reserve assets fell from $A79.7 billion at the end of June to $A32.7 billion at the end of November.

This is unsustainable in the longer term. If it continues, the RBA will have to borrow internationally to fund the current account deficit, let the currency fall to a new equilibrium level, or some combination of the two. Whichever way it goes, Australia is in a degree of trouble.