## 2009/04/19

### Death by Success

Being too successful leads to failure unless you are aware of the problem and carefully monitor and protect against it. Every large company faces this problem - in I.T. for example, Google and Microsoft.

The rule applies at all levels - individuals, projects/teams, companies and countries. Even potentially our species and the whole living planet.

I was reminded again of this yesterday by Victor Cook in "The New Battle for Your Desktop" where he analyses the financials of Google and Microsoft (GOOG & MSFT). He describes a problem with Microsoft:
The company actually captured 77.5% of combined revenues in the quarter ended June 30, 2007.

Sometimes it's great to be the market leader. But in this case it's not. Microsoft shelled out $539 million for that 77th share point. And it was worth only$172 million after total costs. Not a good thing. To maximize earnings (by optimizing total costs) the company should have captured only 60.3% of the market. That's the point where the marginal cost and earnings per share point were exactly equal.
Microsoft's earnings were $3.991 billion at its actual revenue share of 77.5%. At the optimum level of competitive spending Microsoft's revenue share should be 60.3%, generating earnings of$6.271 billion. The difference is the \$2.3 billion in theoretical earnings that management threw down the drain in the 2nd quarter of 2007.

Cook analyses Google in the next piece in the series and concludes they'd been under-spending into 2007, but were correcting it. (Piece is "Blue vs. Red Ocean Earnings Productivity")

### Economics 101 - or What's behind this apparent contradiction?

If Microsoft had 100% of the market, a pure monopoly, wouldn't that maximise income and hence profits?

There are three issues to address in there:
• income isn't profit. (Profit = Income - Expenses)
Max income may cause a loss if the expenses in earning it are too high.
• Maximum profit occurs when the cost of the last dollar of income earned equals the cost of gaining that dollar (as in sales/marketing/production&distribution).
MR = MC. (Marginal Revenue = Marginal Cost)
• Monopolies have a different problem, as there are no 'substitutes' for their products and not other players in their market.
Do they charge a single-price or not?
Effectively this creates a series of markets which compete at the change-over price.
People won't pay 'anything' for a good that's not necessary to life: there is a Price/Demand curve. A small number of people will pay a high price, and everyone will have it 'for free'. The trick is knowing the shape of the Demand Curve (because that's external) and matching that to your Supply/Cost curve (you should know this, its internal).

Wikipedia has good introductory pieces on these topics:
Marginal Revenue, Marginal Cost, Profit Maximisation, Price Elasticity of Demand and Mirco-Economics. A piece on Monopolies discusses the "The single price monopoly profit maximization problem" - which states that price should be twice the production cost (MR = 2 * MC).
It also introduces the notions of "Consumer Surplus", "Producer Surplus" and "Deadweight Loss".

Note that while the Profit Maximisation rule is invariant - it applies to all operating companies - it is just one area needing close attention/management in very large, successful companies.

Microsoft has been operating below its Optimum Profit level for a time - ignoring this ecomonic law will lead to financial disaster. The only question is "how long before they notice and correct?"

Google likewise has to attend to this same problem. It's in a better position - under-spending - but by how much can they afford to under-perform?

### References for "Death by Success"

I haven't found a book that documents the causes of the 2007/8 Global Financial Crisis in these terms. The financial manipulation at the root - knowingly making bad loans (sub-prime mortgages) and passing them off to others - is obviously a Ponzi or Pyramid scheme if phrased this way. Kept small, it would've been a blip... Allowed to become mega-successful, it has come close to bringing down the global financial system

Jarrod Diamonds' book, "Collapse: How Societies Choose to Fail or Succeed" documents this for societies.

Sydney Finkelstein, in "Why Smart Executives Fail: And What You Can Learn from Their Mistakes" does it for companies and their CEO's.

Jerry Weinberg teaches the rule at the Project/Team level in simulations within "Problem Solving Leadership" and is probably in his extensive writing. "Becoming a Technical Leader: An Organic Problem-Solving Approach" is the PSL textbook.

There's enough media coverage of self-destructing celebrities, sports stars and the newly rich to illustrate the idea.
Waldroop and Butler's "The 12 Bad Habits That Hold Good People Back: Overcoming the Behavior Patterns That Keep You From Getting Ahead" makes a good start for self study.