Behavioral Finance, Product Design and Entrepreneurship

Now that I’m entering my fourth week maintaining this blog, I’ve decided to come back to the subject of why I really believe that these three topics are intertwined.   These three topics are the reason that I named this blog Psychohistory, and these three topics seem to completely dominate my education and professional career.

The reason for this belief is crystalizing, and it’s remarkably simple:
I truly believe that incredible opportunity lies at the intersection of the irrational (human emotion) with the rational (finance, technology, business).

Behavioral Finance offers us the opportunity to design financial systems based on the basic insight that the way that human beings relate to money involves far more emotion than intellect.  To understand economics, you must understand your very human economic actor.

Product Design is based on the premise that deeply understanding the ways that people interact with technology can lead to profoundly more useful (and desirable) designs and products.  To understand product design, you must understand your very human customer.

Entrepreneurship offers us the opportunity to build companies by figuring out how to replicate the economic miracle of creating billions of dollars in new value by unlocking the very human emotions of inspiration, motivation, cooperation, and self-determination.  To understand entrepreneurship, you must understand your very human entrepreneur.

Like all good elevator pitches, I probably need to reduce this in complexity by an order of magnitude before I’ll be happy with it.  But I’m excited about this insight, and more importantly, I’m already seeing incredible leverage from it in my industry, where everyone is talking about the intersection of technology, commerce, and community.

Behavioral Finance: The More We Make, the Better We Want

I actually got a chance this evening to read the New York Times Business section in careful detail, and I found this gem of a column by Robert H. Frank, economist at the Johnson School at Cornell University:

The More We Make, the Better We Want – New York Times

This is a wonderful piece, because it captures three things that I find equally fascinating in one, elegant piece:

  • Classical Economics can fail in prediction when it does not take into account the uniquely emotional relationship that people have with money. It’s funny in retrospect, but I remember reading about John Maynard Keynes prediction of productivity growth leading to a shorter and shorter work week, and an excess of leisure time. Like Lamarkian evolution, this type of economic thinking meets the initial “sniff test” for critical thinking, but because it gets the base mechanism wrong, fails in the critical scientific goal of not only explaining the past, but predicting the future. Outside of small enclaves in France and Marin, there are likely few who actually believe that increased productivity should lead to a shorter work week… but why? This is the first article that to me clearly articulated the concept that as productivity rises, so do incomes. And as incomes rise, an “insatiable demand” for increased quality follows. This is a behavioral finance insight in my book: an insight into the predictably emotional behavior of people and money.
  • Flaunting superiority is not the only reason people spend money on luxury goods. Living in the Silicon Valley, where people measure revenue per employee in the hundreds of thousands (and market capitalizations per employee in the millions), this insight is instantly recognizable. While it is of course true that people to some extent will spend money for status symbols and competition, this explanation does not really explain everything that people spend money on. This article ascribes this to pursuit of “increased quality”, which is a touch idealistic, but it still rings true. Do people spend thousands of dollars on computers and Plasma TVs just to have one “as good or better than others?” Possibly in some cases, but in many cases it is because people spend a lot of time with these goods, and they have the income to spend on making that time higher quality. What are the limits here? Are there any? If there really is no end to the consumption demands of individuals, that really validates some of the brightest and darkest theories about human happiness.
  • American vs. European Spending Patterns. When you look at the recent economic evolution of the major western economies, one of the striking divergences between Europe and the United States has been the balance between growth & productivity vs. stability & social welfare. After the malaise of the 1970s, the divergence becomes incredibly acute – the incredible growth of the United States, on top of an already incomparably large US economy has been astounding. I am personally skeptical of “purchasing power parity” methods for ranking international incomes for a large number of reasons. But leaving that topic aside, this article explains to me a lot of what I’ve personally experienced during my brief stay in France. You have many people, quite happy with a dorm-room sized refrigerator, a water heater the size of a waste basket, and a 19″ television. In the US, a similar person, in a similar economic decile (or lower), somehow has a 50 gallon water heater, a 25 cu. ft. refrigerator, and now probably a large, flat panel television. The easy answer is to say that all Americans are gross, disgusting over-consumers, who put all their value in material things. This article puts some basis behind an alternative explanation – higher productivity and incomes in the United States have allowed people increasing amounts of disposable income to spend on higher quality products & services. More importantly, that process is a never-ending cycle, leading to more productivity gains, and an ever-increasing standards bar for the quality of goods & services.

This seems like an incredible economic advantage, and it speaks to the recent incredible growth in the luxury goods market as a secular trend. Economies that continue to generate outsized productivity growth may in fact establish a powerful strategic moat based on their insight into the “next level” of quality in goods & services. That certainly seems to be part of what continues to happen on an ongoing basis in 21st century Silicon Valley.

One of the truly great aspects of economics is being able to read decades and centuries of theory – some of it incredibly insightful, some of it woefully wrong. The reason it is wonderful is because, unlike the hard sciences, economics is fundamentally a study of people – individuals, crowds, and their interactions. As a result, understanding the history of economics and the reasons why very intelligent economists ended up with the wrong predictions is incredibly edifying.

This is an article worth reading, and then letting it digest, and re-visiting again. I also find this line of thinking a portent of an upcoming golden age of economics, as ground-breaking for this area as Max Planck was for particle physics.

As a side note, I also learned that finding an article on the New York Times website is nearly impossible. I did a direct search for this title on Google, Yahoo, and on the NYT site itself, on the homepage and in the business section. No luck. It was only through some very intricate checkboxes and sub-filtering of the NYT search that I was able to find this article – I have the printed copy sitting right next to me!

You have to love the Internet – you can find everything that you didn’t know existed, and you can’t find the one thing you know exists and want.

Ning on GigaOM & SearchBlog

It looks like Ning has been picked up on some heavyweight blogs today:

Om Malik on Ning

John Battelle on Ning

I’ll save my comments on Ning for another post, another time. I certainly think that Ning shows just how tenuous, from a technology perspective, the Web 2.0 sites hold on users can be.

In any case, I’m going to take this opportunity to share instead one of life’s little pleasures – seeing a friend’s name in print. I first met Gina Bianchini in high school here in the Bay Area, and got to catch up with her a few years ago when she accompanied another Stanford friend to one of my birthday parties.  Growing up in Silicon Valley is fun that way.
I remember hearing the news when Gina took on the opportunity, and its great to see some positive press around Ning. Like all startups, it certainly seems to have evolved considerably from its early days.

Honestly, seeing Gina’s company called out on these major blogs is just a really nice way to start the day. Congratulations to Gina & the Ning team.

Randy Smythe & Glacier Bay DVD (former eBay Powerseller)

Two eBay-related posts in as many days?  There goes that promise…

However, it is newsworthy to note that Randy Smythe, a former eBay Powerseller who achieved over 200,000 positive feedback, has started a column outlining his views on eBay.

Randy decided to leave the world of online selling in February 2006, and the radio silence since then has created quite a bit of chatter in the eBay community.

The introductory article is here:

What is the E! True Hollywood Story About eBay’s Former Top Seller Glacier Bay DVD? 

Interestingly, Randy is quite reticent about his own successes and failures in business, which to me is refreshing.  Running a small business is one of the most difficult challenges professionally, and running one online is no exception.  If Randy chooses to share his insights from this experience, it could benefit a lot of people.

I’ve commented on this blog that people are rarely rational with money, and surprisingly, this can even impact people when they run multi-million dollar businesses.  Like personal finance, I believe that entrepreneurs have the most to learn from each other – the good, the bad and the ugly.

To give some insight into Randy’s perspective, he linked to this article from The E-Commerce Guide on the challenges facing eBay.  It’s an interesting piece as well.  You can find it here:

eBay: Down But Not Out 

I am, of course, extremely optimistic about the future for eBay and for e-commerce in general.

Shameless Plug: A Great Search on eBay Express

First and foremost, please remember, I am extremely biased.   As I have explained in previous posts, I run the Product Management team responsible for eBay’s newest specialty site:

eBay Express

But when you work harder than you ever have in your life on a new product, or in this case, a new website, it’s hard not to brag a little when you see something wonderful.

Last week, my wife was shopping for double strollers.  After researching the subject, she decided that she really like the “E3” brand of strollers.  She asks me, “Do you think there are E3 strollers on eBay Express?”

So she goes to the eBay Express homepage, and types “E3 Stroller” into the search box.  This is what she sees:

“E3 Stroller” on eBay Express

(10/22 Update: The liabilities of a dynamic marketplace… I’ve been alerted that there is no E3 Stroller inventory right now! I think you can see what I’m talking about just searching for Strollers in general).

Wow.  What a gorgeous page.  What a nice selection of colors and sizes.  Great prices and great brand-new products from great eBay sellers.

An amazing amount of incredible technology and innovation went into the new search engine for eBay Express.   But even though I know in detail how eBay Express managed to come up with that beautiful search result, it’s still wonderful to see it in action, on a query that I know we didn’t test specifically, and yet one that really mattered to my little family.

Just one anecdote, just one query out of millions.  But hey, here’s a quick shout out to the eBay Express search team – you are making magic happen every day.

Blogs I Read: My Open Wallet

This is a blog that I bet many of my friends don’t have on their regular reading list.

My Open Wallet | Madame X

This blog is one of a growing number of personal blogs where people display an unprecedented amount of openness about the most taboo of all subjects – their money. More specifically, their personal financial situation. These blogs, many times anonymous, provide detailed information about the author’s finances – salary, savings, goals, and ongoing progress.

I found this blog almost a year ago when it was featured briefly in the New York Times. I keep reading it, and commenting, because it’s incredibly useful to learn from the insights and foibles of other real people.

One of the tragedies of personal finance is that it is so hard to talk about. Personal finance is generally not covered in school at any level, and it’s shrouded in mystery and urban legend. Even close friends and family often have trouble talking about money in an honest and open way.

Blogs like My Open Wallet provide a forum where we can start to learn from each other. They allow people to gather and share information that is incredibly specific. Personally, I’m more fascinated by the common mistakes and misunderstandings that I see in these blogs. It reinforces my belief that we, as a society, do not do a good job of educating ourselves with regards to money.

This trend of Personal Finance Blogs is so large, there are even competing Web 2.0 companies, like NetWorthIQ, that provide a sophisticated toolset for people to measure and share their personal finances.

So, check it out. Let me know if you find these blogs as interesting as I do.