Andrew Mackie, business catalyst

Information asymmetry

In his excellent book The Undercover Economist, author Tim Harford discusses (among many other topics) the problem of information asymmetry, first identified by Nobel prize winner George Akerlof in 1970.

Information asymmetry
Information asymmetry is a market condition where the sellers of a certain good know more about the product than the buyers. Akerlof’s example was the second hand car market where sellers know the foibles of their cars but buyers cannot tell the good cars from the bad. Buyers therefore compensate for this uncertainty by offering a price lower than the sellers of good cars are prepared to accept, preventing the sellers of good cars from entering their car in the market at all. Ultimately the effect of information asymmetry is that the second hand car market becomes a market for lemons.

Solution #1 - Experts
Given the value to both sellers and buyers in reducing uncertainty, a variety of businesses have been created to solve the state of asymmetric information in a number of markets. Two examples might be pre-purchase vehicle inspections in the second hand car market and building & pest inspections in real estate. Of course, experts sometimes have different incentives to that of their clients - real estate agents, for instance, have little incentive to get the best price for their clients, instead looking for turn houses over as fast as possible. Freakonomics discusses one study which found that real estate agents kept their own houses on sale ten days longer (waiting for a better offer) than the average, getting 3% more than the price they obtain for you and I.

Solution # 2 - The internet
Of course, the most powerful antidote for information asymmetry has been the internet. Information is no longer controlled by the powers that be - it's now democratised and readily searchable through Google. It's also changed the speed at which information is available so that everyone gets it at the same time. Finally, a large number of comparison services have been created to deal specifically with this issue, be it a restaurant guide or customer reviews on Amazon & EBay.

Solution #3 - Other signals of quality
Where information asymmetry persists in spite of experts and the internet, Tim Harford explains that consumers look to other signals for quality that have nothing to do with the product itself. A car dealer with a marble-floored showroom would therefore be viewed more favourably than someone who operates from their garage. This is because their larger investment suggests they are more interested in protecting that investment than doing a dodgy deal and leaving town. I see two problems with this, however, where significant financial investment is involved:

a) Apparent risk only
Investing in non-product quality signals speaks to apparent risk rather than real risk – the marble flooring makes no actual difference to the quality of the BMW parked on it. Being an inefficient solution it may worsen the problem - sellers may seek to recover their investment by massively inflating prices, selling lower cost goods or hitting you with hidden costs.

b) The past, not the future
The second problem with this high-investment solution is that a showroom is an indication of a previous commitment, rather than a future commitment. That prior commitment might also involve high levels of debt, requiring solid-looking businesses to close without warning.

What does all this mean? It's hard to get people to trust vendors in faulty markets. For you and I who want to sell things, this is a serious problem. In a future post I'll discuss an inexpensive solution that any business can employ.

Being remarkable

In this classic 20 minute TED.com video, Seth Godin explains how to make your idea spread:

The core ideas:

• The TV-Industrial complex (where more advertising -> more sales) is dead.
• People don't care about you, they care about themselves.
• Be remarkable (both being different and worth talking about) to cut through the noise.
• Find a passionate audience - sell to people who are listening & maybe they'll tell their friends.
• Making average (merely very good) products is now risky - no one will notice.
• Be remarkable.

For further reading, check out one or more of Seth's books.

Persuading Led Zeppelin

Wanting to use Led Zeppelin's Immigrant Song in the movie School Of Rock, director Richard Linklater cunningly asked Jack Black to beg them:

As discussed in Friday's book review, Jack used three of the six weapons of influence to greatly enhance his chance of success:

Liking - Jack used this in spades with both humour and genuine respect,

Reciprocation - in the sense that they went to so much trouble - going to some trouble (in allowing them to use the song) is to be reciprocated, and

Social Proof - 1,000 people screaming - it's not just Jack who wants this, it's everyone in the theatre.

Liking is my favourite weapon of influence. Not only am I more likely to get what I need, the person I'm dealing with is more likely to enjoy their day. It's based on mutuality, the bedrock of long-term business.

Book Review: Influence - The Psychology of Persuasion

Who is it for?
Influence: The Psychology of Persuasion is for anyone whose role requries persuading others, particularly marketers & entrepreneurs. It doesn't mean manipulating other people, it means aligning your approach to the way that others assess their decisions and opportunities.

Who wrote it?
Robert B. Cialdini Ph.D. of Arizona State University who researched which psychological principles influence our tendency to comply with requests.

The core idea
Being busy, we humans rely on shortcuts - triggers - to help us decide which requests we will comply to eg. whether we take a salesperson's call or help a stranger. Robert has determined that there are six universal triggers which he calls weapons of influence. His book details them so that we can use them or avoid falling for them as appropriate. They are:

1) Reciprocation
An extremely powerful tool, this is used extensively - free samples, free gifts, donated time, etc. Having been given something we are obliged to reciprocate and are more likely to comply, even if we don't like the person we are obliged to.

2) Commitment and consistency
As humans we demand internal consistency so that we are not lying to ourselves. Examples of triggers include our previous decisions, presale surveys, asking for stated responses (eg. 'How did you enjoy the free sample?') and asking people to make minor concessions to encourage larger ones later. Think interrogation techniques, salesmen who ratchet up the pressure, etc.

3) Social proof
We look to see what other people are doing before making our own decision. How do we know if someone lying on the road is a sleeping drunk or someone in need of urgent medical assistance? We watch to see what others are doing. Testimonials, 'our millionth customer', seeding tip jars with cash, etc, are also examples of social proof.

4) Liking
We tend to comply with people who we like (are friendly, warm, personable), are like us (race, religion, creed) or we aspire to be like (eg. Tiger Woods).

5) Authority
We give more weight to authority figures - police, doctors, etc. Scarily We also allow this weight to be transferred to people wearing uniforms (rent-a-cop security guards), actors who play authority figures (and then do a TV commercial recommending medical products, say) among others.

6) Scarcity
We assume that things that are scarce have more value. Scarcity may be in terms of availability ('Hurry, only three left!') or it may be in terms of time ('Quick! Sale ends tomorrow'). More subtle uses include limited editions of photographic prints, etc.

Why I liked it
This book has enabled me to get a higher response rate on my offers and requests, be they in person, via email, flyers, advertising or on my website. While I have always made mutually beneficial offers, people don't have the time to trawl through a whole website to come to that understanding. By including as many triggers as possible in each request people can quickly assess my offer and give it the additional attention I believe it deserves. To this end I've memorised the weapons of influence so that they're always at my fingertips. Finally it's also helped me avoid a few pitfalls, and understand why some people and businesses are more successful than others.

A motivational speaker owes me $100k

I once did business with and lost around $100k to a woman who was a big-picture visionary, able to see incredible opportunities and create trust with others almost instantly. She did, however, consistently over promise and under deliver, creating an increasingly long line of disgruntled former investors.

When despair was upon her, she would sequester herself to listen to her library of a well-known motivational speaker's tapes, reappearing again an hour or so later ready once more to take on the world. In doing so, this unconsciously incompetent businesswoman avoided painful self-reflection, replacing it with a large dose of audio fire walking. The way I figure it, the motivational speaker owes me (and no doubt other former associates) about $100k.

Self-reflection can be painful, but pays incredibly large dividends. Avoid it at your (and others’) peril.

Book Review: The new business road test

Who is it for?
The new business road test is a must-read for anyone wanting to start a new business, now or in the future, and should be read before writing a business plan. Reading the book will help you identify which of your business ideas are likely to be viable and which should be thrown in the bin.

Who wrote it?
John W. Mullins, Associate Professor of Management Practice in Entrepreneurship at the London Business School.

The core idea
John W. Mullins contends that there are seven domains that a business must be tested against and pass in order to be successful:

- Will the fish bite?
- Is this a good market?
- Is this a good industry? (Porter’s forces)
- How long will your advantage last? (Building a sustainable advantage)
- What drives your entrepreneurial dream? (What are your personal goals?)
- Can you and your team execute?
- Your connections matter – which matter most?

Why I liked it
This book gave me clarity in an area where entrepreneurs are typically weak – in performing their due diligence. It has allowed me to systematically look at each business idea and evaluate it objectively, without much overhead.

I think it’s compelling enough to make this bold statement, an echo of a statement in the book, that if more entrepreneurs read this book or resources like it we’d have stronger economies. Entrepreneurs are both a scarce resource and the engine for our economic growth and far too often they waste their time, investment opportunities and considerable talent on projects that have no chance of succeeding.

Balance it with:
The Art of the Start by Guy Kawasaki, which covers starting a venture from a holistic, passion-centric position.

Blue Ocean Strategy, which (in spite of being IMHO a very dry book) helps entrepreneurs see beyond fighting in competitive markets (a red ocean strategy) to find new markets where you have no competition (a blue ocean strategy).