Wealth Concentration - Yes. Central Planning? Not so much.

My facebook feed was filled today with links to a post by Tim O'Reilly which itself references this post by John Robb. John theorizes that centralized planning is to be blamed for the recent hurdles the US Economy is facing.

The summary of John's hypothesis is as following:

  1. The USSR failed because of central economic decision making.
  2. Decision making in such a complex system can only be made efficiently by letting the players in the market make small parallel decisions - that is, letting the "market" work.
  3. The US was successful because it was very good at letting markets work. However:
  4. Recently, too much centralized government planning leads to misallocation of resources.
  5. But more importantly, the increasing concentration of U.S. wealth among a handful of rich people leads to even more centralized decision making - only those wealthy enough make the decisions, and they control most of the assets to decide on.
I liked the theory, as it is novel, and gives a new angle to the causes of the recent economic crisis.
I am quite positive, however, that wealth concentration is neither evidence, nor a cause for central planning and its failure in the U.S.
The reason is that wealth concentration hasn't changed tremendously in the last 90 years in the U.S.
And here's why.
As support for his claim about wealth concentration in the U.S., John shows the US Income distribution graph from the NYTimes Economix blog:
If you don't like reading graphs, the one line summary is: "The top rich 0.1% make much much more than all the rest". This indeed shows that income is very unequal in the U.S.
To verify John's hypothesis, we can do three things:
  1. Focus on wealth, and not on income. If the claim is about wealth concentration, why look at income and not total assets owned by people?
  2. See if it changed over time - suppose the U.S. was always unequal about its wealth distribution - in that case, the recent economic issues are probably not a result of that inequality.
  3. Compare it to other countries - If there are other countries, with unequal wealth distribution, and even central planning, do they also face similar problems?
To answer these questions, we need data. Luckily, this page by Sociologist Bill Domhoff from UCSC has all the information required to answer these questions.
So let's start:
  • Is wealth concentrated by a handful of people in the U.S.?
The probable answer is Yes, as can be seen from this NYTimes Economix Graph:
This graph shows that the top 1% of U.S. population controls between 20%-30% of the wealth in the USA.
  • Did wealth concentration change drastically in the last 80+ years?

The probable answer is No.

The following graph, with data as old as 1922, shows that the wealth concentration in the U.S did not change dramatically over the last 25 years or so. To add on that, there is less wealth concentrated in the U.S. by the top 1% today than there was during the 1990s, and roughly the same amount as in the 1960s and 1930s. One caveat is that the data goes only up to 2007, but probably hasn't changed much:
Source: Adapted from Wealth, Income, and Power

This means the U.S. was always unequal in its wealth distribution. 
It's not a recent phenomenon.
  • So how does the U.S. compare to other countries?

The data I found was for the year 2000 (I didn't look too much, though), but let's assume no dramatic changes have happened in wealth concentration since 2000. Also, changes did happen, they probably went in the same direction for most countries. The data is for the top 10% of the population, not the top 1%:

wealth owned
by top 10%
Switzerland 71.3%
United States 69.8%
Denmark 65.0%
France 61.0%
Sweden 58.6%
UK 56.0%
Canada 53.0%
Norway 50.5%
Germany 44.4%
Finland 42.3%
The table clearly shows that although the U.S. has most of its wealth concentrated in the top 10% of the population, this is also the case for Switzerland, Sweden, France, and Denmark. 
All of these countries have very centralized planning. 
Many of them have very high tax rates compared to the U.S.
Some of them are in bad shape.
But Switzerland seems to be doing well, no matter what. Especially given its wealth concentration.
Conclusion: We can't really conclude anything from this short exposition of data, but it looks probable that wealth concentration did not cause more centralized planning which did not cause the recent difficulty the U.S. economy is facing.

צרכנות ומחיה בישראל

לפעמים, כל התשובות נכונות

מירב ארלוזורוב פרסמה היום בדה-מרקר ניתוח של בנק ישראל על שיעור החסכון בישראל, כולל זה של מעמד הביניים.

מסקנות הניתוח פשוטות יחסית - שיעור החסכון מההכנסה נטו של משקי בית בישראל עולה עם השנים, ונמצא ברמה של 12% מהנטו בעשירון השישי. בקצרה - ישראלים גומרים וסוגרים את החודש, ובגדול.

הייתי קצת מופתע מהתוצאות - אם נסתכל על המחאה ברחוב הישראלי, המצב הוא פשוט אינו כזה. עוד הייתי מופתע מהעובדה שמירב פרסמה את הנתונים כמעט ללא ניתוח. ההסתייגות היחידה (העיקרית) היא שהנתונים הם משנת 2009.

ולכן, אני כותב את הפוסט הזה. המטרה היא פשוטה - לא צריך להיות כלכלן (אבל צריך להעמיק בפרטים) כדי להבין איך שיעור החסכון בישראל גדול וגדל, אך משקי הבית עדיין אינם סוגרים את החודש.

לקסם הזה יש שני שמות, וטריק אחד. הטריק טמון בהגדרה של "שכר נטו". והשמות לחסכון הם "פנסיה ופרישה" ו"קרן השתלמות".

נתחיל מהטריק - מהי הכנסה נטו? אם תשאלו אישה או גבר ברחוב, בד"כ יענו לכם - הסכום שנכנס לי לבנק מהעבודה בתחילת כל חודש. הוא כמובן צודק, מכיוון שמהסכום הזה משלמים שכר דירה, חשבונות, עלויות מכולת, חינוך לילדים וכל הוצאה אחרת.

אם תשאלו את בנק ישראל (או הלמ"ס, במקרה הזה), תקבלו את ההגדרות שנמצאות כאן. בקצרה הן אומרות "הכנסה נטו היא הכנסה ברוטו לאחר ניכוי תשלומי חובה".

טוב, זה קצת מסתבך, אבל לא יותר מדי.

"הכנסה ברוטו" - מוגדרת ככל ההכנסות של משק הבית. זהו לא הסכום שאדם מהיישוב היה קורא לו הכנסה ברוטו. זהו סכום שאדם מהיישוב היה קורא לו "הכנסה ברוטו עם כל מיני הפרשות בצד" (או משהו שקרוב אליו מאוד). ההבדל טמון בהפרשות לפנסיה (כ - 5% מהברוטו) ולקרן השתלמות (7.5% מהברוטו). בנוסף, ישנה הפרשה לפיצויי פיטורים במרבית המקרים. לא ברור האם הלמ"ס מכליל אותה בברוטו או לא. בחישובים בהמשך הנחתי שלא. אם הם כן נכללים בחישוב, המצב גרוע יותר.

תשלומי חובה - כאן הלמ"ס ברור מאוד - תשלומי חובה הם רק מס הכנסה, ביטוח לאומי ומס בריאות. הפרשות לפנסיה, ביטוחים, רכב וכו' אינם תשלומי חובה.

לאחר כל בליל הפרטים, הנה דוגמא מספרית. כל החישובים מעוגלים כדי שיהיה נוח לכתוב אותם. החישובים נעשו באמצעות אשף הנטו של חילן טק. בחישובים הנחתי ששכיר בעשירון השישי זכאי להפרשות מעביד לקרן השתלמות. אם לא, החישובים משתנים.

לפי הכתבה בדה-מרקר, השכר נטו של אדם בעשירון השישי הוא 10,982 ש"ח בחודש.

מהו השכר ברוטו של אותו אדם?

החישוב קצת מורכב (בגלל כל ההפרשות בצד), אבל לפי הלמ"ס השכר יהיה כ - 13,000 ש"ח לחודש. לפי האדם מהיישוב, ואיך שמוגדר תלוש המשכורת שלו, השכר הוא 11,500 ש"ח.

להיכן נעלמו 1,500 ש"ח? כ - 900 ש"ח מפריש המעסיק לקרן השתלמות, וכ - 600 ש"ח לפנסיה.

ההבדל לא מסתיים כאן. אמנם הלמ"ס אומר שההכנסה נטו הינה 10,982 ש"ח, אך בפועל, תלוש המשכורת יסתכם רק בכ - 8,700 ש"ח לחודש. כבר סיכמנו ש - 1500 ש"ח מההכנסה נטו מושמת לחסכון על-ידי המעסיק. איפה שאר 800 השקלים? הם מנוכים מהעובד מתלוש המשכורת, לאותה פנסיה וקרן השתלמות.

אם נסכם את הכל, החישוב שלנו הראה שכ - 2300 ש"ח מופרשים כל חודש כבר בתלוש השכר לחסכון. מדובר ב - 20% מהכנסה נטו על-פי הלמ"ס.

אלא מה? הפלא ופלא! לפי הכתבה, העשירון השישי חוסך רק 12% מהכנסתו נטו. וכרגע אמרנו שהחסכון הוא כ - 20%!

וכאן טמונה העצם - העשירון השישי אכן חוסך סכומים מכובדים מאוד, רק שאת חלקם הוא יראה בזמן הפרישה (גילאי 60-67), ואת חלקם פעם בשש שנים, בהיותם שייכים לקרן השתלמות. אף אחד מהסכומים האלו אינו נכנס לחשבון הבנק בתחילת החודש ומאפשר לסגור את החודש. ההפרש הזה, של 8% מהשכר נטו (כ - 800 ש"ח) נמצא באוברדרפט של שכירים בישראל, ותופח עם השנים בגלל הריבית.

מסקנה - כולם צודקים - מעמד הביניים חוסך המון בעתיד, אבל נמצא במינוס תמידי בהווה...אין זה בהכרח אומר שצריכים לבטל את ההפרשות לחסכון בתלוש המשכורת, אבל זה כן אומר שכשבודקים את יוקר המחיה של משקי בית, צריכים להתעמק בפרטים של הנתונים.

Deciphering the genome of ... startups!

Over the last three months or so I had the pleasure of working with the talented team of blackbox.vc (http://blackbox.vc/) on the startup genome project (SG).

The goal of the project is extremely ambitious - to map, model and analyze what makes startups tick, what helps them succeed and why many of them fail. We are hoping that the insights generated through this project will create useful tools for increasing success rates of startups during their initial growth periods, as well as will shed light on interesting phenomena, pitfalls to avoid and much more.

My part in this project was to aid with the technical and scientific analysis of the data, anywhere from initial definitions of the questions to be answered up to giving input on what conclusions can be drawn using different statistical techniques. An academic marketing background is excellent for this purpose, as it brings in tools from survey design, econometrics, some psychology and more.

[Source: 12manage.com]

The process was fun (and is still going on), but initial results will appear any day now first report we publish. One interesting conclusion is that many firms today, especially young startups, own hordes of data they are not sure how to handle. This is similar to a person striking an oil field, but without any refining technology in sight to turn oil into usable fuel. The firms sit on gold (or oil) in the form of data, but cannot tap into this resource because of uncertainty on how to attack such a problem.

I think there is a lot to be learned from how we analyzed the data and the methodological process that happened while writing our report, and this post is aimed at telling the story. If there is any specific part or topic which you are interested in, leave a comment in the comments section, or contact me, and I'll do my best to elaborate more. If you're interested in future updates, just follow me on Twitter.

As in any genome project (as if I was ever part of one), there are three main parts to this project:

  1. Mapping - Initially, we were first tasked with a simple question - we had lots of data, some of it good, some bad, some accurate, some not - what is there that is useful?
  2. Modeling and Hypothesizing - Once we had a better grasp of the data we had in our hands, we needed a way to think about the questions we would like to answer. In order to ask smart questions, we needed a simple way to describe the process startups go through, if they go through a standard one at all.
  3. Analysis and Reporting - Given a model and the data, we set upon checking our hypotheses and drawing conclusions from the validated ones. We ended up with tons of numbers, tables, graphs, equations and what not. The final goal was to somehow synthesize it all into readable content, which is also (hopefully) actionable.



Mapping and exploring Data


The initial survey created by Max and Bjoern and the rest of the StartupGenome team was exploratory in nature. It contained a long list of questions covering many areas that can describe a startup to an outside observer.
In more formal language, the survey took a static view of the world and tried to capture a snapshot of a startup's developmental stage using a list of questions. The team had understood that a static view will probably provide very limited actionable information for startups, since the current stage of a startup does not contain all of its historical information. We had, however, to start somewhere.

The goal of the survey was to give us enough information to formulate a model that we can later focus on and test in future surveys. The future surveys are planned to take a more dynamic view of startup development. Although the SG team had an initial model in mind, it was still unclear if the model is correct, and what the answers to the questions would look like.

The first thing we had to do, given survey answers, was to describe them in a succinct and parsimonious manner. (On a side note, did you ever notice how people like to use "parsimonious" to say "simple" in a non-simple manner?).

The result of describing the data is called "descriptive statistics". The typical descriptive statistics are averages, standard deviations and counts of various aspects of the data. In our process we created a huge amount of different cuts, views, cross tabulations, graphs, means and statistical significance tests to check relationships and correlations in our data. Once we had those, we leaned back, looked at them from afar and tried to ask ourselves "do these results make sense".
The sanity check stage was very important, it showed us where we had inaccuracies and other problems in the data, where the people who answered the survey may have misunderstood the questions, and also where initial correlations show a promising direction for deeper research.

An interesting question was what tool to use to perform data analysis. As uncool as it may be, I still believe Microsoft Excel (yes, even the Mac version) is by far the most powerful tool to work with with raw data if the amount is not too large (up to 1 million rows of data or so).
It lets you easily filter, change, transform, graph, cross tabulate and do many other tasks very simply.
Another option would have probably been using SPSS for that manner.
Google spreadsheets is getting there, but until a week ago had no pivot table support, which was our main tool for generating insights and reports.

Some interesting things we noticed in this process were:

  • There was a lot of useful information that could be gleaned even from the simple descriptive statistics. When we showed it to outsiders, the typical response was "wow, that is something I wish I had known before".
  • Some of the survey questions could have been answered in several different ways for the same answer. The main reason was the different startups viewed their market potential, and potential customers in a subjective manner which can be interpreted in different ways. This gave rise to the concept of a startup "Type" which says that startups belong to underlying families. Startups within a family seem similar, but they behave very differently across families. This is one of the main themes in our initial report.
  • It is very hard to tell from a static snapshot of a startup whether it is successful or not. That is, even given all of the details about the founders, their current stage, whether they raised funding and whether their product looks like it has a good fit with the market, it is still hard to differentiate a winning from a struggling startup without knowing more of how it evolves over time. One conclusion is that the current investment process in startups is done "half blindly" because of the tendency to do a static analysis.

Modeling


Once we had our descriptive statistics, we wanted to start and see if we can tell which startups face more difficulties than others, and whether we can create measures that startups can use to benchmark themselves against best practices.
I remember that in our first day of working on the data, Max had a pretty solid understanding of the stages model and what is the current common knowledge in industry about what stages startups go through, and how. I served as a sort of "devil's advocate" and "question guy", constantly asking questions about the model, and whether answers from the surveys could be interpreted as a one-to-one matching to the different stages in the model. Another thing that had to be done was transform the abstract stages model into something mathematical, or something measurable. Markov chains came as a natural model, and more on them is described later.

We then looked for questions in the data that will identify a stage. Identification (in the academic sense) has a very specific meaning, but intuitively, it says that a specific piece of observed answer or data can only mean a specific value of some unobserved information.
To put things more concretely, in our case the observed data are the answers to questions to the survey, and the unobserved information is the stage a company is in.
Here's an illustrative example (but it's not exactly what we did):
When firms were supposedly in stage 3 or above in the SG model (known as the Efficiency stage), they were supposed to have already achieved a fit between their product and their market, and were also supposed to scale their sales and marketing by pouring money into it.
As a result, we used to questions analyzing the product/market fit and marketing expenditures to determine whether a startup was in stage 3.
We performed this process for every stage in the model, and for each startup we had a Yes/No answer to whether they passed through each of the stage.

We also calculated a "score" for each firm, depending on its recorded answers and clustered firms according to similar score areas, and hence received the aforementioned startup "Personality Types".

Suddenly, we had a serendipitous moment.

We noticed some startups didn't go through all of the stages (according to their answers). We called these startups "inconsistent" and went to their detailed answers to see what inconsistency means. We found out that inconsistent startups were much more likely to lag behind and face difficulties in their developments. Inconsistency looked like a good predictor (or correlator) with a struggling startup.

[Source: StartupGenome Report]

This was an initial indication that the stages model makes sense as a view of the world.
The second thing we did regarding our modeling is assuming our stages model is correct. As a result, we received a model where a (consistent) firm can only move from one stage to the other sequentially. The entire model can then be seen as a Markovian process, or specifically, a POMDP.

If I were to explain what a POMDP is in one paragraph, think of a person making decisions which you observe, but you do not observe the underlying information the person has. Since the person uses the unobserved information to make decisions, one cannot analyze the chain of decisions at face value, but rather needs to have a "belief" about what the decision maker knows and does not know. If we then assume that startups of the same personality type are similar (homogeneous), we can assume the date we observe in the world is an equilibrium of sorts of a process for generating startups and having them move through stages.

All this babble mean we can treat the data for different startups in the same type as if it was almost the same startup in different stages, and reach some nice conclusions.

To simplify things, however, we just assumed we "know" the underlying stage (given the answers to survey questions), and tried to see what actions carried on by entrepreneurs help them move through actions.
Actions, as an example, can be hiring employees, pivoting more, raising money, consulting mentors and more. They do not indicate the stage of a startup (in our model), but can help a startup advance in its stage.

The technical method we used to estimate this model is a "simple" ordered probit, where firms generate "value" which is then converted to a stage by an outside observer. The software (for the geeky oriented) was Stata.
Our initial results seem promising and will be published once we formulate their presentation style (they are complex to read) and also finish all of the statistical testing.

Analysis


In many of my previous encounters with big data analysis projects, both in my VC years as well as in other positions, I noticed that most people stop after step 1, some continue to step 2, and almost no one does the important job - that of step 3.
Step 1 and 2 are descriptive steps - they tell us how the world behaves and what it looks like. It is interesting, and as people, we love reading graphs, seeing statistics and digesting information.
The reason (and this is purely a conjecture of mine) is that as people, we do not like uncertainty, and statistics brings some order to how we grasp the world.

The main question, I think, is what you do with the statistics and the data. The goal is to provide actionable results for startups, and although we have initial results, we still have a lot of work to do.
The analysis step is (in my opinion) where the true creativity of the team will come out. What we do is first take a step back, and look at the results. We analyze if they make sense and what they mean.
Then we ask a simple question: "What would happen if we actively changed something, or did some action". To test this, we can run a survey, perform an experiment, or run a simulation assuming our model is correct.

I guess our next step with the project is to focus more and more on the modeling and analysis phases, until we will reach the exciting conclusions we aim for.

If you've reached this far down the post, I hope you enjoyed it. As a summary, just remember that every data analysis task, as daunting as it may look has only 3 typical steps, and that the best results, in my opinion, are achieved only when you get past the Analysis phase.

A note on statistics: Many of the results presented in the report are based on somewhat small samples, mostly for the personality types. The majority are statistically significant using simple tests. We have tried to specify all the interesting cases where conclusions might not be statistically significant. During our work we have refined many questions in the surveys and are now collecting more data to validate the results and make inference more accurate.

More is yet to come. To keep tabs on future results, just sign-up for an email update from this blog, or follow me on Twitter.

How the industry of innovation makes itself obsolete

There's a lot of buzz lately around Silicon Valley about angel investors, startup accelerators, crowdfunding, business model development and much more.

A typical claim is that the VC business model is broken. Another one is that VCs have just not adjusted to the modern needs of their companies.

As I am not in the valley, I watch the changes somewhat from afar, but not too far. This gives (IMO) an excellent perspective on things, and one of the interesting phenomenon is how the VC industry is funding its own demise.

If you're reading this blog and know nothing about VCs (venture capitalists), here's a short explanation: VCs take money from investors, and invest it in startups. Their (claimed) expertise is allocating investments smartly in a way that funds groundbreaking innovations that bring huge returns to their investors.

The industry started in the early 1960s (late 50s even), and had funded probably every large and innovative technology company you have heard of or not, including DEC, Apple, Cisco, Google and many more.

In the last 5 years or so, a big shift in the industry can be observed - much smaller investments are needed to start a company, and VCs many time stay outside the game of the smaller company creation and exit process.


The typical explanation is that starting a company requires smaller amounts of capital, and as such, VCs are just too big to succeed.

If you think about it, however, VCs are exactly the reason costs are so low to begin with.

Over the years, the technology industry invested significant amounts of money in making technology more affordable, available and easy to use.
One result, for example, is the emergence of e-commerce. In case you did not notice, the following chains went into bankruptcy (or closed their stores) in the last 5 years: CompUSA, CircuitCity, Borders, Tower Records and Blockbuster.

What's common to all of them? They needed to compete with an ever growing online selection and new business models relying on lower costs driven by technology.

And the same thing is happening to the VC industry. If at first VCs have funded innovation in areas such as semiconductors, telecomm, banking and travel (have you used a travel agent lately?), where manual labor was slowly replaced by computerized technology, later they funded inventions that lowered the cost of creating technology in general.

One result was that they created a lot of rich people, who are technology savvy, and can easily compete with VCs when the costs are lower. The second result is that the wave of "basic/big" infrastructure innovation is mostly over, and as the technology sector matures, their services are less needed.

The third result, which is probably the most interesting one, is that VC investment is essentially a manual process. It is grudgingly slow, and sometimes inefficient.

So what does the technology industry do when an inefficient manual process exists? It creates the technology to replace it, or make it better and more efficient. As a result, service such as the Angel List had sprung up, as well as technology accelerators and several other projects and tools.

This is literally slowly cutting off the branch you were sitting on, while inventing the saw, and making money of selling saws.

How will the VC industry react?

Although a famous (Hebrew) saying is that Prophecy is given to fools, I will go out on a limb and say that many VCs will disappear, and the rest will fund truly great innovation, or shift to different industries.

Self inflicted paranoia - The "secret" of insurance deductibles

It is a well known fact (or at least strong belief) that most people make very wrong choices with respect to buying insurance products. The majority of people over-insure, that is, pay much more than they should, or just neglect to purchase insurance altogether.

This post turned out to be a bit long and somewhat technical, but here's my promise - if you can keep with it until the end, the chances are you will feel fooled by insurance companies, but will also be able to save lots of money in the future.

As someone who studies consumer decisions, buying insurance is one of the most fascinating phenomena to study, for several reasons:

  1. Insurance is a complex product, containing many details, but at the end, there is just one price (premium) to pay.
  2. Consumers buying insurance need to make many decisions about many "parameters" of the product they buy.
  3. Insurance sells something in the future (coverage against negative events), that might happen or might not - who can predict his own future with accuracy?
  4. The product sold is very emotional - it is related to negative events with big and bad impact. Most people have a hard time entangling their emotion about the event itself and the decision of how much coverage to buy.
  5. The insurance industry (in the US) is rather competitive, so the products are abundant, advanced and should be fairly priced.
  6. People make the decision to buy insurance over and over again, many times annually for a period of 30-40 years. This means there is ample time and information for learning from past mistakes.
I am fascinated by this phenomenon, since it shows how firms produce a complex, emotional product and profit on consumers' inability to understand too many details, or their plain fear from negative events.
A very interesting and roughly "simple" parameter of insurance where consumers make almost unanimous mistakes is how much deductible they would like to pay in case of an insurance event.
A paper by Justin Sydnor analyzes the case of homeowners insurance, where this paradox is sometimes stronger than in the case of other insurances.
To have a clear example, let's take auto insurance deductibles for instance.
A deductible is a sum of money that someone pays from his/her own pocket before the insurance kicks in. For example, if a car was involved in an accident with damage worth $2000, and the insurance policy has a $500 deductible, the insured will pay $500 from his/her own pocket, and the insurance company will pay the remaining $1500 to fix the damages.
If the damage was less than $500, the insured person pays for all the damages from his/her pocket.
Why are deductibles interesting? Deductibles are interesting because they come with a clear menu of options. 
A typical auto insurance offer will have the option (for example) to select deductibles of $250, $500 and $1000. In addition, a change in the choice of deductible affects the price of auto insurance greatly.
Every time a person chooses a lower deductible, they need to pay a higher premium for that. That is, the price of having to pay less out of pocket in the future, costs more today.
The second interesting point about deductibles is that the difference between one option to the other is very clear - the value of a $500 deductible vs. a $1000 deductible is at most $500 per year.
If you don't see why, think about it for a minute - buying a lower deductible just gives you the option to pay less of the difference in that year.
Let's focus on the choice of a $500 vs. a $1000 deductible. Here comes the interesting part (if I haven't lost you by now) - how much are people willing to pay for the option to pay less in the event of an accident?
That depends only on one parameter - their beliefs about their probability of being involved in an accident with damages over $1000.
(To simplify things. This is very close to the actual reality).
It is important to understand this does not depend of how much damages will be created to the car (once they are above $1000), since everything above $1000 is covered anyway by the insurance company.
If you go to your car insurance provider, and ask them for two quotes for the same insurance policy, with just one difference, one quote for a $1000 deductible, and one for a $500 deductible, the difference in annual (yearly) premium will probably be on the order of $150-$250. Let's suppose it's $150.
I urge you to go and check. This difference can be very different for many people.
What does this mean? It means that if you believe you will have a 150/500 chance of an accident (30%) with damages above $1000, you should buy the lower deductible. 
Why? Because you are paying $150 extra every year for the chance of getting $500 in return (or the chance of not paying $500 in the event of an accident). If this chance is higher than 30% (say 40%), you will get back 500*40% = $200 back, thus having a "profit" of $200-$150=$50. If this chance is lower than 30%, you will get back less than what you paid, on average.
Is 30% chance a lot or a little for having an accident? Think about it - if you are involved in a car accident with big damages roughly every 3 years, 30% is about right (100/30). If you are not (and I hope most people are not), then you shouldn't get the lower deductible. To make things worse, if the difference of the two quotes was $250, and you bought the lower deductible option, it implicitly means you believe you will be involved in such an accident every second year (250/500 = 50% chances of an accident each year). Assuming you and most people around you are decent drivers, this is clearly a self inflicted paranoia.
Another way to look at it is as a savings scheme - get the higher deductible, and put the savings from insurance price in a savings account, and call it "emergency car repair fund". Use these funds only to pay for deductibles. I would assume this "fund" will pass the value of $500 quite fast.
There are essentially only two cases where buying a lower deductible is worth it:
1. You cannot afford the $500 in one time - In case of an accident, if you cannot afford to spend $1000 (but can afford to spend $500), then get the lower deductible. In this case you are basically paying the insurance company a very high interest rate (roughly 15%-20% is my estimate) on having not to save $500 on the side.
2. You are a very reckless driver - If you are prone to accidents, get the lower deductible. Insurance companies are smart as well, though. The chance your entire premium won't raise once you have a bad driving history is zero, so you will be paying for being reckless anyway.
This anomaly can happen in any industry where insurance is sold, but I have a hunch it happens the most where the  negative events might have large financial consequences - health insurance, home insurance, earthquake insurance and such, and also when recent negative events have happened. If you've paid attention, however, you should be able to say by now that the choice of deductible should depend on the size of the "average" damage and not the "extreme" damage, since both deductible options will cover the extreme damages.
Hopefully after reading this, some of you went to check out what their deductibles are, and some of these some, saved roughly $500-$1000 per year on unnecessary over-insurance.

Are VCs the new recruitment agencies?

Roughly a month ago I had a lovely brunch with two friends, both currently in the online advertising industry.
Our chat touched on many topics, from crazy Halloween parties to China's media agency.

If you ask yourself "Huh?", the answer is Yes - they are connected in some twisted way.

We finally resolved to talking about the recent burst of small startups, small investments and multiple small exits of companies occurring all around the bay area. Are these signs of a new "tech bubble"?
Some attributes of the current frenzy are similar to previous tech-crazes, but one is unique - the exits are not IPOs but rather many small acquisitions by larger firms, and the investors are not "regular" people doing it through the stock market - they are "sophisticated" angels and acquiring firms.

At one point, I raised my hypothesis that it appears that investors are recently being "exploited " as recruitment agencies by entrepreneurs and acquiring firms.

And it goes like this.

Once upon a time, perhaps 5-10 years ago (or more), founding a startup required significant initial capital. Getting the business to grow and to become profitable, or even with decent traction required on the order of $10M-$20M if not more, except for certain stellar cases.

This caused two phenomena - entrepreneurs had to either raise considerable amounts of money to start a company, or join a large company with a strong financial backing to create their dream products. It was not possible to just "create it and see if it works".


As a result, investors required significant return to let a company be founded, let it grow and then let it be sold. Let's say 5x return would have been considered good. When an acquirer would come, and see that startups spent $10M-$20M, they would know they would be required to shell around $100M to buy the startup to make investors happy.

If you're saying to yourself - "this is not how companies are valued", be aware that sunk cost fallacies are big players in the investor's world, VCs and angels included.

Shelling $100M and upwards is a big deal. Not many companies can do it, and the ones that can really need to justify it to their shareholders, their board, and essentially themselves.

In the last few years, however, it is much easier and cheaper to to start a company. In the Internet business, a founder or two with little or no money can launch a web product. Some very creative ideas have sprung up with an investment of just time, or less than $100k.

This situation is a game changer for two reasons:
1. Talented entrepreneurs (see my post on Talent vs. Business acquisition for the definition of what I call "talented") suddenly have the opportunity to create their dream product without owing almost anything to anyone. Since their passion is many times about the product, and less about building businesses, once the product exists and is a success, it makes sense to be absorbed in a large firm to grow the business.

2. Large firms suddenly found themselves without talented employees. If in the olden days the promise of a big budget and great technology was enough to lure the talented entrepreneurs, today this budget is not necessary, and the technology is easy to create and build. How can you then bring in talented people?

Give them a big "sign-in bonus"! As firms now do not need to compensate investors with large sums for building a product and a business, these sums are transferred as "bonuses" to the startup founders and hopefully a small set of employees.

So why are investors serving as a recruitment agency? The answer is simple - finding which entrepreneur is talented requires to let them (the entrepreneurs) try. Someone needs to cover the cost of this "test", and angels (microfunds, super-angels, anyone) seem to have taken this job upon them.

Dilbert.com

Their money is used not to build businesses, but to vet future employees. Essentially the smaller investors do not create competition for larger firms, but just strengthen their market position by helping entrepreneurs be acquired early.

They are compensated generously for their investment, but not much value is created through the process - just a lot of trial, error and acquire.

Talent Acquisition vs. Business Acquisition

Over the years I have been lucky to meet many smart people. I consider myself even luckier by the fact that many of them have become my friends.

If you are engineers, or worked at a startup or a similar environment before, you are probably aware that the 10:1 employee is not a myth. A 10:1 employee is that employee who performs like ten others. They code faster, make less mistakes, design smarter solutions, solve problems better, the customers love them, and they are as flexible and artistic as can be. To put it shortly, they are super-persona of sorts. For the mathematically inclined, if we assume an average person has an output of 10 units, and assume that 95% of the population perform at most 50 units (5:1), then the probability of a person being a 10:1 employee is less than 1 in 10,000. (I cheated a little on the math, don't kill me). When I say "smart", I mean 10:1 "smart".

The interesting thing about smart people, at least in the business world, is that the fact they are rare yields a high premium for their services. In other words, companies are willing to pay a lot to hire them or receive their services.


During the last year, roughly 5 to 10 of my smart friends have approached me all with a similar story, albeit in completely different industries - they started a small business, typically a technology services company, or a bootstrap technology startup. The business started growing and attracting attention, customers and even initial income. Roughly after a year, when the company typically has 2-5 employees, my friends were approached by one of their customers, partners, or just a big company.

Initial relationships with those companies typically turn into a joint project, or some form of a contract, but after some time, a VP typically appears and says: "What would you say about us acquiring your company?"

Typically, at this point, shy smiles appear on my friends' faces, their eyes sparkle, and you can almost see the $ signs change into staring ??? signs, I ensue to explain.

A (technology) business, in its essence, has four sources of value:

  1. Capital - If the company has lots of cash, its value is at least as the amount of the cash it has.
  2. Human Capital - The company's employees, especially in technology startups and services companies are what makes the company valuable. Without them, even the most advanced technology cannot function.
  3. Technology - Good candidates for acquisition should have good/unique/innovative/sophisticated products and technologies. They are not necessarily rocket science material, but they are better/more impressive than what internal engineers at the acquiring company can produce or have time to work on.
  4. Customers - This is the business part. Except for the cash, if a company has a lot of customers, preferably the paying type, the company's value increases by orders of magnitude.
Every day we read news about "small" acquisitions of startups for sums of anywhere from $5M to $30M and up. We almost never read about the more common type of acquisition - a talent acquisition.
Since large companies are large, they many times have problems finding and convincing talented people to join them. Recruitment is hard, and in addition, you never know what you get when some employee with unknown exact history arrives. Another issue is compensation - even if an employee is a 10:1 employee, typically firms will not want to pay them ten times above the average employee.
For this reason, startups serve as a screening ground of sorts. Larger companies get to experience interaction with the startup's founders, and sometimes the small number of employees. They get a good feeling of which ones are experts and which ones are not. When they are convinced of the quality of a team, the rational next step is to try to have them work for the larger company, and acquisition allows the company's management to justify paying a premium for the talent.
The issue arises when the acquired company is in an early enough stage that it has virtually no "business", but only "talent". The acquisition offers, in those cases, are typically much lower and are contingent on the acquired employees working for the acquiring company for a significant amount of time. In addition, the acquiring company many times completely ditches the technology, and reassigns employees to other projects. In that case, the acquisition is clearly a "talent" acquisition.

My entrepreneurial friends are many times dismayed by this process. They do not want to sign up for some job in a big company, while stopping to work on their baby product, and receiving a significant, yet non life changing sign-up bonus.

And this is where my story ends with a moral - if you are an entrepreneur (or even just any business owner), and you hope one day to cash on your investments in your company, make sure not to confuse between the appearance of a business, and a real business. Decide on day one what your goal is, and build your company towards that goal. If you are seeking a quick "talent" acquisition, try to emphasize the talent in your firm and create marvelous products. If you would like to build a business, try to make sure there are customers involved, and a significant number of them.

Quant Marketing? What is THAT?

Lately I've been meeting lots of new people. Some industry and startup people, some new friends and some from other departments in Berkeley.

When I tell them I'm a PhD student, they ask about the topic of my PhD.

When I say "Marketing", the reaction of surprise/disappointment splits into two, depending on their PC skills.
It is either: "Marketing - that's interesting" (a.k.a - "You seemed like a serious person until a minute ago"). If they are Israelis, or know me from the past, the response is "Marketing? You? But you seemed like a serious person".

This is why I decided to write this post to dispel some common myths and inaccuracies about what academic marketing research is, and what quantitative marketing is.

On a side note, I started my 3rd year roughly two months ago, and finally have time to focus more on my research and other hobbies. There's nothing like the sight of a blog being resurrected just after Halloween. It almost beats seeing The Rocky Horror Picture Show on Screen and Stage in SF. Just almost.

Marketing research deals with how people and firms interact and what affects those interactions. Examples include research on how individuals make decisions and what affects those decisions, how firms compete over consumers, how products are developed to match customer tastes or maximize profits and much more.

My personal (and this is strictly subjective) division of the marketing world is into Applied Psychology (Consumer behavior) and Applied Economics (Quantitative marketing). Marketing departments in business schools are typically divided into two parts - a consumer behavior (CB) side and a quantitative side.

CB people perform what I call "Applied Psychology" research. Their research is typically experimental, and includes running experiments and collecting data using surveys and other methods either in the lab or in the field. Many CB professors have a PhD in Psychology as a result.
The topics covered are typically related to individual decision making in various scenarios, and experiments are designed to single out the causes and effects of specific phenomena. Examples are how emotions influence our decisions, what role information and uncertainty has in decision making, how colors change our choices etc.

Quantitative marketing (which is what I do) involves a rigorous mathematical analysis of marketing settings. Quant marketing researchers typically do either theoretical research (sometimes called analytical or modeling), or empirical research. Sometimes quantitative marketing is called marketing science, but I have met "real" scientists that frown at this term, although both of us solve the same differential equations when we go back to our offices...

Theoretical research involves creating simplified models that describe specific phenomena in consumer/firm interactions and analyzing them using mathematical tools to gain insights about the behaviors of firms and consumers. Some famous models analyze how new products are adopted by early adopters and then by followers (the Bass diffusion model), what the optimal level of advertising is (Steiner-Dorfman model), and how firms compete in different scenarios.
Typical tools used in quantitative marketing research include game theory, microeconomic consumer theory and several optimization techniques. My research, for example, looks at websites that compete on organic search results on Google and other search engines, and analyzes their incentives to try and cheat the ranking algorithm, and the effect of such cheating on consumer happiness.

The second part of quant marketing includes empirical research. Empirical research involves collecting data that was typically created by an uncontrolled experiment, and using sophisticated econometrics to analyze the data and arrive at conclusions. If you've never heard the term "econometrics" before, think "applied statistics". Good conclusions from empirical work help explaining how consumers and firms arrive at decisions and also help validating theoretical models. Really good conclusions help forecast how changes in the market affect choices by consumers and firms.
There are many examples for empirical research. One example is research by Brett Gordon and Wesley Hartman about political advertising, that looks at how spending on advertising affects voters choices. Another example is research I am conducting that tries to define a new way to measure the impact of sequences of online ads on consumers.

Another up and rising topic of research (in the last 15-20 years or so) is behavioral economics, which looks at biases people have in their behavior (what economists might call "irrational behavior") and tries to build a mathematical model that explains and predicts this behavior. This area of research is a "bridge" of sorts between CB research and quant research, as it takes experimental results and wraps them with sound rigorous mathematical models.

When people (who have gone through an Economics grad program) ask me about marketing research: "isn't this what Economists do?", I answer: "Yes, they also do that". "So what is the difference?" they ask. My reply is typically: "Like engineering is applied physics or applied chemistry, so is business research applied economics". I am not sure I can say (yet) where the boundary of marketing research and economics lies, but they are very much related. You can find economists performing research that will be considered marketing, and marketers that perform research that can be considered economics.

As a summary point, quant marketing is becoming more and more relevant as time goes by. The ability to reach interesting conclusions about decision making many time hinges on availability of data - lots and lots of it. Given the advent of Internet data collection through advertising, tracking, surveying, social networking and just browsing, marketing researchers today have the data needed to reach those conclusions. But as always, some ointments sometimes have flies in them (so my dictionary tells me), and too much data is also problematic.

Which gets me to present day - marketing research today deals with handling these huge amounts of data, and building the smart mathematical tools that help us refine the insights hiding in the data. Those insights will hopefully help businesses create better products and services, that will lead to happier consumers.


Tax Tips for International Grad Students

Intro

After moving to the US, I had to submit a tax report (called a tax return) for the first time in my life. I found an intricate list of details, rules, forms and what not to deal with. It intrigued me...

I later obtained certification for being a Tax Preparer in California.

As an international student, I found it hard to understand my rights (and wrongs), and found the information supplied to us by the university, and the software that came with it, extremely lacking.

I found out that in many cases it is possible to pay less taxes (or get a higher refund) by just completing the right form.

Given how cash-strapped grad students are, I wrote this list of tips, to help students maximize their tax benefits.

Any comments, corrections and suggestions for this project are welcome. Feel free to contact me using my contact information in the About page.

Disclaimer

The text below does not constitute tax advice or recommendation, and does not replace professional consulting. The details were collected according to the author's best of knowledge. The author holds no responsibility and cannot be held accountable for any implications resulting from actions taken based on this text. Use the information at your own risk. It is always advisable to seek professional tax, legal and financial advice regarding tax issues.

Contents

The tips are contain many items, and are therefore divided into smaller subsections:

  1. Federal Taxes
    • Tax Treaties
    • Maximizing Credits and Deductions by using the proper form
    • Adjustments to income
    • Itemizing Deductions
    • Extra Items
  2. California Taxes
    • Non-resident or resident forms?
    • Adjustments to income

Federal Taxes

There are basically two (legal) ways to minimize the taxes you pay, or maximize your refund: make sure you receive all tax treaty benefits you are entitled to, and claim all the deductions you can.

Because the number of items in some sections is quite large, the content of several sections was moved to pages of their own with a link here.

Tax Treaties

Many foreign countries sign on agreements with the U.S. to make sure citizens of the foreign countries do not pay double taxes on their income. The agreements, called "tax treaties", give many benefits, including lowered tax rates on many type of income. In many cases, certain types of income, such as scholarships and fellowships, and also certain types of gains, such as capital gains, are completely exempt from taxes, and are tax free.

The tax treaty details and rules are complex, and change according to each country of origin. A good summary can be found in IRS Publication 901.

The 3 short tables at the end of the publication summarize most of the relevant details according to country of origin. It is better to first look at them instead of reading throughout the entire document.

Maximizing your deductions by submitting form 1040NR instead of 1040NR-EZ

Deductions are sums of money which that can deduct from your income before tax is calculated. The more deductions you have, the less tax you will pay and the higher refund you might get.

US residents and citizens are allowed to deduct a "standard deduction" from their income (which is $5900 in 2009 for a single). Non-residents, unfortunately, cannot deduct this large amount, which means that in order to pay less tax they must specify each deduction they are entitled to on their tax return forms.

The majority of tax preparation software your school will supply you with, or that you will find online will help you fill out the IRS 1040NR-EZ form. This 2 page form (called EZ for "easy") takes a short time to fill, but does not let you claim all of the deductions many graduate students can claim.

This means that as a general rule, it is almost always worthwhile to spend some time on filling out the longer 1040NR form.

A list of some common deductions for which students might be eligible is described below.

Adjustments to income

Adjustments to income are deductions which can be claimed directly on the 1040NR form. This means that the entire amount spent on eligible expenses can be subtracted from the total income you had.

The list of relevant deductions is contained in a page of its own: most relevant adjustments for nonresident graduate students, and other foreign employees.

Itemize Deductions

California Taxes