21st Century Economics

The demographics of the coming crash are undisputed and unavoidable.  They pertain to the market forces driven by the baby boomers – all 77 million of them.  21 million households in the US are boomers – 46% of the total homes in the US are boomers.   Their influence comes from the fact that there are so many of them.  Their impact comes from the fact that this large quantity rose and fell so quickly.

Following WWII, a lot of horny soldiers and sailors came home from the war.   They married, made babies and worked very hard and were a part of making a lot of new infrastructure and industry come into its own.  The world was making a rapid recovery, economically, from the war years and the economies of most industrialized nations of the word began to grow rapidly.  Despite a brief interruption from the Korean War, this growth trend continued.  This was a good thing because the huge quantities of babies cost a lot of money to care for and educate.  Fortunately, our industrial and economic success could absorb the burden of those costs.

In a relatively short period – from about 1950 to 1960, the baby population grew to record levels.  This was a huge influx of people into our society.  By 1960, most of the WWII generation parents had had two or more babies and were now ready to settle down to being parents.  Coincident with that, came “the pill”.  The first easy to use oral contraceptive that was safe and worked.  The birth rate plunged to very low levels and did not rise again until the echo-boomers (the children of the boomers) began having their children.

The baby boom officially was from 1946 to 1964 but if you look at the above chart, you will see that from 1950 to about 1960 is the greatest rise and from 1960 to 1974 is the largest decline in births.  Using the median age of these groups, you can see that the average boomer is 52 years old in 2007 and will be 65 in 2020.

The rapid rise of the boomers is what created the school shortage and overcrowding in the 50’s and 60’s. 

In the 60’s, we had the Love Generation, Hippies and counter-culture that were primarily driven by 77 million teenagers going through adolescents.

In the 70’s we had a massive boom in employment as these 77 million people entered the workforce.  Part of that boom was in massive increases in productivity as more people with money began buying the things that adults buy and the manufacturers had to increase production to keep up with demand.  Another part of the workforce extended the counter-culture and boom in personal computers into the workplace.  This created the beginnings of the tech boom, personal computer sales and the entire software industry.

In the 80’s, when the median age of the boomers was in the early 30’s, they reached their peak home buying years.  The housing boom of the 80’s drove home sales and new construction to all time highs.  Car sales also boomed as did furniture, TV’s, microwave ovens and the other entire household and family expenses that come from full employment.

In the 90’s, the boomers were approaching their peak earning years in their 40’s and 50’s.  With that earning, they began, for the first time, earning more than they were spending.  In this decade, the boomers put more than $7 trillion into the stock market – mostly into mutual funds.  This rapid influx of money into businesses allowed them to expand, do R&D, introduce new products and explore new markets.  This was massive influx of money was what drove the technology boom of the 90’s.  The search for new investments created Silicon Valley and put Apple and Dell and Microsoft on the map in a big way.

The large amount of money was, in fact, larger than the real value of the stocks that were being invested in.  Price-Earnings Rations (P/E) of the mid 20’s was considered to be reasonable and normal but toward the end of the 1990’s, we were encountering P/E rations of 180 or more.  This was a bubble in the truest sense of the word and existed only because of the competition between investors to find and invest in almost anything that would show a profit.

Surprising is the fact that beginning in the late 1980’s and continuing to the present, the boomers, as a group, have saved less money than any other generation.  In fact, the net total spending of the boomers exceeds the net total earnings for the past decade and a half.  That means that the boomers are buying things faster than they are earning money to pay for those things.  There is a net negative savings across the entire group of boomers.

The realization of the possible impact of the crash of society from the Y2K scare, the aging and maturing of the boomers and some nasty manipulations by the banks and Wall Street giants brought the boomers back to reality by 2001.  We experienced the Tech Bust of 2001.  Stocks crashed.  Thousands of tech companies with P/E’s above 80 simply ceased to exist.

For a brief time, people tried to recapture that moment of robust stock activity by “day trading”.  The single guy that thinks he can find that winning stock better than all the Wall Street gurus.  That quickly died when they realized that sales commissions and taxes ate up all but the luckiest buys.

In the early part of the new century, the boomers have mostly been earning lots of money, putting more of that into investments and buying more stuff.  Since they are earning as much as they ever will in their lives, the boomers are searching for places to put all that money.  What they found and are buying in massive quantities are second homes, vacation homes, big-ticket items like expensive cars, boats and airplanes.  Vermont is one example – there are more non-resident homeowners than there are resident homeowners.  Major sports and entertainment centers have grown significantly in this period.  Las Vegas, Orlando, Vale Colo., Vermont, the Gulf coast, etc..

As we come to the end of 2007, we have a few boomers that want to retire early.  These are the boomers that did well in the stock market, bought big homes and second homes or vacation homes.  They are empty nesters because the kids are not living at home and many of them are already out of college.  When looking at the value of their homes and their real needs, many are deciding to sell off their homes and retire early.  If one in ten boomers are doing this, that is more than 2 million homes put on the market in a relatively short time.  It might be more if the couple with a big main house (over 3,000 sq ft) and a vacation home or second home want to sell both of them to buy a ranch or condo.  That puts two houses on the market.

The early impact of this began in 2004 and has been increasing since.  As more homes come up for sale at the same time that the buying population is decreasing, the homes have to go down in price to sell.  This is often measured by the “time on the market” before a sale is closed.  In early 2004, the average time on market was 37 days.  By the end of 2004, it was 67 days and by the end of 2007, it was 137days.  That is the average.  In some markets, sales are almost at a standstill with time on market measured in years.

Of course, if you are among those that want to sell your home to retire early, you will lower the price to sell it in this kind of market.  Home sale prices have dropped more than 25% in some flooded markets.  New home construction is way down, especially for large homes.  The shows on TV about “flipping” a home are now telling stories of homes that have not sold in 6 to 9 months.

A by-product of all of the money and home sales is creating a secondary effect in the economy now.  In the 1990’s and up to about 2006, the banks have had so much extra money that they were having a hard time finding people to lend it to.  They are, after all, in the business of selling money in the form of debt, i.e. loans and the biggest loan is for real estate. 

Like any business, when they have too much inventory, (in this case the excess inventory is money) they have to lower the price.  That took the form of lowering the interest rates on mortgages but that was not enough, they also needed more buyers so they lowered the standards needed to qualify for loans.  This is the sub-prime market and the adjustable rate mortgage markets. 

As was fully predictable, these high risk loans do what high risks loans do, they defaulted.  Some defaulted because the adjustable rate mortgage adjusted upward to a point they could not pay.  Some defaulted when they realized that the housing bubble has popped and their home is not worth on the market what they still owe on it.  Still others were simply bad risks that never should have qualified for a loan of that size.  The result has been a huge drop in the value of real estate and related investments.  That has pulled down the worth of the banks that valued their property or mortgages as part of their net worth and market value.  The failure of several banks has shown that it can happen and is causing the stock market to react by an exodus out of real estate and financial markets – dropping the market further.

Unfortunately, this is all in advance of the highly predictable impact of the retiring baby boomers.   In the second decade of the new century, we will see the boomers begin to retire at a rate that will rise to over 1,000 per day. 

Once retired, they will want their social security and Medicare which is another can of worms that I’ll cover in another article but suffice it to say that the US Government is not at all ready for what is to come.  Since so many saved so little during their peak earning years and so many planned to finance their retirement with the sale of their homes plus social security and investments that any drop in any of those three sources of income will become significant.  Unfortunately, all three of those three sources of income will probably be way less than anyone had planned for.

These retired boomers will put their homes up for sale because that is the way that most planned to finance their retirement.  As with the housing boom of the 1980’s, the bulk of boomers will try to sell within a relatively short period of time and the result will be a flooded market with way more inventory than buyers.  Prices will drop thru the floor.  It is, indeed, unfortunate that the sub-prime and mortgage financial crisis has hit at this time.  This may well depress the market until the bulk of boomer homes floods the market – driving prices even lower and creating even more defaults and foreclosures.

As we have seen in 2008, the sub-prime and mortgage financial crisis has spread to the general stock market which is down to where it was 16 years ago and still going lower.  Gold is at al all time high and there is talk of a recession that will devolve into a major depression.  It is, indeed, unfortunate that this stock market financial crisis is hitting just as the boomers are retiring because it is now that they will begin to withdraw that $7 trillion that they put into the market over the past 20 years.  Cash out of stocks will put more available stock on the market – lowering the price.  Dividend payments will withdraw cash from corporate spending and cause them to cut back in other areas – most often it begins with R&D and plans to expand and then moves into cutbacks in production – cuts in staffing.  We have seen massive layoffs from all of the airlines and all of the automakers and many smaller industries and businesses.  The current crisis will bleed right into the period when the boomers will suck out their investments and lower the market even more.  If they panic and try to withdraw early or all at once, this could collapse the market.  Certainly the investments that the boomers are planning on will be much less than they think they will be by the time they begin to withdraw it.

The bottom line is that the baby boomer demographics has caused and will cause massive changes in the US economy in each age it has influenced.  A prudent investor will find ways to profit from such an economy.

Even in this chaos and financial ruin, there is room for the shrewd investor to make a profit.  These three strategies may not make you rich but it will let you survive the recession in comfort.

1.    Long Term Investments - If you can afford it, invest now in condos, ranch style homes and apartment buildings that have many small apartments.  There are still some places where you can buy a property and then rent it at or above the mortgage.  (that is what I did in Vermont)  There are other places that are now so depressed that real estate prices have crashed.  Small to medium size towns in which the primary employer (factory, assembly plant, mine, etc.) has left town - usually to be reestablished overseas to take advantage of cheaper labor or because foreign goods can be made cheaper.   If you find a place that is structurally sound but is a “handyman’s special”, then reduce the rent to someone in exchange for them working on the property.  I lowered the rent by $100/mo on one of my properties in Vermont in exchange for work - the tenant has since painted the entire house, landscaped the yard, installed a new furnace and hot water heater (no labor charges) and done numerous small jobs around the house.  The idea is to acquire these properties now and then rent or sell them when the boomers place their peak demand on this kind of housing - in about 10-15 years (the statistical peak will be 2019).  But be careful not to get sucked into the mass overstock of large (over 3000 sq ft) or second homes that will flood the market for a decade or more and will drive housing prices way down.  This is also not the time to invest in any real estate related stock, ETF, mutual fund or a traditional “investment property”

2.                  Mid-term Investments - Not all of the stock market will crash.  Those industries that are funded primarily by the federal government to provide public services (contracted medical services, outsourced housing, food and transportation) and those that cater to the geriatric market will flourish.  There will be mutual funds and ETFs specifically designed to invest in the industry of old age.  If you keep tuned in, you will know when these are first started - the mutual fund or ETF equal to an IPO - that is when to invest.  This could occur anytime in the next decade but will certainly increase in the rate of creation in the period from 2015 to 2025.  Don’t get into these any later than 2015 and don’t stay in them any later than 2023 or your will be chasing your money down a hole.  Avoid individual stocks.  The loss of high quality experienced management talent (as the boomers retire) and the rising costs of health care plans and pensions will bring down lots of companies  - even ones in the old age industry.

3.                  Short Term Investments - I have reported many times on the usefulness of selling short and buying long.  As we approach the depression years, this will be a very lucrative opportunity for the affected industries.  One perfect example of this is that the price of gold has risen from just over $400/oz to over $1000/oz in the past 18 months.  Taking options to sell short on gold anytime in that period would have resulted in a substantial profit.  In 2007, I took a contrary position to take advantage of the January Effect and bought an option on 1,000 oz of gold on Dec 14^th when the price was $795.  I sold on January 14^th at $900.  After the cost of the option and call orders, I made about $100,000 in 30 days.

 “Event Investing - If you know an event is going to happen, you can profit by it“.

August 12, 2006  

Insurance companies and investors have actuary studies that show that people do predictable things at certain ages.  The 77 million baby boomers bought houses in the 80’s and early 90’s as they moved into their peak earning years.  As early as 1982, they were calling the rising sales a housing market bubble but by 1992, they were talking about a housing slump.  This eight-year period marks the peak house buying ages (from age 27 to 37) of the boomers.

Those same actuary studies indicate that it is inevitable that those same boomers will sell their homes in record numbers as the owners age, moving out of their large primary homes for a smaller home - usually seeking a ranch style (one floor) or a condo (no yard maintenance).   The so-called “empty nesters” will most often sell the larger homes (4 or more bedrooms or over 3,000 sq ft), second homes and those with high-maintenance property.  In Vermont, these are also the homes with high heating, electricity and tax costs that are likely to be sold.

There is another reason that the boomers will sell.  In their lifetime, most boomers have never seen a prolonged period of time when there was a major housing market crash with protracted losses in real estate investments.  In fact, under the motto of, “No one has ever lost money in real estate”, many boomers invested in their homes with the idea that it will gain in equity and, when sold, will provide a substantial boost to retirement savings, adding to the motivation to sell.  Thinking of taking advantage of large real estate appreciation of the past, a home bought in the 80’s would, by that logic, be reasonably priced in the seven figure range by the time they retired in the early to mid 2010’s.  This might have been true if there weren’t so many that had the same idea. 

Certainly some will keep their homes but it is a statistical certainty that more than the average quantity will sell.  As with the buying boom of the 80’s and early 90’s, this sell-off will occur over a relatively short period of about 10 years probably something like 2009 and 2019.  The laws of supply and demand dictate that prices will drop as the supply increases but unfortunately, the demand will be dropping at the same time.

 Following the baby boom of the late 40’s and 1950’s, we experienced a precipitous drop in birth rate.  This was due to the rebound from the baby boom combined with the introduction of “the pill” in 1960.  The result was a fifteen year drop in birth rates. However, many boomers decided to put career ahead of family or to have children later in life, resulting in an echo boom that diffused over a longer period of time - more than 30 years.  The end result is that anything of enduring quantity created to accommodate the volume of baby boomers will be in excess supply for more than three decades before the population will again rise to the levels to create a similar demand.  

One possible scenario – The Housing Dimple – the economic reverse of the buying boom of the 80’s:            The boomers sell-off will increase normal annual large home sales by as much as 400%.  The expected buyer population will be much less than the volume needed to maintain a modest market demand.  As a result, there will be a glut of unsold large homes on the market.  Desperate sellers will lower prices and new construction of large homes will virtually stop.  The excess supply will drive the sale price of large homes down and home values will fall dramatically.  In some of the more contested markets, a home that might have sold for $650,000 in 2005 might sell for $250,000 or less in 2015. 

There are, of course, lots of factors that might mitigate this kind of scenario.  There are also lots of factors that might exacerbate this scenario.  It gains credibility when you consider that this has already happened in some high value markets.  Actuary studies predict a high statistical probability that there will be implications and ramifications in real estate and in other markets and investments.  Large losses as well as gains are possible.  A prudent choice might be to plan ahead. 

References:

 http://www.realestatejournal.com/buysell/markettrends/20060619-fletcher.html?refresh=on

Baby Boomers - The Real Cause Of Our High Taxes 

If you tilt your head to one side and stand on one foot, you might see what some have seen - that Baby Boomers are the cause of our high and rising federal and State taxes.  More importantly, Vermont may be the harbinger of what is in store for the entire nation over the next two decades. 

Between 1946 and 1964, approximately 78 million babies were born and America would never be the same again.  Even before the boomers began paying taxes, the government was spending a lot of money on taking care of them.  More elementary schools were built in 1957 than any other year, before or since.  In 1967, more high schools were built than any other year, before or since.  From 1965 to 1975, 743 new colleges were opened and the college student population rose from 3.2 million to over 9 million.  During this same time, the average school enrollment for all schools rose by more than 500%.  All that cost a lot of money and started a trend that continued, as the boomers grew older. (1)

As the boomers moved into their peak earning years from age 24 to 55, the economy exploded and taxes poured into the State and federal governments.  Annual federal budgets rose from $478 billion in 1978 to an estimated $2.5 trillion for the budget now being developed for 2008. (2)

More money came into the government coffers from other sources.  In 1977, $39 billion excess dollars were paid into social security.  By 2006, when the median age of the boomers was 51, the annual excess payments rose to $1.99 trillion.  These excess payments are spent each year without regard for the future debt created to the soon-to-retire boomers – estimated to be $2.5 trillion per year by 2075. (3, 4)

Spending all that boomer paid tax revenue is what our government does best and they spent every last penny collected - $19 trillion between 1993 and 2003.  Then they spent all the excess social security contributions – $14 trillion between 1993 and 2006.  Then they continued to spend far more than was collected for 36 of the past 40 years - accumulating and additional $8.7 trillion in public debt. 

This massive influx of tax revenue paid for more and more welfare, healthcare and entitlement programs and infrastructure changes.  Today’s government paid (with tax revenue) healthcare has risen 700% from 1980 levels.  Total annual welfare rose from 6,400% from 1965 to FY2005 costing cost taxpayers $8.29 trillion (in 2000 dollars).   As the boomer tax revenue rose, the spending spree extended to hundreds of small programs.  Dairy Subsidies rose 673% and soybean subsidies are up 501% between 1998 and 2003. (5)

All this available money has established a pattern of massive spending that has pervaded our government and our cultural attitudes for more than five decades.  An entire generation has grown up with a lifetime of increasing benefits paid for by the government.  History has shown that such spending attitudes have a momentum of their own.  It is hard for our politicians to stop or even slow the spending.  It is harder for the aging boomers to reassume the responsibility for paying for what has been provided by the government for their entire lives.  So the spending continues.

The problem is that beginning now and for the next two decades, we will see the boomers moving out of their peak earning years and their peak tax paying years.  Tax revenues will decline but those persistent welfare, healthcare and entitlement programs and infrastructure changes will remain, costing us long term commitments of increased administration, maintenance and operating costs.  And soon the retiring boomers will compound the spending with demands for large increases for Medicare, Medicaid, Social Security, Veterans Assistance and other costs.

Vermont has one of the smallest and oldest populations in the entire US and will see more people retiring earlier than most states.  Our unique demographics magnify this pattern of spending and make us more sensitive to the effects of lowered tax revenue and higher medical costs from the retiring boomers.

For a large and growing population, the burden of our taxes outweighs the benefits of the government programs.  It will take a significant effort by our government to slow or reverse a generation of spending.  It will take a larger effort for the public to give up on the extravagant, noble and excessive benefits of that spending – but we have to try.

References

1              Digest of Education Statistics, 1998, National Center for Education Statistics

2              Data from the Office of Management and Budget

3                Congressional Budget Office, Long Range Fiscal Policy Brief #9 July 1, 2003

4.                Congressional Budget Office, Long Range Fiscal Policy Brief #2 July 3, 2002

5.                Backgrounder Report #1710, Heritage Foundation, Dec. 3, 2003 by Brian Riedl    

  It is a little known fact that Yogi Beri is one of this nation’s best business philosophers.  Although often misunderstood by the layman, his insights and profound understanding of business are so deep that his writings have been compared to the explicit quatrains of Nostradamus or the precision of Salman Rushdie.  His writings and quotations, in fact, combine the very essence of true philosophical malapropisms, Colemanballs and modern mondegreens.  In my humble way, I’d like to share some of the genius of this icon of wisdom and insight.

“You can observe a lot just by watching.” As in most of Yogi’s obiter dicta, he emphasizes the difference between the common use of words and their literal meaning.  “Observe”, in this use, refers to the recognition of what is happening around us.  In business, this is profound when applied to observing the behavior of customers and the competition.  The enormous consulting and analysis business of Customer Relationship Management (CRM) has its basis in this simple Yogi-ism.

 “Even if you’re on the right track, you’ll get run over if you just sit there.”   Although sometimes credited to another great paronomastic master, Will Rogers, it is generally agreed that if Yogi did not say this, he might have.  Yogi’s intent in this thought was originally based on his profound insights into the declining railroad industry but he quickly imagined its application to every business and industry.  As a result, we now generally recognize that without a continuous effort in innovation and growth, the essence of market competition, a business will quickly lose market share and experience declining sales. 

“If you don’t know where you are going, you will wind up somewhere else.”   Yogi modernized and simplified this wisdom that dates back to 470 BCE when the Chinese philosopher Confucius observed. “Any man can make long journey, takes smart man to know which direction”.  Even more profound is that there is no evidence to show that Yogi copied this from Confucius – he developed it independently!  The whole industry of business process analysis, workflow management and strategic planning has evolved from this analect.

“Yeah, but we’re making great time!”  A response by Yogi when asked, “Are we lost?”.  He was, of course, speaking of the corollary to the two above observations, to point out the difference between business activity and progress, between productivity and efficiency and between effort and effectiveness.  He so rightly commented that business is a journey, not a destination and when you arrive, you’re there but you always have to keep moving so you can get there otherwise you’ll get run over by those that have arrived.

  “If you can’t imitate him, don’t copy him.”         Recognized as one of the most informed and perceptive academians in modern times is Michael Porter, the Harvard Business School professor.  Although he modestly has never admitted this, if he did, he would probably give credit to Yogi for most of his recognition as one of the most influential management and strategy thinkers.  Professor Porter now teaches what Yogi was, of course, referring to: differentiation from your competition as the cornerstone of marketing position and sustainable competitive advantage.  Virtually every agency and consultant in the marketing Mecca of the world, Madison Avenue, owes his or her very existence to Yogi. 

“I never blame myself when I’m not hitting. I just blame the bat, and if it keeps up, I change bats.”  Yogi was a master of the ironic subtleties that are so effective at teaching lessons about business.  Here, it is clear that he is making fun of those managers that can’t assume responsibility or accurately define cause and effect in management decisions.  Out of this observation and its obvious extrapolations, an entire industry of decision support and risk analysis has grown.  That industry’s methods and techniques are critical to the discovery and definition of the root cause of a management or business problem – perhaps one of the least understood aspects of improvement analysis and planning.  Unfortunately, the complexity of his thinking and subtlety of his expression caused some people to interpret this prima facie and corrupted it to mean what it says instead of its intent.  The financial industry has adopted this misguided interpretation as the hallmark of their investment strategy proving that sometimes even the best wisdom is not the wisest. 

“If you come to a fork in the road, take it.”    Of course his most famous quote needs no explanation because it so clearly describes the true secret to business success. 

Yogi Berra is as wise as he is a great philosopher.  His observations will forever be the visions we all could have if we saw it his way.  Everything I have written about him is true or should be.

References:  Wikipedia at http://en.wikipedia.org., facts not found in Wikipedia, aren’t.

Future Customers, Employees and the Economy 

It is prudent for any business, large or small, to look ahead at what might change in the future so they can prepare today.  Not having a crystal ball, I tend to look at the mega-trends and intuitively obvious changes and their consequences.  Here are three that you might consider:

The predictable whiplash from the Bush-Oil-Big Business Axis of Corruption will undoubtedly result in a more “green” oriented federal government that will be more environmentally friendly, small business oriented and more protective of personal and privacy rights.  Combined with a greater awareness of the global warming issue, the sales of energy efficient appliances, energy reduction construction, alternate energy heating and cooling and other energy and environmentally friendly products and services will thrive in this new economy.  Solar panels, solar heating, home insulation, metal roofs, hybrid cars, thermal windows and other similar products will experience record sales over the next decade.  Big cars, luxury boats, huge houses and other big energy users could very well face tax penalties and fees to discourage their purchase.   The federal tax breaks and tax penalties will filter down to local governments and into commercial sales.  If you can wait, some major expenses may have better tax advantages in 2010 than now.

Here come the Boomers!  Age Power!  With 32% of the Vermont population being baby boomers (third highest in the nation), we will feel the effects of the boomers sooner and to a greater degree than most states.  This is good and bad.  Their vast numbers will dominate politics, marketing, sales, jobs, styles and design.  Their large numbers will also put a burden on public and welfare services and health care.  With an annual spending power of $2.1 trillion, the boomers will have a powerful impact on the economy but they will have very specific preferences for goods and services.  The good news for Vermont is that travel, resort services and vacation spending will rise significantly over the next two decades.  Financial and medical services will thrive.  However, new car sales will flatten or decline slightly.  Real estate sales will take a marked decline as large and second boomer homes are put on the market at a time when the quantity of buyers will decline even faster.  Many boomers will have to work to fund their longer-than-expected retirement and lack of savings in their working years.  The good news is that boomers will make good employees – mature, good work ethic, honest.  The bad news is that they may drive up employee medical expenses.  Vermont businesses would be prudent to examine how to best cope with this inevitable change by planning inventory changes, store access improvements, new marketing methods and employment. 

Technology is also a major force in shaping our world.  Robotics have replaced thousands of assembly-line workers in factories.  Automation and computers have eliminated thousands of other jobs in almost every industry and business.  The speed of computers and the improving ability and efficiency of the human-computer interface is making it more and more possible to replace humans in most “left-brain” jobs.  Any job that is based on a set of rules that is logical, sequential, rational, and analytical or objective can be performed by a software program.  When you think about it, that is a surprisingly long list.  Jobs like ATM bank transactions, telephone operators, self-service checkout at stores, GPS navigation, assembly-line workers have already been automated.  Designers are planning driverless cars, pilotless aircraft and banks and courthouses without people.   A great deal of accounting, sales, medical and financial services are already automated with more coming.  In the military, we now have UAV’s (unmanned aerial vehicles), autonomous weapons and robotic combat vehicles.  By contrast, right-brained jobs are in high demand and growing.  Jobs that involve imagination, synthesis of ideas, and subjective views will thrive in the future.  These are jobs that cannot easily be programmed.  These jobs include artistic design, music composition, writing, dance, theatre, architecture, design and marketing.  These are jobs that involve innovation of ideas and solutions and to the application of new concepts in a holistic, intuitive and sometimes random manner.  Lots of businesses are now creating job positions with titles like envisioneer, design strategist, marketing coordinator and creative engineer.  It might be time for your business to consider institutionalizing thinking outside the box.

Remember, “It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change”, Charles Darwin.

Housing Dimple

  Written Jan 29, 2007

We use the term “bubble” to describe a brief expansion in a select market, as in the recent “housing bubble”. What is the opposite of a bubble?  A Dimple?  Whatever it is, I believe we are heading for a doozy in about 8 or 10 years.  Here’s why.

Insurance companies and investors have actuary studies that show that people do predictable things at certain ages.  The 77 million baby boomers bought houses in the 80’s and early 90’s as they moved into their peak earning years.  As early as 1982, they were calling the rising sales a housing market bubble but by 1992, they were talking about a housing slump.  This eight year period marks the peak house buying ages (from age 27 to 37) of the boomers.

Those same actuary studies indicate that it is inevitable that those same boomers will sell their homes in record numbers as the owners age, moving out of their large primary homes for a smaller home - usually seeking a ranch style (one floor) or a condo (no yard maintenance).   The so-called “empty nesters” will most often sell the larger homes (4 or more bedrooms), second homes and those with high-maintenance property.  In Vermont, these are also the homes with high heating, electricity and tax costs that are likely to be sold.

There is another reason that the boomers will sell.  In their lifetime, most boomers have never seen a prolonged period of time when there was a major housing market crash with protracted losses in real estate investments.  In fact, under the motto of, “No one has ever lost money in real estate”, many boomers invested in their homes with the idea that it will gain in equity and, when sold, will provide a substantial boost to retirement savings, adding to the motivation to sell.  Thinking of taking advantage of large real estate appreciation of the past, a home bought in the 80’s would, by that logic, be reasonably priced in the seven figure range by the time they retired in the early to mid 2010’s.  This might have been true if there weren’t so many that had the same idea. 

Certainly some will keep their homes but it is a statistical certainty that more than the average quantity will sell.  As with the buying boom of the 80’s and early 90’s, this sell-off will occur over a relatively short period of about 10 years probably something like 2009 and 2019.  The laws of supply and demand dictate that prices will drop as the supply increases but unfortunately, the demand will be dropping at the same time.

 Following the baby boom of the late 40’s and 1950’s, we experienced a precipitous drop in birth rate.  This was due to the rebound from the baby boom combined with the introduction of “the pill” in 1960.  The result was a fifteen year drop in birth rates. However, many boomers decided to put career ahead of family or to have children later in life, resulting in an echo boom that diffused over a longer period of time - more than 30 years.  The end result is that anything of enduring quantity created to accommodate the volume of baby boomers will be in excess supply for more than three decades before the population will again rise to the levels to create a similar demand.  

One possible scenario – The Housing Dimple – the economic reverse of the buying boom of the 80’s:            The boomers sell-off will increase normal annual large home sales by as much as 400%.  The expected buyer population will be much less than the volume needed to maintain a modest market demand.  As a result, there will be a glut of unsold large homes on the market.  Desperate sellers will lower prices and new construction of large homes will virtually stop.  The excess supply will drive the sale price of large homes down and home values will fall dramatically.  A home that could sell for $650,000 in 2005 might sell for $250,000 or less in 2015. 

There are, of course, lots of factors that might mitigate this kind of scenario.  There are also lots of factors that might exacerbate this scenario.  It gains credibility when you consider that this has already happened in some high value markets.  Actuary studies predict a high statistical probability that there will be implications and ramifications in real estate and in other markets and investments.  Large losses as well as gains are possible.  A prudent choice might be to plan ahead. 

References:

 http://www.realestatejournal.com/buysell/markettrends/20060619-fletcher.html?refresh=on

The 21^st Century Business Model  

Here in Vermont, we spend a lot of time and effort holding on to “the good old days”.  Its nice to walk into a local store where you know all the sales people and the owner by their first names and they all know you.  Mostly because of that, we don’t mind that the store’s inventory is not as large and prices are not quite as low as the mega-mart over in the big city mostly because of that good old fashion Vermont service.  This is a 20^th Century business model that is coming under increasing pressure to change.

Part of that change is that the growing use of computers and the internet is making it more and more possible for people to shop almost anywhere in the world for almost anything they need or want and at prices to which most store-front sellers can’t compete.  Even without the competition of a nearby mega-mart big-box store, the global economy will eventually affect most merchants and many service industries.

One way to address some of that competition is to go online.  Nowadays, even local stores are often expected to be listed in online directories with store hours, maps and phone numbers.  It is becoming increasing important to have an online presence just to remain competitive but with a little extra effort, you can also create added income streams and cash flow with a surprisingly modest investment

The most elaborate web sites cost about $250 per page but it is possible to begin with building a simple static web site using free template-based applications and online web hosting services with monthly hosting fees as low as $10.  Alternatively, you can use some easy online services or hire a programmer to create a dynamic web site in which you frequently change web-page content in as little as one hour per month.  Annual costs can be as low as $360.  Any business can break into this market with one of three basic options without the need for expensive computers or training.

The Menu Option:             You can setup a simple static web site that offers a menu or inventory listing of your sales offerings.  Similar to a restaurant menu, you list what you sell or just list types or groupings of merchandise or services, but without prices.  You also list store hours, maps and contact information.  The advantage is like having a large, detailed, online business card or permanent advertisement for about $120 per year.

The Take-Out Option:            If you already have a small or computer-based inventory, you can easily setup an online version of a take-out order by allowing web users to see all or some of your inventory listing and place orders online for later store pickup.  By adding a simple order save function, you can allow people to build their shopping list over some period of time (weeks or months) and then schedule the in-store pickup for a specific date or they can place special orders or orders that require preparation.  The order could show up on an in-store printer and be prepared for customer pickup and payment.  This avoids online money transactions but can still enhance sales and provide a value-added service for your customers.

The E-Commerce Store:  The most elaborate online sales option is to put up a full function store web site.  There are turnkey, off-the-shelf, e-commerce software packages and online services that can provide this capability starting around $50/month.  Such a web site does everything for you except delivery.  It takes the order, adds in shipping, handling and tax and then collects the payment.  All you have to do is collate and mail the order or prepare it for pickup.  Such sales can be for a very select portion of your inventory that might appeal to online buyers outside of your immediate store location. 

Don’t dismiss these options too quickly because experience shows they can enhance customer service and might lead to large volumes of sales at less labor and lower overhead expense than in-store sales.  These options are ideal for home-based or Vermont specialty stores and many small businesses.

This is the 21^st Century and your sales competition as well as your potential buying market is growing every day.  You need a 21^st Century business model if you are to survive.   It is possible that your regular customers of the future could be a rancher in Wyoming or a schoolteacher in Japan.  They, too, might get to know you by name and you know them and they are repeat buyers from you because of your good old fashion Vermont service.

Essential Business Strategy

“Tactics without strategy is the noise before defeat”; Sun Tzu 540 BCE,  “If you don’t know where you are going, you won’t know when you get there”; Yogi Bera 1950.  All through the ages, great thinkers have commented on the value of strategy.  Today, the world’s best-known business academic is Michael Porter, a Harvard Business School professor.  His first book, Competitive Strategy: Techniques for Analyzing Industries and Competitors (Free Press, 1980), is in its 53rd printing and has been translated into 17 languages.  He offers some good advice for the Vermont small business owner.Although the basic concepts of business strategy predates Michael Porter,  his notions on strategy are preached at business schools and in seminars around the globe.  However,  his concepts of strategy are being replaced by expedient and easy fad-based notions of competition analysis and profit optimization.   In effect, short term tactics and an emphasis on operational effectiveness are replacing strategy and long term planning.  To understand this, we have to look at the difference between business tactics and strategy.

Strategy consists of making decisions and choices, trade-offs; it’s about deliberately choosing to be different; delineating how a company seeks to be unique.  The essence of strategy is that you frame and limit what you’re trying to accomplish. You can’t be all things to all people.  Strategy defines the basic value you’re trying to deliver to customers and who your customers are.  It serves as the map to optimum sales.A company without a strategy is willing to try anything. If you’re strategy is to do the same thing as your rivals, then it’s unlikely you’ll be successful. It is, in fact, incredibly arrogant for a company to believe that it can deliver the same sort of product that its rivals do and actually do better for very long. That’s especially true today, when the flow of information and capital is incredibly fast and the consumer is more informed and mobile than ever before.  Only strategy can create sustainable advantage.Business tactics or operational effectiveness, is about how to do the things that you do in the best manner possible; it’s about what every business should be doing.  In today’s market, you need to define how you’re going to be distinctive.  Word processors repalced typewriters because it was operationally effective.  Using computers to manage inventory, analyze sales and examine cash flow are all tactical functions.  Tactics is a means, strategy is a direction.  Unfortunately, the line between tactics and startegy is getting fuzzy.Porter says that companies have bought into an extraordinary number of flawed or simplistic ideas about competition and quick-fix, automated solutions that promise fast and easy increases in profits — what Porter calls “intellectual potholes.” These include TQM, JIT, TCO, BPR, BSC, ERP CRM and many others.  The thinking is that these analysis methods provide immediate results and, as a result, many have abandoned strategy almost completely.  To be sure, these tactics have their uses but not as a substitute for an effective strategy.  Driving faster does not replace knowing where you are going.This focus on operational effectiveness actually creates a mutually destructive form of competition. If everyone’s trying to get to the same place, then, almost inevitably, that causes customers to choose based only on price. This is a bit of a metaphor for the rush to globalization of the labor market and big box retailing in which we’ve seen a widespread focus to lower prices.  This leads to operations on such a thin margin that relatively minor market or economic fluctuations can be disasterous.There are those that will argue that such a form of destructive competition is simply the way competition has to be.  Michael Porter believes that there are many opportunities for strategic differences in nearly every industry; the more change there is in an economy, in fact, the greater the opportunity.  

Therein lies the challenge to business owners:  Can the locally owned businesses adapt their strategy to remain competitive in the face of big box retailers, national chain stores and internet sales?   We must, of course, assume that local governments will not favor the big box chain stores with massive development subsidies and tax advantages.  Once they are on a level playing field, the local businesses must adopt strategies that differentiates them sufficiently that the consumer is aware and understands the benefits of “buying local”.   The development of such strategies could benefit from guidence from Michael Porter and a clear understanding of the distinction between business tactics and strategy.

What has happened in the financial markets

Banks are just money stores.  Our sample bank buys and sells money.  It sells money by making loans and mortgages to people at an interest rate so that they pay back more than they borrowed. 

They don’t exactly buy money but they do lease it.  By offering various services, safeguards and payments, the bank gets people to put money into the bank’s inventory.  The bank then makes payments to the depositors by giving them payments in the form of savings interest rates, free services and other benefits.  They can afford to make these lease payments because the interest rate they get from their loans is much higher than they pay out for the use of the money they are loaning. 

The pool of money that is deposited ends up being very large when compared to the amount that has been put out in loans.  In fact there are laws that mandate that the bank must hold in reserve a very large pool of money to cover the normal fluctuations of deposits and withdrawals.

While this large pool of deposited money is held by the back, they try to make it earn more money by making investments.  Some of this is in Treasury Bonds but mostly it is in things that people want to buy by borrowing money from the bank. 

In this regard, this money bank operates like any other store.  It has sales people (loan officers) that try to sell their inventory and inventory managers that try to attract more deposits from more people.  The profit of the bank is made from making that large pool of deposited money earn additional income while it is in the banks control. 

Now suppose that our economy is booming and lots of people are earning lots of money.  They will want to put it into a bank for safekeeping and that makes the large pool of deposited money grow ever larger.  When the bank has millions of dollars just sitting in its vaults, not earning money on interest loans, then the back is effectively losing money. 

The response is to tell the sales staff to make more loans.  The problem is that in a given community serviced by several banks and in a booming economy, there may actually be a shortage of people that want to borrow large sums of money.  To entice borrowers, the bank will lower their interest rates.  They don’t want to lose money, just get that initial sale so for mortgages, they offer a low rate for the first few years and then will raise the interest rate back up. 

But again, the community is serviced by several banks and there are just so many mortgage loans that can be given out so the bank looks for other kinds of investments that can earn money.  Most banks have a portfolio manager that handles the investments into various Wall Street kind of investments.  But this is not the kind of investments that normal people make.  A bank might have $300 billion in its large pool of deposited money and it is not legal for them to put very large sums into one stock investment and it is not cost effective to make thousands of small (under $10 million) investments in stocks.  

So the banks have come up with their own kind of investments.  These are the kind of investments that you need billions of dollars before you are allowed to participate.  One kind is to bundle all of your mortgages and sell them to another bank or investor.  This had the effect if giving the bank an immediate return on its mortgage loan and the buyer gets its reward by gaining the long term high payoff that every mortgage pays.  There are also tons of other weird and very complex “instruments” that banks use – like derivatives. 

These high cost instruments cost billions of dollars and are valued based on their risk level.  As with most investments, if the bank is willing to take on a little more risk, then the reward is potentially larger. 

Ah but here is the problem.  As the large pool of deposited money gets larger, the bank is under pressure to gets more of that money out into investments and earning profits for the bank.  When they have tapped out the market for loans and investments at a safe and secure risk level, they are under pressure to change that acceptance level of risk and loan out to greater and greater risks.  In this case, the risks may be that the collateral of the loan is not wroth the value of the loan or it might mean that the derivative has a high risk if the economy fluctuates any.

In the great Savings and Loan Crisis of the late 1980’s and early 1990’s was just such a situation.  A booming economy and the offer of high interest rate on deposits brought in billions of dollars.  When the real estate boom of the 1980’s hit, the S&L’s wanted to make all that deposited money work for them.  Deregulation had removed most of the normal safeguards allowing the S&L’s to invest in more than $160 billion of bad loans – mostly for real estate that was not worth the amount of the loan.  The US government paid $128 billion to bail out the S&Ls. 

Over the past 30 years, the baby boomers have put more than $7 trillion into various stock market, real estate and banking investments.  Companies like Bear Stern took those deposits and made a lot of investments – mostly in the high risk derivatives.   They were overextended and under-collateralized into high risk ventures that collapsed when the national economy took a dive. 

One of the impacts of the baby boomers retiring is that they will be selling off their homes.  Many have second homes or very large homes that they will not want to keep in retirement.  The sale of these homes will oversupply the market and drive prices down – which is exactly what is happening right now. 

That combined with the devaluation of the dollar on world markets and you can see why Bear Stern defaulted.  But stand by, this is just the beginning.   The sub-prime mortgage problem, the massive rise in bankruptcies and the devaluation of the dollar will combine with the real estate crash to make for one awful economy and any financial institution that took on a little more risk than was prudent will find themselves in big problems. 

Unfortunately, that includes the federal government.  The FED has a finite ability to manage these crisis situations.  One is to lower their prime interest rate but it is no at 2.25 – the lowest since WWII – and if it goes must lower, the primary tool that the FED can use is gone.  In addition, the FED has just paid out $160 billion to guarantee loans for the Bear Stern bailout.  Since this is a federal guarantee, the buyer has very little risk and if they begin to falter, you can bet they will call in that guarantee. 

There is no honest appraisal of the US economy that does not lead to the conclusion that we are headed for a major financial crisis in the next decade and it will be unlike anything we have ever seen before.