Small but Essential, Non-Linear Thinking, & Skewed Home Insurance Prices
Small Cities Weekly | 07.19.2024
As part of the work we are doing on the Small City Segment, we send out a brief weekly post of thoughts, links, and research in progress that reflect the week’s work. I’d love to hear from you if you have any thoughts, questions, disagreements, or things to add. Please forward this on to people you think might enjoy reading it.
Small, but Essential
I just finished the book Buying a Small Business: Think big, Buy small, Own your own company, written by the hosts of the podcast I shared last week. The authors have a concept of an “enduringly profitable” company. One of the characteristics of these companies is “The Importance of Being Unimportant”. In short, it means:
Be a small part of your customer’s costs, but an essential input to their success.
By being a small part of costs, you stave off your customer shopping for other solutions - there are bigger ponds to fish in for savings. By being essential, your product or service is a chokepoint in their formula for success. The risk of taking on a new, lower-cost provider is actually quite high - they save relatively little money and introduce a lot of downside risk.
It reminded me of The No-Stats All Star by Michael Lewis about the basketball player Shane Battier. The point of the article was that from a individual stats perspective, Shane Battier did not show up on the radar as one of the NBA’s best players. But if you look at a team’s measure of success - scoring more points than the other team - he was wildly effective.
One well-known statistic the Rockets’ front office pays attention to is plus-minus, which simply measures what happens to the score when any given player is on the court.
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A good player might be a plus 3 — that is, his team averages 3 points more per game than its opponent when he is on the floor. In his best season, the superstar point guard Steve Nash was a plus 14.5. At the time of the Lakers game, Battier was a plus 10, which put him in the company of Dwight Howard and Kevin Garnett, both perennial All-Stars. For his career he’s a plus 6. “Plus 6 is enormous,” Morey says. “It’s the difference between 41 wins and 60 wins.” He names a few other players who were a plus 6 last season: Vince Carter, Carmelo Anthony, Tracy McGrady.
If you look across his career, he was a steal from a cost perspective. He had lifetime earnings of $56.6M, compared to $186M for Carter, $241M for Anthony, and $163M for McGrady. Battier has said about this dynamic:
And wouldn't you know it that in Daryl and Sam's models and their algorithms, which was brand new to me, I popped as a tremendous player because I produced outsized value at a very reasonable cost.
He was a small part of costs, but essential to success.
Part of his ability to do this was to not become obsessed with the metrics that everyone else assumed mattered, just because they were easier to measure. From Lewis’s article:
For most of its history basketball has measured not so much what is important as what is easy to measure — points, rebounds, assists, steals, blocked shots — and these measurements have warped perceptions of the game.
This harkens back to our discussions in the past on Goodhart’s Law (“When a measure becomes a target, it ceases to be a good measure”). It also rhymes with a great post on non-linear thinking (also included below in Links):
Step 2: Focus on outcomes, not indicators.
One of senior management’s most important tasks is to set the organization’s direction and incentives. But frequently, desired outcomes are far removed from everyday business decisions, so firms identify relevant intermediate metrics and create incentives to maximize them. To lift sales, for instance, many companies try to improve their websites’ positioning in organic search results.
The problem is, these intermediate metrics can become the end rather than the means, a phenomenon academics call “medium maximization.” That bodes trouble if a metric and the outcome don’t have a linear relationship—as is the case with organic search position and sales. When a search rank drops, sales decrease quickly at first and then more gradually: The impact on sales is much greater when a site drops from the first to the second position in search results than when it drops from the 20th to the 25th position.
Battier chose to chase value in the team goal of winning games and championships - which he was well positioned to do, even though it was harder to measure - rather than chasing the more easily-measured box score race that he probably couldn’t win.
I’m thinking through what can be taken away from these related ideas for the cities and companies that matter to me.
We are already small - that’s hard to change. What does a focus on being essential look like? Can we find opportunities, industries, and companies where we play an outsized role in success, without having to be something we aren’t?
We might have to give up being legible to the typical intermediate measures of economic development. We might not have the box score - venture capital dollars, population growth, corporate investment - that puts us on any ‘top cities’ list.
But I think up and down the stack - as an individual, a company, or a city - this is a fun identity to try on:
Small, but essential.
Links
You can find links from this and all previous editions here.
Linear Thinking in a Nonlinear World: The obvious choice is often wrong, Bart de Langhe, Stefano Puntoni, Richard Larrick, HBR
Test yourself with this word problem: Imagine you’re responsible for your company’s car fleet. You manage two models, an SUV that gets 10 miles to the gallon and a sedan that gets 20. The fleet has equal numbers of each, and all the cars travel 10,000 miles a year. You have enough capital to replace one model with more-fuel-efficient vehicles to lower operational costs and help meet sustainability goals.
Which upgrade is better?
A. Replacing the 10 MPG vehicles with 20 MPG vehicles
B. Replacing the 20 MPG vehicles with 50 MPG vehicles
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But in business there are many highly nonlinear relationships, and we need to recognize when they’re in play. This is true for generalists and specialists alike, because even experts who are aware of nonlinearity in their fields can fail to take it into account and default instead to relying on their gut. But when people do that, they often end up making poor decisions.
Economic Renaissance or Fleeting Recovery? Left-Behind Counties See Boom in Jobs and Businesses Amid Widening Divides, August Benzow, Economic Innovation Group
Left-behind communities have enjoyed their strongest three-year stint of job and establishment growth since the turn of the century. Nearly half of them have already recovered the employment levels they had prior to the pandemic-driven job losses, and their population levels look more stable than they have in years. Nonetheless, on important measures of job and income growth, left-behind counties continue to trail behind national averages. While their absolute economic performance has reached multi-year highs, their relative standing compared to other parts of the country remains unchanged as they work to regain their pre-pandemic footing.
Home Insurance Rates in America Are Wildly Distorted. Here’s Why., Christopher Flavelle, Mira Rojanasakul, NYTimes
There are some other possible explanations for why insurance companies charge wildly different rates in places facing similar threats.
Insurance can be more expensive in smaller, more rural states, where there are fewer households to share the risk, said Karen Collins, a vice president at the American Property Casualty Insurance Association, which represents insurance companies. Some states require higher minimum levels of coverage, which makes policies more expensive. And fraudulent claims, which end up increasing premium costs, can be more prevalent in some locations than others, she said.
You can reach me at dustin@invanti.co if you want to chat more about the small city segment!