How An Economist Runs A Casino: Apply Economics Ideas to Any Business

December 5, 2011 • Blog, Business, Ideas, Research • by
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I am really interested in how businesses and other organizations can implement economic ideas. That’s why I was really excited when I saw podcast #323 from Planet Money entitled, From Harvard Economist to Casino CEO. It’s about former Harvard economist Gary Loveman who is now CEO of Ceasar’s Entertainment Corporation, one of the largest casino companies in the world.

One of the things I found interesting was how Loveman tests everything. He completes trials of every new initiative before rolling it out company wide. Whether it’s how much of an incentive is the right amount for waiters to get their customers to order drinks (that have higher margins than food) without getting naggy and annoying, or how to decrease the amount of randomness in the level of pleasure in the Ceasar’s experience (Loveman says that it’s better to have lots of experiences distributed closely to the mean return than a wider distribution), Loveman completes as close to a randomized trial as possible.

I love Planet Money in general and if you’ve never checked them out, listen to From Harvard Economist to Casino CEO and if you’re looking for ways to implement these kinds of ideas into your organization, Contact Me about my consulting practice.

Why Journalists Should Take Statistics

November 23, 2011 • Blog, Research • by
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Newsweek reported this week about college students paying their universities to get official credit for unpaid internships. They pretty clearly think its a bad idea. I have to agree with them but some of their reasoning was a bit off.

For example, they write,

“Unpaid internships don’t do as much for you in the job market as paid ones do. According to the 2011 Student Survey by the National Association of Colleges and Employers, paid interns spent more of their time on professional duties, while unpaid interns were given clerical ones. Sixty-one percent of paid interns working at for-profit companies received a job offer; only 38 percent of unpaid interns working at for-profit companies did. And paid interns netted higher starting salaries.”

On surface level this makes sense. If paid internships lead to better paying jobs and offers then they must be better than their nonpaying counterparts. That would be true if students were randomly assigned paid and unpaid internships, but they aren’t. Given that paid internships are probably more sought after than unpaid ones, they are able to choose the most gifted and able students. This then replicates in the job market where the more gifted and able students are more likely to get a job offer and at higher pay.

We often try and create causal connections like this but they generally aren’t true. Like I said the other day, randomness matters. I never cease to be amazed at how statistics and logic are generally misunderstood by the public, including journalists. I actually worked with a professor during graduate school collecting stories from the media where statistics were misunderstood and this is a classic example.

The Importance of Randomness

November 17, 2011 • Blog, Ideas, Leadership, Measurement & Evaluation, Research • by
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Randomness plays a larger role in our lives than we would ever like to give it credit for. As humans we want to create causal connections between events. We want to extrapolate from the past, into the future. We want to feel that we can cause things to happen. We tell ourselves, “If I work hard and am honest I can make a good living.” Or “my stockbroker had a good year last year so he’ll have a good one this year.”

Yet in many situations, randomness plays a huge role in the outcome of the event. The past is a poor predictor of the future unless we account for a lot of randomness and luck.

One industry that seeks to fulfill this need for causal understanding is the business book industry. We are constantly told that successful leaders do X,Y, and Z and that if you do X,Y, and Z, you too can lead a successful business. Do business practices and leadership affect the outcomes of a business? Of course they do, just a lot less than the business literature would suggest.

For example, let’s say that the success of a business and the quality of the CEO is correlated generously at 0.30. All this means is that what makes a business successful and what makes a high-quality CEO overlaps 30% of the time. What we then must ask ourselves is this; from Daniel Kahneman‘s book Thinking Fast and Slow.

Suppose you consider many pairs of firms. The two firms in each pair are generally similar, but the CEO of one of them is better than the other. How often will you find that the firm with the stronger CEO is the more successful of the two?

In a well-ordered and predictable world, the correlation would be perfect (1), and the stronger CEO would be found to lead the more successful firm in 100% of the pairs. If the relative success of similar firms was determined entirely by factors that the CEO does not control (call them luck, if you wish), you would find the more successful firm led by the weaker CEO 50% of the time. A correlation of .30 implies that you would find the stronger CEO leading the stronger firm in about 60% of the pairs—an improvement of a mere 10 percentage points over random guessing, hardly grist for the hero worship of CEOs we so often witness.

Now this does not mean that management practices do not matter, it just tells us that identifying those best management practices is extremely difficult! When doing comparison work, such as that made famous by Jim Collins (whom I love but now question), we have to look at it much more skeptically. If the business with the better CEO performs outperforms randomness only 10% of the time, it will be very difficult to even identify those businesses that are really better by skill rather than luck.

Luck plays important roles in our lives. This can be a scary reality, or one that is somewhat freeing. It is certainly scary to realize how little we can control the outcome of our lives, but it can be freeing to have some of that weight lifted from our shoulders, and just maybe it will give us more empathy for those that are struggling.