Crazy Russian incentives

Around 1992 Russia privatized state companies. The government gave each citizen one voucher they could bring to an exchange for a share of that day’s company. A simple plan – until humans get involved.

Not all Russians wanted to own shares. Local markets emerged. A small fish bought all the vouchers in one neighborhood, a medium fish bought all the neighborhoods in a town, a large fish bought all the towns in a region. Eventually sacks of vouchers made it to the national exchanges.

Though unintended, these mini-markets worked. Free economies FTW. So far so good.

Each exchange had a schedule. A modern Monday might be 1,000 shares of Apple at nine, 200 of IBM at ten, 500 of Ford at eleven and so on. If only one person showed up Monday at nine they would get all the shares for their vouchers. It was the market mechanism at work. It’s cheaper (more valuable) to not bid against someone in an auction. When one companies shares went up they shut down the airport the day before their voucher offering. Another company ignited a tire fire on train tracks leading in and out of town.

Insiders were insistent on owning their companies because the valuations were way off. By one estimate, the voucher privatization program valued the entire Russian economy at ten billion dollars, or one sixth the market cap of Walmart. If you could buy a legitimate twenty dollar Amazon gift card for one dollar would you? Rather, how many? This economic transition was called a katastroika. A combination of the catastrophe and perestroika – Gorbachev’s politics.

George H. W. Bush has his last year as president, Achy Breaky Heart finishes the year as the fifteenth most played song, and there’s money to be made in Russia.

“I went to someone in the investment management division,” Bill Browder writes in Red Notice, “expecting him to hug me since I was sharing the most joyous jaw dropping investment opportunity he would ever see. Instead he looked at me as if I was suggesting the firm should invest in Mars.”
Russian privatization was a huge opportunity. Everyone at Salomon Brothers missed it. Why? Incentives.

On Browder’s first day, his first manager explained the system: generate five times your salary or you’re done.

“Nobody at Salomon Brothers could divorce themselves from their own narrow mindset. Perhaps if I had been more subtle and clever I could have pierced their myopia, but I wasn’t, I had no political skills. I presented my idea for weeks and weeks hoping that through repetition I would get through to someone.”

Incentives and culture form what people do when they’re not told what to do.

At the London office the formula – which worked wonderfully – was fees through consulting.

Eventually Browder’s repetition got through and he got a call from Bobby Ludwig in New York. Two days after a phone call with Ludwig, Browder pitched the idea. An hour later Ludwig delivered twenty-five million dollars and marching orders. At the New York office the formula for Bobby Ludwig was to make money.

When Browder returned to London he had to switch departments but couldn’t find a desk. “Bill, why are you bothering me with this?” Ludwig asked when Browder appealed to him, “If they won’t give you a desk just work from home, I don’t care where you work. This is about investing in Russia, not desks.”

There’s this idea that to understand what’s going on in the world someone has to know the history or stay on top of things. But sometimes we can come back to first principles. We’re all humans with incentives. Also, the Red Notice audiobook performance is amazing.

Russian Markets

Competition’s effect is the “market mechanism”. This example is from 1996 Russia.

Bill Browder is looking at stock in a Russian oil and gas company. The country’s companies have just become public, and though MNPZ has slightly smaller reserves than British Petroleum, it’s trading for 100x less. Why?

I was convinced that there must be some other explanation for the deep discount and spent the next several days searching for it.

Did the preferred shares have different par values? No. Was the ownership restricted to workers? No. Could the higher dividends be arbitrarily changed or canceled by the company? No. Did they represent only some minuscule part of the share capital? No. There was no explanation. The only reason I could fathom for why they were so cheap was that no one had showed up to ask about them-until I had.

Amazingly, I found that this anomaly wasn’t restricted to MNPZ.

Nearly every company in Russia had preferred shares and most of them traded at a huge discount to the ordinary shares. These things were a potential gold mine.

If there’s a name, there’s a market mechanism. If the invisible is now visible, there’s a market mechanism. If something is weird, new, unknown, secret, there may not be.

Pricing power evaporates with the heat of the market mechanism. Sometimes though, in the far reaches, someone can, find a gold mine.

Can someone be, like MKBHD?

Can someone become like you now Guy Raz asked Marques Brownlee?

It’s different today. “I’ve noticed that in polls of younger people their dream jobs used to be firefighter or movie star, but they all say YouTuber now”, said Marques, “this is fascinating to me because when I started that did not exist.”

If something is legible it’s something to compete on. But illegible things – becoming a YouTuber before it was a thing – make the competition harder.

Legible means playing according to the rules of the game. Illegible means making up the rules as you go. “I just wanted to make the kind of videos I liked to watch,” Marques notes. Illegible also means there’s time to find your rules. Brownlee spent years making videos. He admits that the early ones are hard to watch because they’re so bad. That’s fine!

With value comes competition, and the market mechanism whirls to life. “Your margin,” Bezos believed, “is my opportunity”. Alpha erodes.

Except in some places like the new, the foreign, the unaccounted, the unfavorable, the silly, and so on. Not every new thing ‘works out’ but every new thing has less competition.

Words hiding value

Patrick O’Shaughnessy asks Gaurav Kapadia what makes a great business. It’s all the basic stuff, “but really when you go down to it, if you look at a lot of the great businesses, they’ve created niche monopoly things. No one likes to say it because you’re not allowed to say it.” Kapadia lists at least four monopolies: cable companies, software companies, aircraft engine manufacturers, and medical device companies – but the real insight is no one is allowed to say it.

Names mean competition. If something is unaddressed with words it’s less available as thought and underpriced in cost (the market mechanism).

Our new dictionary series highlights the opposite end of Kapadia’s point. New words new thoughts.

Later Kapadia talks about diversity and inclusion in the investing industry. “I don’t think anyone’s heart is in the wrong place, I think everyone’s heart is in the right place. So we have to stipulate that, people really care, but so many decisions are made by the network. And so the only way you can break down existing network effects is with data.”

For words like monopoly the network has agreed on one meaning, and it’s mispricing. For words like diversity, the network has agreed on one meaning, and again it is mispriced.

The same week Mike Prada joined Wharton Moneyball and was asked a kind of ‘what’s next in basketball?’ question. One thing Prada pondered was what if Memphis is playing the next form of basketball? There’s no fast break or half court offense, only running. Types of offense thinking, like monopoly and diversity, hides value.

The invisible visible

In the beginning, we measured the world one way. Then another way came. This way offered different fidelity, and we used that. Sometimes the thing we measured was a fixed supply, and the new fidelity changed demand and prices. Then a new new way came. The first two examples are this. Sometimes there is is no supply constraint and no change in price. The second two examples are that.

Investing. There are at least two areas where the invisible became visible. One is quantitative. It’s in the numbers, not the stories, where good investments can be found. A second is in scale. It’s the size of the company where there’s information which is invisible at one scale but very clear at another.

Moneyball. Like quant investing, Moneyball is a way to use numbers to find patterns and to frame our thinking.

Personal. “You work with a lot of teams”, Shane Parrish prompted, “what have you learned about making good decisions?” Well, says Diana Chapman, “people don’t practice nearly enough candor.” The whole episode (#130) is basically about this, making the invisible visible in our collection of relationships. How? Through candor.

Jobs to be done. The JTBD framework is a way of articulating purchase decisions. People take action to change what? We’ve many examples of this: Leatherman tool, Headspace meditation, and Instagram stores.

One way to find the recently visible is in words. What was so great about Chapman’s podcast with Parrish was the embodiment of her ideas. Chapman is physical: use notecards, stand here, dress like this and act accordingly. We are a visual species. Today’s prompt then: What is invisible here?

Market Mechanism 2

Photo by Tirachard Kumtanom on

This is in addition to the previous post on the market mechanism. Briefly, it’s the idea that competition erodes the value captured by the producer.

Barry Ritholtz asked Morgan Housel about what he wished he knew when he started. Housel responded, “One thing that sticks out is that good investing is not about being good at something but you have to find something that other people are bad at. The fact that you are good at modeling does not necessarily make a difference because a lot of people are good at that.”

This, said Fredrik DeBoer, is part of the myth of college. One way to avoid the squeeze of the market mechanism is to have a rare skill. In Housel’s words, to be good at something other people are bad at. People are compensated by what they know, proxied by a degree, then a graduate degree. More degrees more (proxied) competition.

Success is found, said Hamilton Helmer, in the durable. “If you do something better, the question is, ‘How can this be durable?’ There has to be something that prevents others from taking all of that away from you.” How can you avoid the market mechanism creating a commodity?

It probably will happen too. Rufus Peabody said about gambling: “I used to bet second halves in college and professional football. That used to drive my yearly earnings, it was an ATM machine basically. But the last three years I’ve basically broke even there and may not continue running the models because the inefficiencies that were there are no longer there.”

Profits attract competition, competition drives profits and prices down. The market mechanism is Santa for the consumer and saboteur to the producer.

There’s one way to avoid the market mechanism; attract less competition.

Movies, wine, investing, and sports all offer financial and psychic income. That’s a double dose of the market mechanism once someone sniffs out the potential rewards. A cooler choice might be digging pools.

What’s next to a cash register?

coffee lifestyle starbucks coffee shop
Photo by Adrianna Calvo on

Tyler Cowen is one of the most interesting and insightful thinkers sharing their wisdom today (and for the past decade-plus!). One of his ideas highlighted in our Twenty-Minute-Read on Cowen is to think of incentives and solving for the equilibrium.

To think like an economist, like Tyler Cowen, we should consider how things work within a market. Tim Ferriss asks Cowen what advice he would put up on a billboard? Tyler responds in an interesting, and quite different way, from what many of Tim’s other guests suggest.

Normally, this question tends to lead to something inspirational or tactical, something grand or granular. There’s also a bit of personal signaling in the answers where after an hour or so of talking to Tim, guests want to step off on the right foot.

Cowen flips the question and wonders: what works on billboards. Casinos advertise on billboards. So do lawyers and radio stations. Auto dealers advertise on the radio, which you listen to in your car, and notice how nice a new car might be. Cowen doesn’t answer Ferriss because there’s not a connection between that medium and his message, and mediums matter.

The same effect came up in the college admissions scandal book, Unacceptable. After dropping off kids, “moms in workout gear might pop into a local coffee shop, where the area near the straws and napkins was blanketed with ads for test prep services and tutoring companies.” If a college tutor, guide, or private counselor wanted to find upper-middle-class clients where better than a coffee shop?

Markets are dangerous for entrepreneurs because they lead to competition. However, markets are instructive for economists, or people who want to think like them, because they lead to understanding. During his lunch with the FT, Cowen said that he looks for Ethiopian restaurants located near other Ethiopian restaurants because “competition works.”

The biggest lesson from the short piece on Cowen is to think that through. Who is getting coffee at this kind of place at this time of day?

Zach Lowe and Kevin Arnovitz

Supported by Greenhaven Road Capital, finding value off the beaten path.

There are few basketball commenters more thoughtful than Zach Lowe and Kevin Arnovitz and they paired up for an episode of ‘most interesting’ NBA teams. We’ve looked at one of their conversations from 2017 that asked, ‘What if Jeff Bezos were a GM?

Making predictions is difficult when we extrapolate linearly. Lowe said, “With (Celtics’s) Brown and Tatum we do this thing where we expect linear development and it doesn’t happen and then we get down on them and one of those guys is going to pop this year.”

The same reason people get down on athletes for bad years is the same reason Jason Blum is in business. Blum says that he likes directors with good past movies despite their last. This is Blum’s version of Moneyball, he explained:

“My Moneyball approach is that this guy writes and directs Saw for $800,000. He does two movies for fifteen and twenty million dollars that aren’t good. He can’t get hired. He birthed Saw, a cultural phenom and he can’t get a job. My Moneyball approach is instead of looking at the sexy statistics to look at the work.”

People over-index on recent and optimistic data instead of the more accurate base rates. In his conversations with Lowe, Sam Hinkie explained this idea.

Metrics only matter if we measure the right stuff. Why, for example, Arnovitz wonders, do the Portland Trailblazers exceed their projected win total each year? Why is some data down on them this year? “What is it that these metrics are seeing about the Portland Trailblazers that I’m not seeing?… I still see a hyper-competent team that understands how to orchestrate a hundred possessions a game of offensive basketball.”

What the metrics might be missing is the culture.

The Patriots don’t measure sacks as much as they measure pocket size. Kawhi Leonard didn’t interview well before the draft, should that matter? Only the first four-thousand of your ten-thousand daily steps make big strides.

In much the same way we make predictions using the first (and easy) things that come to mind we tend to measure the first (and easy) things. Baseball’s Moneyball began with walks but teams don’t rely on those numbers anymore.

Numbers are ‘cut and dry’ but the world they describe is anything but.

Market mechanisms set prices, and evaporate good deals. Lowe said, “Someone asked me what I’d pay for DeMar DeRozan’s contract extension and that’s not a fair question for me because he will immediately reach a market value that I would never pay.”

Investors like to ‘fish’ by themselves and venture capitalists love to visit college campuses to talk to students. Fewer people means less bidding.

‘Peak Uber’ was in 2012, before they had to compete with Lyft. Moneyball was published in 2003 and now those same advantages don’t work.

Lowe and Arnovitz are thoughtful and these first three points demonstrate the holistic mindset required. It’s never just one thing. The Celtics had to make wise predictions, measure the right things, and avoid the market to trade down to draft Tatum.

Alpha erosion is the cousin to market mechanisms. Once a rival is familiar with your advantage they’ll work to reduce it. Lowe said, “Last year the sheer speed of how they (the Sacramento Kings) caught a lot of teams off-guard. Everybody knows that’s coming this year.”

Both Annie Duke and Nate Silver rode the poker wave before it got too competitive. Daryl Morey annually complains to Bill Simmons that their draft board looks more similar to the draft order. Venture capitalists pile into companies once they see something that works. It’s just the name of the game.


Thanks for reading.