Tom Spencer consulting blog — Management Consulting & Business Strategy

Moral Hazard

November 30, 2010 · 1 comment · Image Source

Moral hazard is when they take your money and then are not responsible for what they do with it.
~ Gordon Gekko

1. Relevance of Moral Hazard

THE unemployment rate in the United States is now around 9%. Over 13% of all US mortgages are either delinquent or in foreclosure (Mortgage Bankers Association). Total loses resulting from the sub-prime mortgage crisis are expected to run into the trillions of dollars.

At the heart of this global financial meltdown is a concept known as “moral hazard”.

2. What is Moral Hazard?

Moral Hazard is a concept that is often misunderstood, or at least badly explained, by people who should know what they are talking about; business writers, politicians, most online business dictionaries and sometimes even economists … And so we turn to Hollywood for clarity.

Gordon Gekko captured the nature of Moral Hazard very concisely when he explained that “moral hazard is when they take your money and then are not responsible for what they do with it.”

Gekko may well have borrowed his definition from Paul Krugman; Professor of Economics at Princeton University, 2008 Nobel Prize winner, and New York Times columnist. Krugman describes Moral Hazard as “…any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly.”

To summarise these two iconic figures, we might simply think of Moral Hazard as any situation where a person or organisation is not fully responsible for the consequences of its actions. As a result, the person or organisation may take greater risks than it otherwise would because it is not responsible for paying the full cost if things go badly.

It is worth noting that “Moral Hazard” is an economic concept and does not necessarily imply that there is any immorality or unscrupulous dealing involved, not necessarily.

Impossible is Nothing

November 20, 2010 · 1 comment · Image Source

in Business strategy, Video

“IMPOSSIBLE is just a big word thrown around by small men who find it easier to live in the world they’ve been given than to explore the power they have to change it. Impossible is not a fact. It’s an opinion. Impossible is not a declaration. It’s a dare. Impossible is potential. Impossible is temporary. Impossible is nothing.”

~ Muhammad Ali / The Greatest / The Champ

Why consulting?

September 12, 2010 · 1 comment · Image Source

in Management consulting

You will be more likely to succeed if you can clearly articulate why you are getting into the consulting industry

BEFORE applying for interviews, one question that you will want to ask yourself is “why consulting?”

Relevance of the question

The question is important for at least two reasons:

You will be asked this question in your interview so it is a good idea to be prepared; and
You will be much more likely to succeed (in the interview and afterwards) if you can clearly and passionately articulate in your own mind the reasons why you are getting into the industry.

How to answer the question

The way you respond to the question is more important than what you say. The most important thing is to be sincere and passionate about getting into the industry.

Think about why you want to get into the industry and write down each reason as a dot point. Memorise your dot points before you step into the interview room.

Your reasons

It is important that you are true to yourself, and have your own reasons for wanting to enter the industry.

Here are the 4 reasons why consulting is an obvious choice:

Solving business problems: Working with high profile clients to solve challenging business problems
Learning from the best: Working with and learning from super intelligent and energetic people
Building relationships: Working on a consulting engagement would be a great opportunity to build relationships with colleagues and business leaders
Travel: Consulting is a great way to combine travel with work

What are/were your reasons for wanting to get into the industry?

Respond in the forum.

Barriers to entry

September 6, 2010 · Image Source

in Economics

You may want to launch a new product, start a new business or enter a new market. What’s stopping you?

BARRIERS to entry are the obstacles that must be overcome and the costs that must be paid by a new entrant but not by firms already in the industry. Barriers to entry have the effect of making a market less contestable and allow existing firms to maintain higher prices than would otherwise be possible.

Here are 8 examples of barriers to entry:

1. Capital requirements

High start-up costs: High fixed start-up costs will deter new firms from entering an industry. Examples of capital intensive industries with high fixed costs include the automotive and telecommunications industries.

High sunk costs: If a large portion of the start-up costs cannot be recovered (i.e. they are sunk costs) then the new entrant risks having to absorb the loss if it decides to exit the industry. Examples of sunk costs include:

Specialised assets: Highly specialised technology or equipment that cannot be used for other purposes and which cannot be sold (or can only be sold at a massive discount).
Industry specific expenditure: Industry specific expenditure, such as marketing or R&D, which cannot be used to benefit the firm’s operations in other industries.

2. Intangible assets

Proprietary product technology: The existence of proprietary product technology represent a barrier to entry. If an existing product is protected by patent then it will not be possible for a new entrant to use the patented technology without permission from the patent owner.

Brand recognition: If existing firms and products have strong brand recognition that will deter new entrants. If customers perceive existing products as unique or high quality then a new entrant will need to spend money to educate customers about about the unique qualities and benefits of its new products. This will increase the cost of gaining market share and deter entry into the market.

Specialised knowledge: Some industries require specialised knowledge, skill or qualifications: e.g. law or medicine.

Customer relationships: If existing firms have strong customer relationships it may be difficult for new entrants to gain market share.

3. Access to raw materials

If a new entrant cannot gain access to raw materials then this represents a barrier to entry. If existing firms have exclusive long term contracts with suppliers (or existing firms own key suppliers) this will make it difficult for a new entrant to obtain the raw materials it needs to operate effectively in the industry.

4. Access to distribution channels

If existing firms have exclusive long term contracts with distributors this will make it difficult for a new entrant to reach the customer.

5. Economies of scale

The existence of economies of scale in an industry creates barriers to entry. Existing firms are usually in a better position to exploit economies of scale than a new entrant and, as such, may be able to force a new entrant out of the market by undercutting on price.

6. Network effects

The term “network effect” refers to the situation where a product or service becomes more valuable as more people use it. One product that experiences positive network effects is the telephone; the telephone becomes more valuable to each user as more people own one. Another example is eBay; as more buyers use the online auction site it becomes more valuable to each seller, and as more sellers use the site it becomes more valuable to each buyer.

If existing products or services in the industry benefit from network effects then it may be difficult for new firms to enter the industry.

7. Government regulation

Regulated markets: The government may restrict entry into a market, or make competition illegal by establishing a statutory monopoly. For example, AT&T had a statutory monopoly in the telecommunications industry in the United States until the early 1980’s.

Trade restrictions: Trade restrictions represent a barrier to entry. For example, import tariffs will deter foreign firms from entering the domestic market.

Licenses and permits: If government approval is required before a firm can do business then this will deter entry into the industry. Examples of government approvals that may be required include taxi licenses, safety standards compliance certificates, mining permits, or investment approvals.

8. Competitive response

It is important to consider how existing firms might respond to a new entrant. If we expect existing firms to respond by aggressively lowering prices then this will deter new firms from entering the industry.

Join the discussion

August 1, 2010 · 3 comments