No-One Understands How Systems Work.

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You may have been listening to economists debating and arguing about the state of the economy and the future of inflation. Are we in a recession or not? What will the economy look like next year? What causes inflation? Will the rate of inflation increase or decrease? What can be done to alter the future direction of change?

There is no shortage of opinions, but a total lack of certainty, of confidence, or even of sound theory.

You probably find the same phenomenon when engaged in discussions about business – about how firms can do a better job of creating customer value, to grow and succeed. How can they achieve a rise in stock price? What are the most critical constraints? What’s the best process for driving innovation? What’s the best way to manage and incentivize employees and to build a strong culture? Those are the kinds of words and phrases business consultants and business school professors use – your own peer conversations are probably more to do with increasing sales, or lead generation or your P&L, or whether all the ingredients you need will be delivered. 

But the challenge, in all these cases is the same. No-one knows anymore how these systems actually work. We can extend the list to climate as a system – some scientists claim they know how it works and can forecast the future, and another set views it as unpredictable and unmanageable. 

We saw during the so-called pandemic that virologists and infectious disease experts and pandemic modelers got their predictions – and their policies – hopelessly wrong, and it cost millions of lives and billions if not trillions of lost economic production. We can see the might modeler Ph.D.’s at the Federal Reserve make the same hubristic mistakes with their models of money supply, inflation, employment, and economic growth. The only thing they’ve ever been is wrong.

In fact, there’s a whole new science of not understanding systems which is called complexity theory, which overlaps closely with chaos theory. It says the following: A system is a collection of elements, components, parts, pieces, or, generally, agents. In an economic system, the agents might include individuals, families, and firms. There are additional elements like processes, government and institutions, norms, traditions, and a whole lot more. These elements and agents interact with each other and with inputs and outputs. There is further interaction after feedback loops establish themselves – agents react to outcomes and results they didn’t expect or anticipate. There are so many variables – individual decisions and preferences, group behaviors, trends, technological changes, money supply changes, etc, etc – that the interaction is described as complex, which means beyond understanding, unpredictable, and non-linear (it goes off in directions and at speeds that no-one expects).

Complexity is science throwing up its hands and saying, we don’t understand these systems anymore, can’t predict them, can’t control them, and can’t manage them. We don’t even have any ideas on how to do so.

There are many fancy new words that come out of this science. One, for example, is emergence. Systems have emergent properties, meaning s*** happens that we can’t account for and couldn’t even imagine in advance. Emergence is a kind of magic.

Another new term is self-organization, which means that the system will evolve and develop as it likes without any input -or despite any input – from the scientists.

Don’t worry, there are lots of government grants being given for the study of complexity, lots of papers and journals, lots of conferences, and lots of sabbaticals being taken to contemplate future studies and grant applications. There is money in complexity.

What’s the alternative? Pragmatism.

When the system (of life, of business, of health, of the economy) is complex to the point of incomprehension and unpredictability, there is only one action: do something and see if it works or it doesn’t work. In business, it takes the form of what is called today A/B testing. Try two different actions (without any prediction or bias or even desire as to which outcome will result) and choose one that works, i.e. moves in the direction you feel is better. Then do another test and another and another until there’s a string of results. Expand the actions so long as they keep working. Start a small store and keep expanding it unit by unit until there’s a big store. Be prepared for things to change without notice. Go back to square one if they do. 

There are fancy terms for this too. Economists call it entrepreneurship. Constantly trying and re-trying, combining and recombining, testing and re-testing. If a promising pattern is established, pursue it and reproduce it, but only so long as the pattern holds. Drop it as soon as it becomes erratic. Start another one. Creativity is the required skill set, and the whole point about creativity is unpredictability. 

Creative entrepreneurship doesn’t try to study complexity. Entrepreneurs face it every day and they take action rather than studying it. 

The Road To Stagnation: Why Government Is The Enemy Of Economic Productivity.

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The federal government is planning to hire an additional 87,000 IRS agents. Some of them may be armed. This is not the action of a friend or partner. It is central to government’s anti-economic behavior. But now that behavior has shifted to beast mode.

Federal income taxation of companies and individuals is an act of extraction from the economy – the seizure of what has been produced. Government produces nothing – all production occurs outside government. Say’s law stipulates that we must produce first in order to be able to consume. This law does not apply to government, who must extract and confiscate first in order to be able to spend. If they spend some of the confiscated funds on production by others, such as arms producers and vaccine manufacturers, they can be counted on to be inefficient, and they don’t subject themselves to the trade-off analysis of alternative and better uses of those funds.

Taxation, of course, is not the only enemy action producers must face. Government regulation is the other major imposition on production. We’ve reported here on the one million Federal regulations the typical large firm faces. These regulations are designed both to suppress activity and to divert spending from productive to non-productive channels. Compliance requires an administrative staff, lawyers, form-filling, and reporting. Regulations often require specific investments by firms – software to interface with government systems, special safety installations and equipment, government-required training regimens, and more inefficient processes. And today, there’s the added imposition of diversity requirements in employment that replace meritocratic hiring and slow down productivity and reduce functionality.

Federal agencies are designed to impede and impose upon productive firms, and their bureaucrats enjoy – and are rewarded for – doing so. That’s how incentive systems work. If a bureaucrat is to be promoted in the SEC or OSHA or FDA or IRS, they must demonstrate the work output of large numbers of successful prosecutions. They must haul in revenues from fines or settlements. Those who get to the top are not the ones that hold back. 

The third army of the enemy assault on economic achievement is the Federal Reserve. By intervening to distort market interest rates, this army creates hard-to-manage financial uncertainty for business firms. Private investments in future asset-building must include a guess – that’s impossible to get right – about the whims of the Federal Reserve’s committees and Ph.D.’s. The Federal Reserve also regulates and controls all other banks, thereby placing their heavy hand on the scale of financing of business undertakings – for example, their location, the qualifications of their recipients, and their preferred projects.

And by destroying the value of the currency – the US dollar has lost more than 96% of its purchasing power since 1913 when the Federal Reserve was formed – the Fed forces pricing, squeezes profits, and removes economic incentives for growth and innovation. There’s less incentive to earn devalued dollars. 

The only way for firms to stay at least half a step ahead of the government bureaucrats is to innovate, to come up with better and better customer services that generate the reward of the marketplace, resulting in growing revenues and profits that can be used to pay off the confiscatory taxes. Happily, America’s innovative firms have been reasonably successful. But, more and more, innovative action is going to be diverted in the direction of new ways to file tax forms, or to do accounting, or to design a multi-national organization that avoids excessive US taxes. Corporate innovation activity will gradually be drained off (which the government loves because then they can use it as an excuse to increase the budget of the Pentagon and NASA and the NSF and other government R&D grant givers).

Eventually, firms will give in. The enemy will win. It’s unlikely that all firms will become publicly owned, but they’ll just sidle up closer and closer to the government and ask, “Just tell us what to do and we’ll do it.” There’s plenty of evidence that that’s already happening. Microsoft and Apple bid on massive government defense contracts. Digital companies execute the surveillance and suppression of open speech that governments prefer. Banks make the loans that government wants them to make. Companies do what it takes to sell satellites and pharmaceuticals and delivery services to the government. They don’t want to be excluded or to miss out.

Why is government the sworn enemy of business and business firms and their productivity and service to customers? It’s a matter of control. Government must be able to exert unchallenged control over the citizenry, and the innovation and service ethic of business threatens to rival that. If customers are loyal to service provider businesses, they might recognize the superior alternatives on offer. Government can’t allow that. Therefore they are committed to outnumbering and outspending any opposition. The federal employee roll of over 2.8 million civilian workers easily takes care of the outnumbering part. The array of lawyers, inspectors, and compliance officers in government can easily overwhelm any private sector firm.

And government expenditures (($6.8 trillion in 2021) easily dwarfs any private sector firm’s spending capacity.

When all this personnel and spending power are arrayed against individual firms, there’s no contest. The firm must comply, hand over the sums that the government says they must cede, hire people and allocate time to engage with all the regulations that they face, and find ways to abandon the activities of which the government disapproves, while finding new ways to innovate to try to get ahead of the inspectors and agents. It’s a race to stagnation.

A Million Regulations: The Narcissism Of Government.

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Professor Deirdre McCloskey, in a recent book, tells us that

The US federal government has in place over a million regulations. One million. The Democrats say, “Add more bureaucrats….” The Republicans say, “Add more police….”

Beyond Positivism, Behaviorism, And Neoinstitutionalism In Economics; Deirdre Nansen McCloskey; The University Of Chicago Press; 2022

The Code Of Federal Regulations is 220 volumes. The hubris of a government that can concoct so many ways to control us is quite striking. They have regulations about the food we can eat, and the packages it comes in, and the ingredients listed on those packages. There are regulations to control the clothes we wear, the fabrics from which they are made and the shops from which we buy them. They control the cars we drive and the oil and gasoline we put in them and the tires we put on them. They control the medicines we take and how we access those medicines. They control the glass in the windows through which we look at the world, not to mention all the other materials with which we build our houses, and the tradespeople and practitioners of crafts whom we hire. They control the media from which we gather information. The Federal Register Index has a span from Actuarial Services to Workers Compensation Programs. There is not a single detailed aspect of daily economic life for which our hubristic government bureaucrats do not have a regulation or a rule.

The cost of this regulation is enormous, and about to become overwhelming. In a 2016 study, the US Chamber of Commerce Foundation estimated the direct cost of government regulation at $1.9 trillion, about 10% of that year’s GDP. (And, since GDP includes government spending, this is most certainly an under-estimation of the burden on private enterprise.)

Possibly more important than the direct cost is the economic waste. All regulations are an extraction from the economy. They require the allocation of administrative personnel and time to the useless tasks of compliance – filling in the forms, filing the completed forms, gathering and tracking the data the government requires for reporting, and informing others in the organization what they need to do to ensure the firm remains in compliance. These people could all be doing something productive instead. Consequently, production that could take place is excluded or neglected, and the economy is smaller and poorer and slower-growing.

And this definition of waste does not even include the wasted dollars paid in fees, and in fines for late filing, inaccuracy and other infractions.

Why does government impose this idiotic waste? For example, as an alternative, government could just impose some kind of a flat tax on GDP or gross revenues from sales, but not go to the trouble of designing, publishing, imposing, enforcing and administering their idiotic rules. Such a tax could sustain government at scale and pay for plenty of bureaucrats’ jobs, pensions and healthcare plans, without all the work.

It’s clear, then, that they enjoy the control.

It makes bureaucrats feel powerful. Their decisions are final. They dictate how the economy performs. They dictate whether or not businesses can grow. They dictate how cars are built and how cows are milked. They have ultimate power. These seedy, weedy mediocrities probably couldn’t qualify for a real job in an honest company that applies meritocratic measures to reward those who add value and discard those who don’t. Yet they are in total control. What could be more admirable? What could be more relevant to elevating themselves above the masses? Self-serving by making the regulations more complex and more all-encompassing is a natural behavior for them, and so obviously good for the economy and the country. The country needs controlling.

Over-regulation destroys much. It especially destroys the discovery and serendipity that characterizes the entrepreneurial economic activity that brings us innovation and growth.

And the damage is not restricted to the immediate effect of regulation. The damage compounds over time, as Dr. Per Bylund of Oklahoma State University emphasizes. Every regulation distorts economic activity, and shifts the interaction of supply and demand, and the interactions of entrepreneurs and customers, for as long as it is in place, multiplicatively compounding the damaging effect as each over-regulated period succeeds the previous over-regulated period.

Rent control is an easy example to think through. Rent control in a city immediately changes the economic calculation of an investor who might otherwise plan to build rental housing or invest in upgrades to an existing investment. The net present value of future cash flows changes and so the return on investment calculation changes. The investor may decide to invest in rental housing in another city where rent control does not apply, thereby permanently changing the relative economic relationship between the two cities in terms of the quality of life of citizens, and relative attractiveness to employers. Or the investor may decide to invest in an entirely different line of economic activity, thereby distorting the relationships between the rental housing sector and other sectors.

When the investor decides not to invest in the housing stock of the rent-controlled city, that housing stock will decline in relative and absolute quality. Renters may choose housing outside the rent control zone if its quality is better or more stable. Those renters may have to commute further. The markets for transportation and cars and gasoline are thus distorted. Perhaps the commuter spends less time with family as a result of the longer commute, and the kids suffer in academic achievement while the quality of life of the commuter declines because of frustration and boredom. Spending more on commuting may result in spending less on entertainment or clothing. In all cases, the demand functions and preferences of individuals are distorted with ripple effects through the local economy. These ripple effects can become tsunamis as the regulatory damage compounds over time: cities become wastelands, wastelands become criminalized, criminalization becomes social breakdown, social breakdown becomes violence.

The narcissism of government is that they don’t care one iota about these economic distortions. They care about being seen as policy designers, as engaged in that they call action, doing something. They care about appearance, not results or outcomes. When the outcomes we describe come about (as they have in many cities across the USA), politicians engage in narcissistic denial. It can’t be us. It can’t be our fault. Someone or something else must be to blame. Just look at us, we are so committed to doing the right thing.

How we wish we could expel the narcissists from government.

Government Economics Versus People Economics

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Economics is beautiful. It’s the science of prosperity – how every individual in an economy can find their way to prosperity by collaborating and exchanging with other like-minded individuals for mutual benefit. The essences of economics include individualism – people helping people; betterment – everyone always seeking a higher level of well-being for themselves and for others; value – the feeling experienced when that higher level of well-being is attained; creativity – the new, never-tried-before ideas that humans are capable of generating; learning – no-one knows, controls or can predict the future, but new knowledge is continuously generated and shared through experience. Learning, creativity, the search for betterment and the pursuit of new value make economics an exciting, dynamic discovery journey of innovation and new horizons. 

We might call this form of economics “People’s Economics”. It’s the science of making people’s lives better. In his book Factfulness, Hans Rosling lists 16 Bad things Decreasing (including children dying, hunger, and plane crash deaths) and 16 Good Things Increasing (including literacy, access to electricity and safe water, and immunization). His point is that the individual drive for betterment and the search for better value – i.e., the science of economics – are the source code for global progress and human thriving. The dynamics behind this progress include experimentation, collaboration, feedback loops, and entrepreneurship – what complexity scientists call “explore and expand”: keep randomly trying things that might work, and expand resource allocation to those that do.

There’s another version of economics that we’re all more used to and more exposed to. That’s government economics. It’s the opposite of the science of prosperity for individuals or the individually-initiated drive for betterment and the search for value. The focus of this form of economics is not individual people and their personal pursuit of well-being. It focuses more on aggregates – meaningless contrived statistical roll-ups such as GDP. Individual people are meaningless in GDP. It focuses on government policy: the government’s fetish for control over the individual in economic terms knows no bounds. Government has explicit and detailed rules to control everything that is produced and everything that is used or consumed. There are government rules about the size of your breakfast cereal package and the ingredients listed on it. There are government controls that govern the car you drive and the airline tickets you buy and every element of your healthcare. And the government’s second major interest in the economy, after controlling it with regulations, lies in extraction: taking, via taxes, tariffs, and fees, the fruits of the economic activity of private producers that remain even after regulation has strangled productive possibilities.

Why does government economics dominate the economic conversation? First, the government employs most economists and subsidizes their research. Most Ph.D. economists are employed by the Federal Reserve and government departments either directly, or as paid consultants and advisors. Most economic research and the papers published by universities and think tanks are subsidized or directly paid for by government grants of various kinds. Economists are paid to do government economics. And secondly, of course, government controls the media through which we get most of our economics information, through the statistics it publishes and how these statistics are covered by mainstream media. All mainstream paid media require government statistics to report on and debate, and government economic policy to publicize and weigh (don’t worry, it’s all good, they tell us). They can’t question the existence of the Federal Reserve when Federal Reserve policy and actions provide them with so much airtime content and therefore so many advertising dollars.

Any of us can switch to people economics. It’s simply a matter of reframing. Frame the economic knowledge you have and the news that comes your way through the lens of individual end-users and individual producers, both people-as-producers and firms-as-producers. For example, take the question of whether or not there is an economic recession. The government statistics say no, not yet. Some of the commentators on “macro” economics believe we are in a recession. To decide the question, look through the lens of you. Do you have a job? Does that generate cash flow for you? Are you consuming? Are you consuming less or more? Is your mortgage rate locked in, or floating? These and other personal questions determine your economic condition and economic outlook, not the statistically-contrived movements of some meaningless aggregates.

You can use the same personal assessment for price inflation. Are things you buy more expensive than they were a year ago or six months ago? All of them, or some of them? Are you able to cut back on some expenditures that don’t seem as necessary as they once did? Can you make substitutions? Can you adjust? The level of price inflation that’s painted as a “national” level is a government number. It signifies nothing about your personal inflation, or your family’s. Your inflation is not determined by the national prices of eggs or gas or any other single item, but by the monthly or weekly dollar expenditures for household expenses. Some of these are fixed and some are variable and you manage accordingly. You economize. You calculate and recalculate and re-evaluate. 

Similarly, on the production side of the economic equation, People’s Economics applies at the individual level. The driver of economic production, innovation, and growth is entrepreneurship. This is a function that any individual can perform. Trading labor hours for a wage is entrepreneurial if the combination of revenue and psychic reward is greater than the individual’s perceived cost of doing the job. Working for a corporation can be entrepreneurial so long as the work is done in a value creation mode as opposed to a bureaucratic mode; bureaucracy is non-productive. Entrepreneurship can be pursued by any business owner, co-owner, or investor, so long as the focus is on producing customer value (as opposed, for example, to maximizing shareholder value).

There are a few economists who recognize people economics. Professor Deirdre McCloskey of the University of Chicago calls it humanomics, and she’s campaigning for an end to the kind of false measurement that characterizes GDP and the centralized control of people that is the driver of government economic policy. She favors individual creativity and discovery as the drivers of economic growth. She calls for liberty from policy.

The entire Austrian school of economics, of course, is the antidote to government economics, built on the consumer as the originator of value – discovering what to want – and the entrepreneur as the producer of value – meeting the consumer’s newly discovered wants with innovation.

The economics profession has a lot to answer for. Mostly, it should cease to debase itself and stop selling itself to governments. We can then rediscover the beautiful science of prosperity.

10 Better Business Perspectives From Austrian Economics

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1. Subjective value.

What is the purpose of business? It is to create value for customers, defined as the experience of a feeling of satisfaction, well-being, or even delight. Austrian economics cuts through the debates about maximizing shareholder value or stakeholder value, and about the cold and calculating pursuit of profit. Profit is an emergent result of creating subjective value, one that’s required to keep the value creation system in motion. A deep understanding of subjective value is a prerequisite for business success, and it results in a broader value perspective for businesses and firms than narrow concepts such as profit maximization or shareholder value maximization. The value-dominant logic of Austrian economics ensures that business is a benevolent force for society, as well as for all business participants on both the producer and customer sides.

Source: Ubiquitous. Subjective value in entrepreneurship, Per L. Bylund, Mark D. Packard 

2. Customer sovereignty. 

How does any economic system – a firm, a project, or a marketing campaign – work and succeed? The customer determines the outcome. By buying or not buying, by paying the manufacturer-recommended price or effectively demanding a lower one, by judging the quality of the experience and rating it and describing it to others, customers are the sole determinants of what succeeds and what fails for producers. By acknowledging this sovereignty, businesses channel themselves into the right business approach: humble, responsive, agile.

Source: Ludwig von Mises Human Action Scholars Edition Ch XV Section 4 The Sovereignty of the Consumers

3. Betterment.

The engine of economic growth is the individual consumer’s drive for betterment. Each individual is eternally dissatisfied with the status quo and seeks constructive ways to improve it through acquisition and use of products and services that they judge might help them in their quest. This dissatisfaction is the universal resource for entrepreneurs and innovators. Those who succeed in utilizing this resource effectively thrive.

Source: Ludwig von Mises: Human Action, Scholars Edition Part 1 Chapter 1 Section 2, The Prerequisites of Human Action

4. Entrepreneurship

Entrepreneurship is the economic function that senses the dissatisfaction of end-users, translates that sensing into innovative economic projects, and proposes new choices and alternatives to them. Entrepreneurs accept the uncertainty that they might not succeed in securing the acceptance of the customer (see 2 above), and they utilize methods of co-creation of value with customers to increase their probabilities for marketplace success.

Source: Murray N. Rothbard, Man Economy and State Ch 8 Production, Entrepreneurship and Change, Section 5 The Entrepreneur and Innovation

5. Empathy as a business skill.

The tool to match entrepreneurial sensing to the customer’s drive for betterment is empathy – the skill of identifying and understanding the customer’s mental model and seeing the world from that perspective. Being able to identify the feeling a customer would prefer to experience is empathic skill, and being able to get the identification right is empathic accuracy. Translating these inputs into potential new marketplace offerings is entrepreneurial imagination. All of these require a human connection that is the essence of the entrepreneurial society.

Source: Peter G. Klein Empathy For Entrepreneurs

6. Business as a flow.

Traditional business management approaches do not deal well with the dynamics of markets. There’s an effort to control – e.g. by making annual plans or compiling 5-year strategy documents that are somehow intended to frame resource allocation and employee activities – and to predict – e.g. by making sales forecasts and driving internal activities to “hit the numbers”. No control and no prediction are possible. Business is better viewed as a flow, a river of activity that is never the same twice and always different depending on the location of the observer. Ludwig von Mises called this situation “constant flux”. In this sense, value is a flow and capital is a flow – the capacity to think in terms of flow and manage in view of continuous flow is a desirable skill.

Sources: Peter Lewin and Nicolas Cachanosky: Austrian Capital Theory; Ch 2 Carl Menger and the Structure of Production

Ludwig M. Lachmann; The Market as an Economic Process

7. Orientation and Intent.

Strategy and planning are replaced by Orientation and Intent. In a business firm, orientation is a shared alertness among all employees and partners to new information coming from the marketplace and the business environment, and a shared way of filtering it and processing it quickly to inform new decisions. Intent is the framing of those decisions in the context of shared goals – no commands and orders but common guidelines for action. Orientation and intent are dynamic alternatives to command-and-control.

Source: Orientation: Bridging The Gap In The Austrian Theory Of Entrepreneurship; Mark J. McGrath and Hunter Hastings; AERC 2022

8. The end of structure.

In a world of flow, traditional organizational structures and the transmission of hierarchical authority can prove to be constraining, impeding vital information flow, and resulting in waste and inefficiency. The most constraining organizational form is bureaucracy. Leadership becomes an emergent situational tool, not a consequence of authority. It is fluid not structural, operating vertically and horizontally from bottom to top and top to bottom, in small teams and grand challenge projects as needed, based on knowledge specialties as they pertain to the situation at hand. 

Sources: Ludwig von Mises: Bureaucracy

Desmond Ng: Entrepreneurial Empowerment And The Austrian Approach To Value-Generating Organizational Design

The Boundless Promise Of Decentralization For Business; Hunter Hastings

9. Shared mental models.

We all see the world indirectly, through mental models. As a consequence of subjective understanding, each individual in a firm constructs their own mental model. Management and leadership in this context come down to aligning all these mental models so that they become one, cohesive, shared model. The shared model becomes the binding force that takes a business forward with growth momentum.

Source: Economics For Business: Building An Entrepreneurial Business Culture With Systems Thinking

10. Simple rules.

Austrian economics understands that markets and firms and industries are “spontaneous orders” – what today we call complex adaptive systems (CAS). Such systems are guided not by plans and policy manuals but by simple shared rules that apply to all and are followed by all. Such rules as the creation of subjective value, practicing empathy, and acting entrepreneurially are among the rules that bind firms together. 

Sources: Economics For Business: Systems Thinking For Business

F.A. Hayek; Law, Legislation and Liberty, volume 2, Chapter 7

What Level Of Return Are You Providing To Your Customers On Their Emotional Investment?

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Happy customers are a goal for businesses. Customer satisfaction, customer trust, customer loyalty – these are all assets that corporations and brands work hard to build. They’re emotional assets. When a customer is satisfied with their purchase and with the experience that results from it, that’s a feeling, not a number. When a customer comes to trust a vendor or supplier or brand, that’s a perception or intuition rather than a cold, reason-based assessment. When that trust translates to loyalty, it may be expressed in behavior (such as repeat purchasing) but it’s nevertheless based on sentiment as much as analysis.

Seen from the perspective of business, happy customers represent purpose. The purpose of a business is to create and maintain happy customers. The business methods and tools for achieving this purpose are not found in the numbers of finance and accounting, and they’re not in the bureaucratic processes of business administration. They’re not in the footnotes of the Annual Reports and 10K’s that the SEC demands that companies spend fortunes on to produce and file.

The business tools that produce happy customers are emotion-based. The most important is empathy: the ability to understand the customer’s mental model – see things from their perspective and with their perception and emotion – and to operate within that mental model when designing products and services for them. One definition of value creation and innovation is the solving of problems that have meaning for others. To even get started on this track requires an understanding of what’s meaningful for customers, an understanding that can only be gained from their perspective.

Think of any successful service, product or business. Why are its customers happy? How do they feel and why? What feelings motivate them? What are their values and how does the business or brand complement those feelings? To take just one example, why are Tesla owners willing to pay as much as they do for their EV? Do they find personal meaning in contributing in some way to the climate crisis (which, itself, is highly bounded by feelings)? Or do they take pride in the green credentials they can display to their neighbors, peers and friends? Does the simplicity and austerity of the car’s design complement and embody these feelings? Elon Musk and his team are able to do this analysis. They have a highly developed feel for their customers.

This is not to imply that business is all “touchy-feely”. In fact, this feeling that the customers have for brands, products and services becomes capital on the business’s balance sheet, as well as becoming revenue and profit on the P&L. The customer’s feelings that a brand will make them happy and result in a feeling of satisfaction becomes revenue through the mechanism of willingness-to-pay. After assessing the potential value and utility of any brand offering or any value proposition, the customer decides (based on emotional, subjective valuation) whether or not to buy. Are they willing to pay to find out whether their experience of the brand will be as good or better than they expect? If they are a repeat buyer, they’ll be more confident. If they’re a new buyer, they’ve developed some tentative trust. If they’re feeling affluent and they’ve already met their more basis needs they may feel a little more relaxed and uninhibited about their willingness to pay. In any of these cases, they’ll assess again after their experience to weigh whether it met their expectations or not, and on this basis, develop their future evaluation for the next opportunity to buy.

These customers are making an emotional investment in the business’s offering. They’re expending their own emotional energy in thinking through their internal problem to solve. They’re trying to anticipate their own future emotions that will arise after the purchase. They are taking a value risk – it might not work out. This is a considerable emotional investment. There are only so many times they’ll be willing to repeat the investment, whether for this product or for the category from which they choose it. A disappointing Tesla can be traded in at some point. A disappointing fashion choice can be discarded and never repeated.

The customer seeks a return on their emotional investment – ideally a high one. When they choose between two different ways to spend their money – to exercise their willingness to pay – they’re weighing two potential returns and they’ll select the higher one.

The customer’s emotional investment becomes the company’s capital. When they buy, revenue flows back to the company. What we know as capital value on a company’s balance sheet is the flow of revenue back to the company, minus the cost of generating that flow, expressed as a single dollar value. If customers are happier, or more customers are happy, more revenue flows, quite possibly at a higher profit since the willingness to pay might be higher, and the company’s capital value increases. This is what becomes stock market value – a stock price can be expressed as a Price / Earnings ratio. The earnings in this equation are those flows coming back from customers. It’s really a Price / Happy Customers ratio. Similarly, in financial analysis, Economic Value Added (EVA) is a similar calculation: the flow of revenues from customers minus the costs of generating them.

Economic calculation for a business requires both numbers and feelings, quantitative analysis and qualitative analysis. It’s necessary to empathize with and assess the emotions of customers, and to translate these into projected revenue flows. It’s equally necessary to identify their willingness to pay as a number (i.e. pricing) and then to choose costs of production that are both consistent with their emotional needs and consonant with the accounting analysis of profitability.

In a book called After Steve: How Apple Became A Trillion Dollar Company And Lost Its Soul, Tripp Mickle contrasts the mindset and approaches of Apple’s Chief Design Officer Jony Ive and CEO Tim Cook. Ive was the design aficionado who sought flawless perfection in Apple’s products as the way to earn the love and loyalty of customers, always surprising them with what was possible and with the degree of elegance and beauty that was achievable. Tim Cook was more of the numbers-based efficiency aficionado, seeking cost discipline to achieve profits at price points the customers indicated they were willing to pay.

Both are necessary, of course. But even costs must be emotionally and subjectively judged as supportive of customer happiness. What, for example, is the cost of Apple’s beautiful packaging which evokes such pride of ownership and delight at the unpacking experience? It would be easy to choose lower priced packaging. But what would be the cost in diminished customer delight? What would be the capital cost of reduced revenue flows from a diminishing army of Apple fans?

All-in-all, it’ a feel for business that’s more important than excellence in business administration, and it’s this feel for business that reveals more of the secrets of the success of great entrepreneurs, great brands, and great corporations. Business schools won’t tell you that, and won’t help you develop that feel. Trust emotions, practice empathy and exercise judgment.