Beyond Rides: Why Uber's Future Might Be at the Pump (3 min)

Why doesn’t Uber operate a network of gas stations?

Uber’s core mission is to move people (and increasingly goods) from Point A to Point B with speed, convenience, and affordability. But there’s one challenge that’s central to their business, yet tangential to their daily operations: fuel.

There’s going to be some handwavy math below, detailed figures are given at the bottom of the post

Uber doesn’t release data on how many miles are driven per year but if we take their headline figure of 10B rides/year and estimate 7 miles per trip on average, we can arrive at 70B miles driven per year + an additional 20-30B miles in “dead” miles driving to and from pickup locations. If we assume an MPG of 25 then we’re looking at ~4B gallons of gas consumed per year. 20% of Uber’s trips happen in just 5 cities (Chicago, Los Angeles, New York City, São Paulo, and London) so let’s say 2.4B gallons of gas in the their top 3 US cities. Now let’s assume that Uber drivers end up utilizing the Uber stations 50% of the time so Uber is going to need just over a billion gallons of gas a year to service Chicago, Los Angeles, and NYC.

According to various “gas industry” publications, an average gas station owner should expect to see something like .05/gallon in net profit which Uber can give to the drivers right away. However, Uber has 3 advantages that will lead to lower prices.

First they can charge drivers using their Uber earnings balances which means no credit card processing fees. This is an immediate 3% savings per transaction. Then they can commit to purchasing a billion gallons upfront/year (or maybe even buy an oil refinery from Delta), which would suggest a 10-15% savings. Finally, they can use the stations locations as a way to pre place inventory (drivers) in optimal locations without having to resort to surge pricing.

On the driver side, drivers will get cheaper gas (to the tune of ~$100M saved/year by drivers in these 3 cities) which is one of the highest input costs for their work, increased loyalty to uber, and presumably access to clean restrooms which are a common driver complaint.

While the capex of building/operating a couple hundred stations and the infrastructure necessary to service them is not a small task, one could argue that it’s attractive for Uber’s next stage of growth. Physical footprints in the form of gas stations would allow Uber to expand into areas like “15 minute delivery” or “Last mile package delivery” easily. Additionally, this is a move that could only be done by the market leader. The best Lyft could hope to compete with is a loyalty card tied to a network like Shell or Chevron with a small discount attached to it.

Uber Mile Calculation: 9.448B trips x [(30% x 5 miles) + (15% x 15 miles) + (55% x 7 miles)] = 9.448B x [1.5 + 2.25 + 3.85] = 9.448B x 7.6 miles per average trip ≈ 71.8 billion total miles driven

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Roosh → You

Video Game Gambling(2 min)

Snowfall Futures (1 min)

What is the video game skins market and who participates in it?

In recent years people have been spending astronomical sums for the right to display custom cosmetic designs on their guns, items, and clothing in multiplayer games. The item below was reportedly sold for $100,000 to a Chinese collector in the game CS:GO. Of course, wherever there is an obscure market with high liquidity that authorities don't understand you can be sure to find two participants: gamblers and money launderers.

There are hundreds of websites that allow you to "wager" any of your virtual weapon-skins on the results of a virtual craps table, the winner of an e-sports match, or the spin of a roulette wheel. Of the $5 billion wagered in virtual skins last year, around 40 percent were bet on esports matches, while around $3 billion flowed through websites offering casino-style games. These sites often disappear, only to be reopened shortly afterward under different domain names, making them impossible to police.

One such site Unikrn, even has it's own virtual currency system that is only redeemable for cosmetic items that can be displayed while gambling in its virtual casino with other people (who are betting "real" currency that they've deposited in the form of virtual skins with real-world value from games such as CS:GO).

Beyond gambling, criminals can use the proceeds of crime to buy virtual currency or a particular item, then sell it — often at an apparent discount — to an unwitting gamer, through a variety of online marketplaces. Most gambling and skin resale sites don't report their numbers publicly but Bloomberg pegged the industry at $50 billion/year.

There have been a few attempts to corral the activities of the people participating in these activities. In 2019 Valve (which owns the Steam marketplace and CS:GO) said that it was banning a particular trading activity on its markets due to their "almost exclusive use by worldwide fraud networks". It's doubtful that this will make a meaningful dent in the usage of virtual items as a way to launder money, but it's still a commendable move by Valve.

As the value of virtual items rises with the ever-increasing supply of gamers it will be interesting to see whether the illegal activity we've seen thus far will continue to grow or will be forced to move to a less popular corner of another market.

In Other Words

Over $5 billion is wagered through the video game skin market every year. The size of this market has attracted criminals who are using the deep liquidity present in the market to launder their ill-gotten gains. Because of its obscure nature, it has been difficult to focus lawmakers' attention on the problem, and the industry has continued to grow.

Why do people bet on how much snowfall there'll be in certain areas of the world?

In 2006, CME Group established the first market for "snowfall futures". Its purpose was to allow individuals and companies to bet on how much snow would fall in cities around the world. As with any specialized derivative product, it's initial customers were found in airlines, snow removal companies, and hedge funds with sophisticated weather forecasting models.

According to NPR, "The average snowfall for winter in Chicago is around 37 inches. So the contracts are like insurance, paying out a set amount of money for every inch over or under, depending on what contract you take out."

As with any form of hedging, participants are investing in insurance in order to smooth out their profits. In this case, the market gives businesses the means to hedge against losses from heavier or lighter snowfall than expected this winter. A snowfall removal company might hedge against the risk of a very light snowfall year because they know that were that to happen they may go bankrupt. Meanwhile, an airline might hedge against excessive snowfall since the delays caused by weather can be extremely costly to them.

In Other Words

Snowfall futures allow companies whose profits are highly dependant on weather-related conditions to hedge against the risk of extreme (in either direction) snowfall years.

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Two-Sided Marketplaces, Trust & Tenancy Rights (3 min)

What is the purpose of a Two-Sided Marketplace and how has it evolved over time?

1. The main purpose of a Two-Sided Marketplace is to provide a proxy for trust that gives two unknown counter-parties the confidence to transact with each other.

2. Two-Sided Marketplaces have gone from neutral market makers (simply connecting supply and demand) to landlords who are now grappling with the challenge of providing their most valuable tenants (drivers who work full-time, hosts with multiple properties, etc) with tenancy rights (sick pay, benefits, etc) that society feels they are owed.

3. Two-Sided Marketplaces are now moving towards treating the small but most valuable portion of their supply-side of users differently and better than the rest of their users but are reticent to do too much because it's uneconomical and unfavorable to offer those same benefits and treatments to the rest of their workforce

Purpose

Two-Sided Marketplaces thrive in areas of low trust or fragmented distribution. eBay is an excellent example of a company that was able to leverage both to its advantage. Instead of having to vet and trust each individual buyer and seller of any item (each of whom you could expect to have few repeat transactions with), you could instead use your trust in eBay as a substitute. With regards to distribution, you no longer had to scour the corners of the internet to find your $600,000 limited edition Princess Diana beanie baby, they were all being bought and sold in the same place.

Evolution

eBay never faced serious societal pressure to do more for the power sellers on its platform. It was able to care out a niche as an efficient connector of supply and demand and collect the transaction fees that came along with that role in the market. However, as two-sided marketplaces have evolved into companies that increasingly look like traditional employers, calls for overtime or sick pay for the gig workers of companies like Uber, Lyft, and Doordash have increased. These companies have resisted these efforts by claiming that the main purpose of their platform is to provide supplemental income for people with surplus time or space (or surplus goods in the case of eBay).

As we can see in the graphic above, the data bears out in Uber's case. There are a (relatively) small minority of drivers in California whose livelihood absolutely depends on Uber. 10% of drivers drive for more than 40 hours a week while 75% drive less than 25 hours a week.

With such a wide disparity in the number of hours worked per driver, treating every driver on its platform the same makes little sense. This is why we've slowly started to see distinctions between elements of the supply side of the gig economy. It seems difficult to argue that we shouldn't be treating these drivers (those who drive for part-time and those who drive full-time) differently but current labor laws make this difficult. So what have companies done to reward their most loyal segments of the supply side of their markets?

In the face of restrictive labor laws some companies have found a way to reward the most active users in the marketplaces. One such company was the ill-fated NYC based rideshare company, Juno. "Drivers would own restricted stock units" in Juno that could translate into cash if Juno ever went public or got sold. The shares were awarded based on how much a driver drove for Juno — as long as they hit 120 hours a month on the platform". Unfortunately, Juno wasn't able to outcompete Uber and Lyft and was later sold (and was sued by multiple groups of drivers who felt they were unfairly treated in the sale process).

In a similar manner, when Lyft IPO'd last year it actually awarded any driver who had completed 10,000 rides $1000 (ostensibly so that the drivers could buy shares with the bonus). Additionally, any driver who had completed 20,0000 trips actually received a $10,000 bonus in recognition of their efforts for the company. During Uber's IPO, they awarded drivers $100, $500, $1,000 or $10,000 for completing 2,500, 5,000, 10,000 or 20,000 lifetime trips, respectively.

While these one time bonuses were a great start, I think it's inevitable that companies such as Lyft and Uber will need to continue to offer more upside to the most active participants of their platforms both to help encourage utilization and also to as a matter of fairness.

Thanks to Charles Rubenfeld for inspiring this post with his piece on AB5 and Uber.

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Platforms Enable Competition by Default (1 min)

The Curious Case of Lee Kun-hee (2 min)

How have existing social media platforms contributed to the rise of TikTok and what does this phenomenon mean for competition?

TikTok's meteoric growth is in large part because it was able to leverage existing platforms to drive its user growth. It spent $1 billion in 2018 to acquire users (that's more than $3 million a day in the U.S. alone). Initially, it focused on acquiring users through Facebook ads where Reuters reports that, “nearly 22% of all ads seen by U.S. Apple device users on Facebook's ad network came from TikTok".

Later TikTok shifted its focus to Snapchat, and over 80% of TikTok's 2019 ad spend was concentrated on Snapchat ads. It was able to leapfrog Snapchat and now boasts more U.S. DAU's (daily active users) than the platform it found the most success acquiring users from (while also being Snapchat's biggest advertiser for the year).

There is no doubt that TikTok has an amazing product and deserves to be a top tier social network. But what it has proven is that any platform that can stomach billions in ad spend no longer has to worry about distribution. When Facebook was scaling its platform it had to rely on real-world network effects, referrals, and traditional marketing techniques. There was no way for it to pay some marginal cost to MySpace to capture some percentage of their userbase. This made growth much harder and a longer process than what TikTok has been able to do.

By being able to advertise to any platform's users, the current crop of social media companies has become the next generation of products go-to source for new customers, ensuring that competition is always just one ad unit away.

In Other Words

In today's world, Facebook, Instagram, Snapchat, (and soon TikTok itself) provide a ready-made path for any upcoming platform to gain immense scale. When we talk about the fact that our social media platforms are too big or have monopolistic tendencies, the fact that well-capitalized companies can take advantage of that size for their own benefit (because of existing platforms reliance on advertising) is often brushed aside.

Why does South Korea have a 50% inheritance tax and what are its effects on its economy?

South Korea has one of the most concentrated economies of the developed world with 5 companies accounting for over 70% of the economy in the country. The largest of the 5 "Chaebol" companies (as they are called in South Korea) is Samsung which comprises just over 20% of the entire South Korean stock exchange.

The government has the unenviable task of trying to make the Chaebol slowly loosen their grip on the economy while ensuring that doing so doesn't send the economy into a tailspin. In theory, South Korea's high inheritance tax is a great mechanism to help encourage this. In practice, the Chaebol have worked in tandem with the government to ensure that their sons and daughters remain in control of the companies that they founded.

Until last week Samsung was controlled by a second-generation founder, Lee Kun-hee. Lee's status as chairman of one of the most important pillars of the South Korean economy led to two separate pardons in corruption cases against him (in 2000 and 2009). Public outrage at these leaders being above the law has led to an upsurge of resentment against them and made it politically toxic to be seen as in league with them.

Lee Kun-hee has not appeared in public since 2014 when he had a heart attack and was reportedly put on life support. Immediately after, Lee Jae-Yong (Lee's son and successor) was forced to come up with a strategy to maintain control of Samsung's byzantine structure of inter-linked companies (spanning electronics, food processing, textiles, insurance, securities, and retail) while still being able to pay a reported $9 billion tax bill. His actions included allegedly bribing a close confidant of the South Korean president at the time (which resulted in her impeachment and removal from power and his ongoing corruption trial).

What's clear from this example is that by targeting the Chaebol through such an indirect measure (inheritance taxes), the South Korean government has failed to bring about a reduction in the power of its economic giants. Instead, the tax has served to exacerbate political discontent because the Chaebol have been caught repeatedly trying to skirt the rule through any means necessary. It seems that if one wants to reduce the power of such companies that perhaps more direct methods are necessary.

In Other Words

South Korea has the second-highest inheritance tax in the world and it was designed to wrest control of the economy away from the powerful Chaebol conglomerates which together account for 70% of the countries GDP. Fearful of the chaos such a split could bring, previous administrations have repeatedly pardoned or colluded with Chaebol leaders to ensure that succession runs smoothly. The previous chairman of Samsung has been rumored to be dead for the last 6 years but his death was only recently announced (presumably because his son was able to find a way to both pay the tax bill and maintain control of the company, once again showing that the inheritance tax is not serving its original aim).

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The Role of Companies and the Evolution of Great Power Competition (3 min)

How has the evolution of great power competition changed the role of companies?

In 2012, the U.S. based hedge fund NML Capital convinced a judge to allow them to seize an Argentine navy vessel docked in Ghana. At the time they owned over $1 billion worth of Argentine debt that the government had defaulted on. Although the U.N. eventually intervened and secured the release of the warship (pictured above), NML Capital later also received its payment in full (and made a handy profit since it had bought the debt at a deep discount right before the default). The last time Argentina had lost a naval vessel was during the Falkland War in 1982 when a torpedo from a British nuclear-powered submarine sank the ARA General Belgrano.

Political science defines force projection as the capacity of a state to deploy and sustain forces outside its territory. In a world where companies can seize warships, sue nation-states, and exert total control over entire industries, it's not far fetched to think that the balance of power has shifted from military might to economic heft. The battlegrounds of the 21st century have been defined by countries leveraging their economic power (through companies within their borders) to exert pressure on their rivals.

When the U.S. decided to apply pressure on China during the opening salvos of the trade war, one of its most high profile actions was to starve two Chinese companies (Huawei and ZTE) from accessing critical components (made with American technology) that they needed in order to function. When Putin wanted to demonstrate the amount of leverage he held over Ukraine during a period of particularly frosty relations in 2009 he ordered the Russian company Gazprom to sharply reduce the supply of gas that they sold to the country, leaving tens of thousands unable to afford to heat their homes during the Christmas and New Years holidays.

Pictured above is the historical weather data during the Gazprom gas shutoff. (-12 degrees Celcius is ~10 degrees Fahrenheit).

As we move into a multi-polar world (one in which China, Russia, and India become increasingly assertive over their respective regions) the strength of a nation will increasingly be measured by its ability and willingness to leverage its companies for geopolitical leverage. The distinction between state and company is already blurring (look at subsidies, the blocking of foreign investment in certain sectors, and surveillance), and the advantages of such actions will only continue to increase. China has been most explicit in its distinction between state and company (no distinction exists), while the United States has yet to take a consistent stance on the issue.

Are companies destined to become organs of the state or will they be able to continue their pursuit of profits in the global economy of the future? While I'm hopeful for the latter, I think it's clear that each country will have to make tough tradeoffs with respect to these two items. In either case, one thing is clear: companies are now so powerful they can no longer hide behind the aegis of the free market.

In Other Words

Companies have been co-opted by the nations they reside in as tools to wage geopolitical battles without risking traditional military forces. As we move into a world where the cost of conventional war becomes higher for the biggest countries, economic leverage will continue to gain importance. Countries are already using their companies to great effect and this raises questions about the relationship between state and industry. Ultimately, it seems likely that U.S. companies will be forced to make suboptimal economic decisions to advance the aims of the country.

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Ass Insurance (1 min)

Monopoly Money: Google and Apple as Dictators (3 min)

What is body part insurance and what are the implications of being able to value specific parts of your body?

The purpose of body part insurance is to supplement lost income for a person if a specified body part is damaged, injured, scarred, handicapped, or lost. In many ways, it can be seen as the ultimate unbundling of the individual as a unit of value. Singers vocal cords, chefs taste buds, and a painters hands generate an outsized amount of utility relative to their other limbs, and being able to value them separately means a whole new class of financial products are now possible.

One of the earliest known policies was written for the cross-eyed silent film actor, Ben Turpin, who was to be given $100,000 in the event that his eyes became straight. Other famously insured body parts include Gene Simmons tongue ($1 million), Keith Richards middle finger ($1.6 million), Madonna's breasts ($2 million), Taylor Swift's legs ($40 million), and Kim Kardashian's ass ($21 million).

The idea behind the policies is that should a body part that is insured be out of commission or unable to be shown/used as normal, then the insurer would pay the total amount of the coverage (over a specified period of time). Then the star would be able to recoup the "losses" they would have sustained while not being able to utilize the insured portion of their body.

But why stop with insurance? We're not far from a world where Kim Kardashian can treat her ass like a liquid asset. Perhaps eventually she'll be able to take out a loan with her ass as collateral. Should she default, the originator of the loan could "foreclose" her ass and be able to collect revenue from certain types of ads and sponsorships that her ass is directly involved in to recoup the losses on the loan. Or perhaps certain types of cosmetic surgery for influencers could be financed using some form of Income Share Agreements whereby the influencer has to pay a percentage of their future sponsorship income over a period of time but gets the surgery for free.

All of this and more is made possible by the unbundling of the individual and the ability to value certain aspects of a person’s body (or even their mind) in ways that were previously inconceivable.

In Other Words

Body part insurance started as a way for Hollywood stars to insure distinctive portions of their bodies should they ever get injured and be unable to work (ensuring that their income wouldn't dry up immediately). Today it represents a new asset class that could potentially unlock a myriad of new financial products for the next generation.

What are the differences between Indonesian cigarette corruption and tech anti-trust battles?

The WHO (World Health Organization) ranks Indonesia third in the world with regards to the total number of smokers. 63% of adult men smoke and in 2008 over 165 billion cigarettes were sold in the country. 9 out of 10 smokers in Indonesia prefer a particular type of cigarette that's indigenous to the country called the "kretek". Kreteks are cigarettes rolled with cloves, tobacco, and cocoa.

In the 1990's the Indonesian dictator Suharto setup regulation so that all local cigarette manufacturers were forced to buy from a company his son Tommy had set up (known as BPPC), which also controlled clove imports from other countries (and thus had complete control of clove prices). With the stroke of a pen, he gave his son a virtual monopoly on the market for cloves in Indonesia.

The effect on the industry was immediate. A farmer "sold his cloves to the local cooperative for 5,000 rupiah a kilo but would receive only 3,000 in cash--the rest “saved” for him by the bureaucracy. The cloves traveled up the BPPC ladder, officials taking 2,000 for “participation in clove trading” fees here, and a 1,000 rupiah charge to persuade farmers to grow other crops there, plus a 2,000 rupiah charge to cover the BPPC’s interest and operating costs at the end. By the time the cloves reached the cigarette factory, that kilo cost 12,000 rupiah (about $1.20 at the time which was three to four times the world market price).

But the monopoly was a disaster. Because prices for cigarette manufacturers were set artificially high, clove production increased as kretek consumption dropped, leaving many farmers with tons of unsold cloves. At one point, BPCC publicly called for farmers to burn half their crop, and the Suharto Government was eventually forced to bail out the industry with credits totaling almost $350 million.

The problem with monopolies of this nature can be summed up with one word: choice. Cigarette manufacturers in Indonesia had no choice but to buy cloves from the company Suharto's son had setup. Instead of adjusting their production and prices based on supply and demand in the market, they were forced to pay artificially high prices (3-4x the going rate) for cloves which ultimately ended up completely distorting the market and ruining many farmers livelihoods (while simultaneously cutting into the profitability of kretek cigarette production as well).

In today's world, Apple and Google stand accused of being "dictators" of the ecosystems under their control (iOS and Android respectively). And to some extent, these accusations have a ring of truth to them. Like any leader or government, Apple and Google are the arbiters of what is considered lawful behavior on their platforms and enforce their rules judiciously. However, unlike true monopolies, they don't deign to take away consumer choice. They merely adopt a favorable default choice (Google Maps and Google Search on Andriod and iMessage on iPhone) and allow consumers to decide for themselves which services to use.

Most people would agree that the stranglehold on the clove market that Suharto and his son Tommy had in the 1990s was bad for the economy and for the country of Indonesia. It's less clear why Google leveraging its dominant position in Android to pre-install itself as the default search engine is inherently bad for the denizens of the Android ecosystem. If people didn't like Google or if there was an alternative available that was an order of magnitude better, people would switch en masse (Internet Explorer, now Edge, has continued to lose market share even though it continues to be the default browser for Windows machines).

A dictator knows that their hold on power has a finite timespan and thus is incentivized to extract as much value as possible from the economy before that grip weakens and they are eventually forced out of power (or die). Companies face a much more robust feedback mechanism (that of consumer choice) which serves as a great filter for ferreting out bad behavior.

The remit of anti-trust regulators should not be to ensure that there are multiple versions of products with similar feature sets and whose only distinguishing factors are the UI/UX of the products in question. What value does artificially supporting the existence of DuckDuckGo, Yahoo Search, and Microsoft Bing do for the market? Consumers are the ultimate arbiters of what products are delivering value and deserve to survive in the free market. If users are unwilling to explore alternatives for utilities they use on a daily basis why should governments focus efforts on forcing the consumer to make explicit choices between alternatives?

In Other Words

Dictatorial rule in the geopolitical realm is often associated with corruption, monopolies, and bad governance. The spectacular failure of a monopoly in Indonesia in the 1990s serves as a classic example of all three of the above. Monopolies that take away the option of choice are bad for the economy and should be scrutinized, but tech companies today are being lambasted for merely making the "default choice" on platforms they built and control. Consumers have expressed no desire to change this and it isn't clear what harm this is doing or why government regulators around the world have decided that this is a problem worth their attention.

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Roosh → You

Fractional Ownership (2 min)

Lottery Savings (1 min)

Vaccines as Startup Investments (2 min)

What effect do fractional shares have on stocks and markets more generally?

Fractional shares allow investors to buy into companies at dollar amounts other than a multiple of the current price per share in the market. They're commonly used by investors who want to own equity in a company with a relatively expensive share price (eg: Amazon @ $3100/share or Berkshire Hathaway Class A @ $327,000/share) but who either can't or don't want to invest the full amount to buy one share. Instead, an investor with $100 can utilize fractional share trading from their brokerage to get 3.2% of an Amazon share (or .03% of a share of Berkshire Hathaway) instead of being stuck only being able to invest in companies with share prices below $100.

Behind the scenes of fractional share trading are the brokerages (Fidelity, Schwab, or Robinhood) who offer the service to retail investors. If Alice wants to purchase $100 of Amazon stock then Fidelity will actually be purchasing 1 entire share of Amazon and giving Alice custody of 3.2% of it. Fidelity will own the other 96.8% until they can find other customers who are looking to buy portions of Amazon. If the next day Alice decides to sell her portion of Amazon stock then Fidelity will give her the current market price for her portion of the share (3.2%) and attempt to match her order with another customer who wants to purchase a fractional portion of Amazon (If they can't find a match then they'll assume the risk of the price moving against them on the share). With enough customers and demand for fractional shares (we call this liquidity) they're able to minimize their exposure to price movements in the equities they're offering and offer fractional trading as a service without adding significant amounts of volatility to their bottom line.

As fractional trading becomes more popular (and cheaper) I think it's likely that we'll see a shift towards people creating their own indices (or "baskets") of companies that they want to invest in. More specifically I think it's likely that people will start to identify companies that they do not want to invest in and will prefer to choose an existing index and subtract companies from it. For example, if Diego wants to invest $1000 in an index fund of U.S. companies but is also climate-conscious he might want to remove Exxon Mobile, Chevron, and ConocoPhillips from his index (thereby creating his own index with fractional shares and distributing his $1000 appropriately). This level of customization is currently out of reach for the average retail investor but will certainly be possible in the near future.

Fractional investing/ownership doesn't just have implications for investors in the equities markets. Platforms like Masterworks and Mythic Markets allow investors to have stakes in art and other collectible markets as well.

In fact, the winner of this year’s Kentucky Derby (a horse named Authentic) is actually part-owned by investors on MyRacehorse. As the demand for access to investments traditionally reserved for those with large amounts of capital grows, fractional ownership seems poised to grow in importance. It's not hard to imagine a future where you don't own just one horse or one piece of art but instead can buy into an index of all horses of a certain breed or an artist's entire collection of works.

In Other Words

Fractional ownership involves one entity purchasing an asset and assigning partial custody to an individual (or group of individuals) who wishes to own a portion of the asset. We've seen examples of this with stocks, art, horses, and even housing. Since we're at the beginning stages of this type of novel ownership structure existing, I think that we'll soon see new financial products and investment strategies that take advantage of the lower barrier to entry and allow people to invest in asset classes they never would have considered before.

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Will turning savings accounts into a prize-linked lottery cause people to save more money?

A startup called Yotta Savings recently launched a savings accounts with one single modification. Instead of paying their user's interest on the money in their savings account, they're paying users in the form of a lottery (whose math works out such that users on average earn about the same level of interest, or APR, as a traditional savings account). "For every $25 held in Yotta Savings account, you get 1 lottery ticket every week. A lottery ticket has 7 numbers. Everyday, one random number is drawn. At the end of the week you win prize money depending on how many numbers on your ticket matched with the numbers that were drawn. The prize ranges from $0.10 to $10 million." It's a clever piece of financial psychology that should cause people to save more money in the hopes of winning a big prize.

It's also not an entirely new model. Prize-Linked Savings accounts are offered by banks in many states across the U.S. They are most popular in Iran, where many savings accounts are actually paid out through a method like this because traditional forms of guaranteed interest are banned by Islamic law.

It seems that there's a growing trend of apps that exist to disguise saving money in different ways. Another popular vein of applications (Acorns being the biggest) utilizes a technique called round-up saving whereby every transaction you make is rounded up to the nearest whole dollar with the difference in round-up being deposited automatically in a savings account.

On one hand, it seems like we are moving towards a society with ever more empowerment for the individual investor where we're democratizing access to assets and asset classes through concepts like fractional ownership. And yet, simultaneously these savings products show us that we still have trouble with basic financial literacy and setting money aside.

In Other Words

Prize-Linked Savings accounts pay users in the form of a variable reward (differing amounts of money awarded on a recurring basis) that ends up being mathematically designed to give out the same amount of money as people would have earned by parking their money in a regular savings account. The excitement around the lottery system seems to work and encourage people who sign up to save more.

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Why is the U.S. investing in so many vaccines when some of them are clearly not going to work?

To date, the U.S. government has committed over $5 billion to vaccines from the following companies: Pfizer, AstraZeneca, Johnson & Johnson, Moderna, Novavax, Merck, Sanofi, and others. There's no doubt that billions of these dollars will ultimately prove futile as some of the vaccines under production fail to work or demonstrate efficacy.

But as long as the money directly or indirectly helps in the development of a successful vaccine then I think it's fair to say that the government has not made bad decisions on how to allocate funding. One of the most famous quotes in marketing is: "Half the money I spend on advertising is wasted; the trouble is I don't know which half". A more appropriate phrase for vaccine development from the government's perspective might be: "Half (or more of) the money I spend on vaccines is wasted; and I don't care which half it is, as long as there is a vaccine". After all the benefit from successfully finding a vaccine will be worth orders of magnitude more to the economy (we’ve already allocated an extra $3 trillion to shore up the economy), population, and world than the few billion that's put into efforts that don't end up working.

Paradoxically, because the government does not have perfect foresight when it comes to knowing which vaccine under development will ultimately prove successful, the government's role looks similar to that of a Venture Capital firm deciding which firms to invest in. As we talked about previously, some venture capitalists would benefit from simply blindly investing in all credible deals (in other words becoming index investors in startups) simply because the value of the single biggest winner is so great that missing it is catastrophic for their returns (we call this a power-law distribution). You can think of the collective investment as the government taking a short position on the status quo (virus stricken economy) and going long on economic recovery for the benefit of its citizens. Each vaccine investment is basically a lottery ticket with an immense potential payout.

As we began to analyze the government's response to the crisis, I think keeping the VC model in mind might help explain why/how money was distributed and should show that money "wasted" was really money well spent.

In Other Words

The value of a single successful vaccine far outweighs the cost of funding all credible vaccines which makes the rational government strategy one where they attempt to invest in as many as possible. This will inevitably result in billions of dollars being poured into vaccines that don't work but this should be looked at positively instead of negatively. I propose that we use the mental model of the government as a VC firm and the vaccines as startups in order to judge their success by the success of the entire cohort of vaccines instead of on an individual basis.

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That’s all for this week. Thanks for making it this far and I hope you found these answers as interesting to read as I found them interesting to write. If you liked what you read, feel free to share it with someone who you think will enjoy it.

As always,

Roosh → You

History of Central Banks (3 min)

Banning Onion Futures (2 min)

Why were central banks originally formed?

Trust is essential in any monetary system. For centuries, gold has been one of the most trusted assets in existence. A combination of government authority and public consensus has conferred upon it a value that people trust as a store of wealth. After all, "Gold is difficult to destroy, its supply changes little from year to year, and its value does not depend on anyone's creditworthiness." Many paper currencies (including the U.S. dollar until 1971) were backed by a guarantee that a certain quantity of notes could be turned in for a specified amount of gold (from 1944 until 1971 that number was $35/ounce of gold).

Banks were one of the original creators of paper currency as they "used to issue notes to the public that could be redeemed for fixed amounts of the precious metal. At first, banks made money by actually charging depositors a fee for storing gold. Later, as it became clear that redemption notes could act as money, banks profited by issuing more notes than the value of the gold they held in reserve and using the additional notes to make interest-bearing loans." The key element in this transformation was that people trusted that the bank's paper notes were 'as good as gold'.

Prior to the appearance of central banks any individual private bank was always at risk from too many people trying to redeem their notes for gold at any given time. Because they were re-lending deposits as long term loans banks could never meet all of the obligations that they had created in the form of paper money (or IOUs if you will). "Once word got out that a bank wasn't able to meet its obligations, note-holders suddenly realized that their money was not quite as good as they had thought. If enough banks were hit at the same time, the result was a financial crisis. Central banks emerged in response to these crises. They could lend gold to private banks in exchange for claims on the bank's assets and calm panics before they turned into a crisis. Eventually, banks started to deposit their gold with the central bank directly and gave out central bank printed notes as the main currency. Thus, the credibility of the gold peg to paper currency was transferred from private lenders to national governments [and the central bank became an essential institution]."

Another way to think about this is to imagine if everyone tried to get all of their cash out of a single ATM on the same day. Even if there was enough money in the banking ecosystem to satisfy people's withdrawal needs, that single ATM would eventually run out of money. The central bank acts to make sure the ATM (in this case a bank) doesn't ever "run out" if a situation like the one in the picture below occurs.

Today the mandate of a central bank has extended far beyond simply ensuring that citizens continue to have faith in the money supply. Interest rates, inflation targets, unemployment numbers, foreign currency reserve levels, and debt issuance are now the purview of central banks around the world. Even so, trusts role in the system has become more important now than ever before since currencies are no longer backed by anything except faith that the issuing government will honor its commitment written on the notes it prints.

Source: Trade Wars are Class Wars by Matthew Klein and Michael Pettis

In Other Words

Central banks were created to confer legitimacy onto the financial system and ensure that people trust that the currency in circulation is worth using. They act as a backstop against runs on any private bank and until recently were also responsible for handling the convertibility of paper currency into precious metals (usually gold or sometimes silver). Their original goal was to protect banks that were technically solvent but for whom the maturity mismatch between assets and liabilities made it impossible for them to redeem liabilities on demand (avoiding a run on the bank and subsequent financial crisis as people rushed to get rid of their paper currency all at once).

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Why did the Federal Government ban the trading of onion and movie futures in 1956?

In 1955 onions were one of the more popular commodities traded on the Chicago Mercantile Exchange (accounting for 20% of the trading volume at the time). An onion farmer (Vincent Kosuga) and a commodities trader (Sam Siegel) decided to team up and see if they could influence price movements by buying every available onion they could find. By the fall of 1955 they had 30 million pounds of onions in Chicago, which was 98% of the market. With this many onions, they were free to charge higher prices and began making significant sums of money both by selling onions directly and betting that onion prices would continue to increase in the futures market.

Realizing that they could drive the price of onions both up and down they ended up taking a large short position in the onion futures market and buying hundreds of put options on the future price of onions (betting that there would be a significant downturn in prices) right before flooding the market with the stockpile of onions that they had previously been slowly releasing at high prices. The sudden influx of onions crashed the price of a bag of onions from 2.95 a bag to just .10 (which was the same price as the mesh bag the onions came in).

In total the two men made over $8.5 million that year. In the process, they bankrupted many onion farmers and angered others who thought that what they had done was reckless and irresponsible. Congress agreed, and in 1958 passed the Onion Futures Act which banned the trading of onion futures (and curiously enough also banned futures markets for movie results at the box office as well after pressure from the MPAA).

In Other Words

Two men were able to corner the onion market by buying up 30 million pounds of onions. They used this control to set prices for the onion market and made money betting on the price movements of the commodity in the futures market. They started by betting that the price of onions would rise (buying call options) before switching to betting that the price would go down (buying put options) and flooding the market with onions to force the price movement they had bet on. They ended up with $8.5 million for their efforts and Congress passed a law outlawing futures markets for onions as a result.

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That’s all for this week. Thanks for making it this far and I hope you found these answers as interesting to read as I found them interesting to write. If you liked what you read, feel free to share it with someone who you think will enjoy it.

As always,

Roosh → You

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Delta’s Oil Refinery (2 min)

Getting Paid with Risk (1 min)

Why did Delta spend $270 million to buy an oil refinery?

In 2012 Delta spent ~$270 million to buy and retrofit an oil refinery. To understand why it's important to see just how much the price of fuel matters to Delta. Airlines are an industry whose profits are notoriously sensitive to oil prices because they make up such a large portion of their cost structure. In 2010, Delta spent $8.9 billion on fuel. In 2011, that number was up to a staggering $11.8 billion. In 2012, even after reducing the amount of jet fuel it was using, the carrier’s fuel bill totaled $12.2 billion– or 36% of the airline’s total operating expense.

Traditionally some airlines have attempted to hedge their exposure to price swings by locking in guaranteed prices for the year instead of purchasing jet fuel on the open market. In 2008, Southwest hedged 70% of its fuel costs with oil at $51/barrel (meaning that they locked in that price for the duration of the hedge). Oil peaked in the summer of 2008 at $147/barrel and, while other carriers were focused on sizing down their operations, Southwest was able to expand into new markets thanks to its lower fuel costs.

Airline hedging strategies have changed over the last decade as fuel costs have gone up and down but in 2011 Delta paid, on average $3.10 per gallon of fuel vs. American’s price of $2.93, and United’s $2.87. Southwest's fuel hedging strategy backfired amidst a downturn in oil prices that year but it still managed to pay slightly less than Delta: $3.09 a gallon. It was amidst this backdrop that $270 million ($120 million to purchase the site and an addition to $150 million on retrofits and upgrades) to buy a mothballed oil refinery in Pennsylvania.

Delta wanted to use the refinery "as a physical hedge against fluctuating and potentially devastatingly high oil prices. The airline’s thinking was that by producing itself a sizeable percentage of the jet fuel the airline would be buying on the market, it could shield itself from the violent up and down swings in the per gallon price and from the periodic supply shortages [for kerosene jet fuel] that tended to drive big price spikes." And while it did offer some modest cost savings for Delta it also resulted in lower fuel prices across the entire industry, meaning that other airlines benefited from Delta's investment as well.

Ultimately the refinery ended up being a cost center instead of a cost saver for the company and in 2016 Delta had to switch to producing normal fuel products instead of jet fuel in order to cut costs and keep the refinery from losing even more money than it was (~$100 million a year). They've been trying to divest the refinery since 2018 but haven't yet found a partner willing to buy or operate the plant.

In Other Words

Fuel is the largest variable cost that airlines have, often comprising 20-30% of their total operating expenses. Some airlines (particularly Southwest in the US) hedge oil price volatility by purchasing options to stabilize the price of fuel for the year. Delta decided to go one step further and buy a refinery in order to produce its own jet fuel and not be reliant on the whims of producers in the market. Unfortunately, this ultimately proved unprofitable for them and they are now seeking to get rid of the refinery.

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Why does Credit Suisse pay its executives in risk?

In 2008 amidst the panic of the financial crisis Credit Suisse decided to pay their senior executives bonuses in the form of junk grade loans and commercial mortgage-backed bonds. This allowed them to maintain bonus levels at a time other banks were slashing theirs (bonuses often comprise 40%+ of a bankers total compensation for the year) while simultaneously offloading over $5 billion of their riskiest assets off the bank's books. By 2012 those assets had gone up 75% making the idea of the toxic asset bonus pool a success.

In 2011 Credit Suisse announced that a portion of bonuses would be paid in a similar manner (bonds backed by derivatives linked to the performance of assets that the bank held). In the words of then CEO Brady Dougan, "We are trying to strike the right balance and align employees with shareholders. It’s a risk transfer from the firm to employees." By structuring bonuses in this way Credit Suisse made it so that a portion of its bankers compensation was tied directly to the long term performance of the assets the bankers were putting onto Credit Suisse's balance sheet. Because the bonuses were in the form of bonds linked to the performance of the bank’s assets that paid out over time, bankers had a much stronger incentive to choose assets that would perform well over the long term instead of riskier assets that just did well in the short term. Thus this facilitated an alignment between the bank’s interests and its employees and this innovative bonus structure has been copied by other banks who are keen to align incentives in a similar way.

In Other Words

During the 2008 financial crisis Credit Suisse needed cash to pay bonus and also needed to quickly offload risky toxic assets from its books. It came up with a scheme whereby it paid senior executive bonuses with the returns from those toxic assets and it proved to be very successful. in 2011 they implemented a similar program where bonuses were paid partially on the performance of the assets on the banks books, which served to incentivize bankers to ensure that the assets performed well over the long term and weren't unduly risky (since their bonus payouts would be affected negatively if the underlying assets defaulted).

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That’s all for this week. Thanks for making it this far and I hope you found these answers as interesting to read as I found them interesting to write. If you liked what you read feel free to share it with someone who you think will enjoy this type of content.

As always,

Roosh → You

Angel Indexing (2 min)

Product Placements (2 min)

Contemporary Acronyms (1 min)

Can an index fund of startups perform better than a traditional VC portfolio?

"The best-performing 4% of listed companies explain the net gain for the entire US stock market since 1926 (as other stocks collectively matched Treasury bills)”

This statement perfectly encapsulates the rationale behind the rejection of active management and stock picking that we have seen in the last couple of decades. As Vanguard and BlackRock have become household names, active management has taken a backseat to index funds and robo-advisors. But why stop with equities in the public market?

A paper by Abraham Othman, head of data science at AngelList, suggests that when it comes to seed rounds investing in every deal is the best strategy possible. According to him: "Investors increase their expected return by indexing as broadly as possible at the seed stage (i.e., by putting money into every credible deal) because any selective policy for seed-stage investing—absent perfect foresight—will eventually be outperformed by an indexing approach." In other words, "If you miss the best-performing seed investment, you will eventually be outperformed by someone who blindly invests in every credible deal".

Abraham reached this conclusion by showing that the returns of a single hyper-successful startup investment can be greater than the sum of returns from all other investments. From the graphic above, missing Uber's seed round investment alone would have cost you ~$2.5 billion in expected returns. Of course, knowing what to invest in is only half the battle. Actually getting access to every deal (deal flow) is difficult for even the best VC's to accomplish making this strategy very difficult to successfully implement.

In Other Words

In the realm of seed stage investing the single highest returning investment performs so much better than the average that not investing in it has been shown to produce a lower expected return on capital no matter which other companies you choose to invest in. Thus we can conclude that investing in every credible seed stage company will yield a better return than actually choosing between specific companies.

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How does product placement in the entertainment industry work?

Contrary to popular belief box office revenues and pay-per-view sales are not the only way that production studios recoup their costs. Paid product placements have existed nearly as long as the cinema industry itself. The silent film Wings (1927) was one of the first films to have a confirmed product placement (it prominently featured Hershey's chocolate bars). Since then product placement has become a lucractive source production companies have leveraged to generate significant amounts of revenue.

As far back as 1999, MGM sold a record "$100 million worth of placements in The World is Not Enough to such brands as BMW, Bollinger, Turnbull & Asser, Smirnoff, Omega, Motorola, Electronic Arts, Microsoft, Caterpillar, and, Heineken".

In 2012, Heineken paid a reported $45 million for a placement in the movie Skyfall. With a deal of this magnitude, not all of the money goes directly into the production budget of the movie. In addition to a scene in the movie where Bond chooses a beer over his signature cocktail, the deal also included: a 30-second commercial starring Daniel Craig as James Bond and a branded web game featuring Craig and co-star Bérénice Marlohe.

Some portion of the money is also earmarked for cross-promotion where Skyfall benefits from the millions that Heineken spends on beer ads that also mentions the film. Skyfall wasn’t the first movie in which Bond changed his drinking habits at the behest of an eager advertiser. Over the years Bond has been seen on screen imbibing on various drinks including Red Stripe beer, Smirnoff, Absolut, and Stolichnaya vodkas, and Macallan whiskey.

Moving on from the Bond franchise, the 2002 film Minority Report sold almost $20 million in placements. "Toyota paid $5 million to get a futuristic Lexus called the Mag-Lev in Minority Report. Nokia shelled out $2 million for the characters to wear Nokia headsets." Other smaller deals with Gap, Pepsi, American Express, Reebok, and more accounted for another $13 million in advertisements across the movie.

Harley Davidson paid a reported $10 million for Black Widow to ride their electric LiveWire bike in Avengers: Age of Ultron.

Product placement doesn't always involve money changing hands. Netflix rarely accepts cash payment for the products featured in their original films and tv shows. Most of the appearances seen in their content are organic and decisions made by the writers/directors. Their focus is on taking advantage of organic placements to initiate broader advertising campaigns to drive awareness. In the picture above New Coke from the 80’s is prominently featured and last year Coca-Cola ran a promotion where they brought back a limited run of the original formula New Coke to take advantage of the buzz that Stranger Things (pictured above) had generated.

In Other Words

Product placement has existed nearly as long as the cinema industry itself. Movie studios have taken in upwards of $100 million in some cases for featuring a long list of brands prominently in their films. Deals often include other perks such as co-branded commercials and product tie-ins. Netflix is famous for not directly accepting payment for the products that are featured in their original content but they do leverage the placements with broader advertising campaigns from brands (such as the reintroduction of New Coke in 2019).

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What do the terms HENRY, CATS, DINK & FIRE refer to?

HENRY is an acronym popular amongst fintech companies which refers to High Earner, Not Rich Yet. Companies such as Chase (Sapphire Reserve) and Goldman Sachs (Marcus and Clarity) have invested heavily to target HENRY's in the belief that they'll be future customers for other more lucrative services both companies offer.

CATS is an acronym that the company Masterclass uses to refer it's target customers: curious, aspiring 30-somethings. According to The Atlantic, "CATS are old enough not to be planning to return to school but young enough that they need help advancing in their career. They’re anxious about their future, their present, and their position relative to that of their peers". So, next time you see an ad for Masterclass in your feed just know that their marketing team thinks very highly of you.

DINK is an acronym from personal finance circles and it refers to Dual Income, No Kids. This represents a couple who are both working professionals but without the associated expenses and time commitment of children. Generally, this is seen as an enviable advantage from the perspective of those looking to reach FIRE (Financially Independent, Retire Early) early in their lives. Sites like the FinancialSamurai, Mr Money Mustache, and reddit communities (FIRE) have sprung up in service of the growing number of people who self-identify with these terms.

In Other Words

HENRY: High Earner, Not Rich Yet

CATS: Curious, Aspiring 30-Somethings

DINK: Dual Income, No Kids

FIRE: Financially Independent, Retire Early

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That’s all for this week. Thanks for making it this far and I hope you found these answers as interesting to read as I found them interesting to write. If you liked what you read feel free to share it with someone who you think will enjoy this type of content.

As always,

Roosh → You

World's First Cyber Attack (1 min)

Income Share Agreements (2 min)

The Waffle House Index (1 min)

When was the world's first cyber attack?

Starting in 1789 Napoleon constructed a nationwide semaphore telegraph system that cut the time taken for messages to be transmitted between Paris and the outer fringes of the country from 3-4 days to 3-4 hours. This system (which pre-dated the electric telegraph) functioned by having a string of stations within line of sight of each other stretching across the entire country. Each station housed an operator whose job it was to watch the station ahead of them with a telescope and re-transmit messages they saw using a system of pulleys and wooden beams. In this way, information was efficiently transmitted over vast distances.

However, in 1834 two enterprising bond traders in France realized that this network could be subverted for other purposes as well. The Blanc brothers knew that if they could transmit information about the days price movements from Paris to other parts of the country faster than the information arbitrageurs of their time (who were focused on trying to find better carrier pigeons and horses) that they'd be able to make a lot of money. So they bribed two telegraph operators to insert errors into the sequences they transmitted which would allow their accomplices in other parts of the country to know whether the market had gone up or down for the day. For two years their scheme proved profitable until they were discovered by the government and tried for their crimes.

Luckily for the Blanc brothers, the telegraph was so new that there was no law against what they had done and they were allowed to keep both their freedom and their gains.

In Other Words

Napoleon constructed a nationwide human-operated semaphore telegraph which allowed information to be transmitted across the entire country in hours but limited its usage to governmental and military purposes. Two bond trading brothers realized they could make money by being the first to know about price movements in Paris and bribed two telegraph operators to encode information on bond prices in their messages. After two years they were caught but escaped conviction because there was no law against their actions since the telegraph system was so new.

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What are Income Share Agreements and how are they being used today?

Income share agreements (ISAs) are a method of financing that allow someone to forgo future income in return for benefits now. Many coding bootcamps such as Flatiron School and Lambda School offer them to their students. Schools like this allow a student to get a free (or close to free) education with the promise to pay back a certain percentage (10-20%) of their income when they land a job for a specified period of time (1-4 years).

ISAs for students seem to be a great alternative to traditional student debt. There is a strong incentive for the school to train each student to be able to get a high paying job so that the school can make more money from the student. This aligns the student and the school's incentives quite nicely.

However, recently there has been some turmoil with one of the main providers of ISAs (Lambda School). It emerged that they were actually securitizing the cash flows from the ISAs they had gathered and sold them to hedge funds and PE investors. Essentially this means they were getting paid upfront (instead of collecting revenue over time from the student's paycheck) and allowing these hedge funds to collect the "future income" from the students instead.

From the perspective of Lambda School, this makes a lot of sense. They are trading future income for cash now which they can deploy to expand their school and service more students. The hedge funds are getting a nice premium with steady cash flow and are protected from the risk of any single student defaulting by owning a portion of the cash flow from all students in a "cohort" (If this sounds familiar it's because it's also how banks package and sell mortgage-backed securities.

Abstractly there's nothing wrong with trading future income for cash now, especially in such a capital intense business with long payback periods. But there is some truth to the idea that there now exists a weaker correlation between Lambda Schools' educational quality and their bottom line. After all, Lambda School is now getting paid upfront (and therefore before their students have even gotten a job) which means that the clearest predictor of revenue will now be the number of students they are able to graduate instead of the income level of the jobs their students get. (Admittedly the income level still matters because investors won't be interested in buying the income from their students if their performance is weak but that data will take years to surface). After much uproar, Lambda School backtracked and came up with a more complicated financing scheme that ensures they still have skin in the game (their revenue still depends on students' performance) while allowing them to keep selling the ISAs to investors.

Interestingly, ISAs are spreading beyond student debt. Athletes have gotten into the game as well. In 2014 Vernon Davis, a tight end in the NFL, listed 10% of his future income for $4 Million with a now defunct platform called Fantax. In baseball, Minor league players are now joining what they call an "income pool" where if anyone in the pool makes it to the majors they would pay back 10% of their salary (on any income above $1.6 million) to their poolmates.

It's early days yet for these innovative financing schemes. There's even a startup that allows you to exchange equity with other startup founders in the same vertical as you. And another one where you can actually IPO yourself and invest in other people (And yes, I have invested in a few people on the platform). We've yet to see the full effect of how innovative financing schemes will affect our society but I'm quite bullish on what's possible given what we've seen so far.

In Other Words

Income share agreements are a way for schools to align their incentives to their students by ensuring they only get paid if their students find high paying jobs after graduation. One school (Lambda School) was recently found to have been selling the future income of their students at graduation instead of waiting to collect the income over time which caused many people to question how effective the incentive alignment ISAs are lauded for is. Athletes have also used ISAs as a way to hedge against injury or to pool risk and potential for success since so few make it to the elite level.

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What is the Waffle House Index?

After a natural disaster in the United States, the Federal Emergency Management Administration (FEMA) steps in to assess the damage and to disburse aid and supplies. One of the informal metrics they use to determine how badly an area has been hit (and later how well it is recovering) is to take stock of which Waffle House stores in the region are still operational. Over the years disaster specialists have taken to calling this the "Waffle House Index" and it's proven to be remarkably accurate at predicting where the worst damage has occurred.

This works because Waffle House is famous for not shutting down even amidst conditions that would dissuade the hardiest of businesses. They even have menus available for different disaster situations at all their stores:

The waffle house index isn't the most scientific of indices but that doesn’t diminish its usefulness in disaster situations.

In Other Words

FEMA uses the Waffle House Index as an informal metric to judge disaster severity and recovery across the United States. A system based on the menu and items being served allows them to see at a glance which parts of the country have power, supply lines, and guage general economic activity.

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That’s all for this week. Thanks for making it this far and I hope you found these answers as interesting to read as I found them interesting to write. If you liked what you read feel free to share it with someone who you think will enjoy this type of content.

As always,

Roosh → You

IPO Pops (1 min)

Dutch Auctions (2 min)

How to Steal an Election (2 min)

Why is there usually an "IPO pop" when a company goes public?

When a company decides to go public it starts by hiring banks to act as underwriters. The chosen underwriting banks will try to determine a fair price for the company and then pitch and sell shares to institutional investors who commit to buying large chunks of the impending share issuance. On average institutional investors get a price per share 13-15% below what the opening price of the stock ends up being (and often the discrepancy is much higher). This is known as the "IPO pop".

The company wants to maximize its windfall from selling shares and wants to make sure that their underwriters are not pricing their shares too low (which would be demonstrated by a higher IPO pop on opening day). Meanwhile, the institutional investors who the underwriters are pitching to before the IPO want the lowest price possible so that they can see their shares rise in value once they're publicly available.

The underwriters are ostensibly clients of the company they are representing but in practice there's an incentive misalignment between the two. The underwriters are only ever going to take this specific company public once. However, they are constantly pitching new companies to the same groups of institutional investors. In essence they are playing a repeat game with these institutional investors where it's beneficial for both sides for there to be an "IPO pop" since the investors make money and the underwriters have an easy outlet to sell shares to for future companies they represent.

Thanks to Matt Levine's ever-insightful writing for being the source of the dynamic between underwriters and companies.

In Other Words

Underwriters hired by a company that wants to IPO have a strong incentive to underprice company shares to ensure that their "real" customers, the institutional investors they sell too, lock in a profit when the newly issued shares debut. This is because underwriters only ever IPO a company once while they are continuously pitching shares to the same groups of institutional investors and therefore need to foster good relationships with them to ensure a continued source of demand for future IPO issuances.

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What can be done to reduce the amount of capital that companies forgo due to the "IPO pop"?

Many market observers have lamented the fact that IPOs leave so much money on the table for the companies going public. The average IPO pop (price above IPO that newly public companies trade at) is 13-15% but it is often higher for certain industries like tech. A large IPO pop means, "[that] the company could have sold its shares for a higher price and raised more money". To take a recent example, Lemonade IPO'd at $29 (raising $319 million) and its share price opened at $50 before closing at $69 on its debut day. Clearly there was demand for their shares at a price far in excess of what their bankers were able to secure. Had Lemonade been able to price according to the true demand demonstrated on opening day they could have raised anywhere between $550-750 million. Instead that change in value accrued to its shareholders (including the institutional investors who bought in during the IPO process at $29).

But IPOs don't have to be run in the traditional way. In fact, Google's IPO in 2004 is a great example of how a company can IPO and still capture a lot of the value for themselves (at least in theory). Instead of going through the traditional IPO process, Google borrowed a method of price discovery they used in their ad business called a dutch auction.

Google allowed anyone to bid on the number of shares they would be committing to buy as well as the price that they would be willing to pay. After everyone had submitted their bids Google set the price of their shares at the highest price that would still result in all shares in the offering being sold (known as the market-clearing price).

Let's say you want to sell 50 shares in an IPO and you have 3 bidders. Alice bids $100 a share for 25 shares, Bob bids $80 for the same number, and Charlie bids $120 again for the same number. In the dutch auction process, Alice and Charlie would be allocated 25 shares each at $100. Both Alice and Charlie pay $100 because this is the market-clearing price (the lowest price at which all 50 shares are sold).

In Google's case, they were targeting a price range of $108 to $135 but the week before the IPO many of the institutional investors who had agreed to "bid" on shares at these price levels instead mysteriously opted to resubmit their bids at $85. (see here for speculation on why) This meant that Google opened at $85 and promptly experienced an IPO pop sending it above $100 on opening day (meaning they failed to capture all of the upside that was technically available to them since they failed to properly price their IPO). Although Google might not have been able to shift the way IPOs were conducted, they at least proved that the dutch auction system was a viable alternative to traditional opaque IPO pricing.

In Other Words

Recently companies have been exploring alternatives to the IPO process because they typically leave money on the table through underpricing of their shares and high banker fees. Google attempted to solve this problem in 2004 using a process borrowed from its advertising unit called the Dutch Auction. However, it too ended up leaving money on the table because its stock promptly shot up 18% on opening day, indicating that it was not able to successfully achieve true price discovery.

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What are the methods countries and candidates use to sway elections across the world?

Seymour Hersh, a former reporter for the Washington Post, talks about his experience with elections in the Middle East in his autobiography Reporter: "[Nasrallah, the leader of Hezbollah in Lebanon] also assured me that the Iraqi opposition would win control of the Iraqi parliament in the 2005 election there... Predicting an election victory was one thing, but Nasrallah's prediction came within one-tenth of a point of the winning margin. I concluded there was much we Americans did not know about fixing elections". The fact that a leader of a neighboring country was able to demonstrate foreknowledge of the election outcome to such a degree speaks volumes about the value of the elections being held in Iraq at the time.

The EIU Democracy Index defines hybrid democracies as those "with regular electoral frauds, preventing them from being fair and free democrac[ies]" and as of 2019, it counts 37 different countries in this category. However, not all election fraud is created equally. There exists a wide middle ground between brazenly fixing an election (see above or Egypt) and trying to subtly (and sometimes not so subtly) influence public opinion through the use of social media or more terrestrial means.

In 2016 Bloomberg interviewed a former political operative named Andrés Sepúlvada who divulged, "My job was to do actions of dirty war and psychological operations, black propaganda, rumors—the whole dark side of politics that nobody knows exists but everyone can see. When the candidates’ teams prepared policy speeches, Sepúlveda had the details as soon as a speechwriter’s fingers hit the keyboard. Sepúlveda saw the opponents’ upcoming meetings and campaign schedules before their own teams did."

Hacking into candidates and their strategist’s phones and emails wasn't even about getting ahead, sometimes it was just evening the playing field. As another former political consultant in the article says, "It goes with the trade in Latin America: Having a phone hacked by the opposition is not a novelty. When I work on a campaign, the assumption is that everything I talk about on the phone will be heard by the opponents."

Beyond hacking for information or donor lists the other major goal Sepúlvada outlined was finding creative ways to suppress turnout for the opposition. "On election night, he had computers call tens of thousands of voters with prerecorded phone messages at 3 a.m. in the critical swing state of Jalisco. The calls appeared to come from the campaign of popular left-wing gubernatorial candidate Enrique Alfaro Ramírez. That angered voters—that was the point—and Alfaro lost by a slim margin."

Of course, these techniques aren't unique to the political atmosphere in Latin America. Often associated with African elections, turning off the internet helps mask accusations of electoral fraud, prevent dissidents from gathering together, and helps keep the opposition in check. In 2019 alone, "Algeria, Burundi, Democratic Republic of Congo, Eritrea, Ethiopia, Gabon, the Gambia, Uganda, and Zimbabwe have all shut down domestic access to the internet during elections".

It would appear that Hersh was right when he said that there is much we have to learn about fixing elections in America.

In Other Words

Influencing and hacking an election spans a wide variety of outcomes such as disinformation and social media influence campaigns, hacking of candidates phones/emails and donor lists, sophisticated voter suppression techniques, turning off the internet to prevent the spread of information and communication, to finally just fixing the election results and calling it a day. It would appear that many countries are democracies in name alone.

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That’s all for this week. Thanks for making it this far and I hope you found these answers as interesting to read as I found them interesting to write.

As always,
Roosh → You

Analyzing Amazon's CAC (2 min)

Netflix's Membership Auto-Cancellation (2 min)

How did ancient humans invent a concept as abstract as financial interest?

The answer likely lies in linguistic clues left by past civilizations. The Ancient Greek word for interest, tokos, refers to the offspring of cattle. The Latin word, pecus, or flock is the root word for pecuniary. The Sumerian word, mash, is a term for calves. The Egyptian word for interest, ms, means "to give birth".

Taken together these terms suggest that the origin of the concept comes from the natural population growth that animals experience. You can almost imagine an ancient Sumerian realizing that he should be getting back more than the 5 cattle he lent out last year since those 5 cattle now number 5 cattle and 2 calves.

In Other Words

The etymology of the word interest comes from a concept related to animals giving birth. The theory is that if you lent an animal or group of animals out for a year you'd come back to find those animals had reproduced and as the original owner it would make sense that you were entitled to more animals then you originally had lent, and thus interest was born.

Source: Money Changes Everything: How Finance Made Civilization Possible by William Goetzmann

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Why does Amazon spend $5 billion a year on Prime Video?

For Amazon it all comes down to customer acquisition and increasing the pool of Prime subscribers. Bezos himself said, "When we win a Golden Globe, it helps us sell more shoes". In fact, in leaked documents cited by this Reuters story (worth the read), "Amazon calculated [The Man in the High Castle] drew new Prime members at an average cost of $63 per subscriber". And this is great for Amazon since the average Amazon customer spends about $600 a year on the site (and the average Prime member spends $1400). Prime video doesn't exist because Amazon thinks it can compete and take market share from Netflix. Prime Video is primarily a route to lowering CAC (Customer Acquisition Cost). This is made more explicit by a metric that Amazon designed called "cost per first stream" which is a factor in program renewal decisions. Essentially they've taken the cost of a production and marketing for their shows and divided it by the number of people who stream that program first after signing up for the service to determine how many prime memberships the show has driven. More informally, "Amazon looked at who was watching a given show and saw how much that person was using Prime for other perks, mainly free shipping. If a Prime subscriber watched a show a lot and wasn’t taking advantage of Prime’s other benefits, the show got credit for that customer’s subscription dollars".

Interestingly if you look at their affiliate commission tables you'll find that driving a new Prime Video trial is worth 2/3 as much as an equivalent trial for Prime Music which seems to suggest that the stickiness of Prime Video is poor compared to Prime Music (which is a topic we'll return to in the next question surrounding Netflix).

In Other Words

Prime Video is a way to decrease CAC for full-fledged prime memberships. Amazon judges shows by an internal metric cost per first stream which divides total cost of the show by the number of people who stream that show first after signing up for the service to determine how many prime memberships the program has driven.

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Why did Netflix decide to auto-cancel members who haven't been using their service?

On May 21st Netflix posted the following article on their blog which got quite a bit of media attention. In it Netflix stated that they will auto-cancel memberships of those who do not respond to an email that will be sent out after 1 and 2 years of inactivity (defined as not having used the service in that time period).

According to their 2019 annual report, Netflix sees ~$11 in revenue per user/month which means that if this move costs them 300k subscribers then that'll be a cost of ~$39.6M in the first year (and a much smaller cost going forward) which when juxtaposed against their 2019 revenue ($20 billion) means that this decision will have little first order economic impact on the company.

I think there are two dimensions along which we can analyze Netflix's decision. The first has to do with market saturation.

Netflix currently has 72.9M subscribers in the U.S. There are only ~128M households in the U.S. which means Netflix's growth in its home market can no longer be fully supported by finding new customers. Instead an increasingly important lever for growth in their mature markets will be from reactivations of lapsed subscribers. Viewed from the lens of improving the relationship with subscribers who haven't yet found value/utility from their platform this is a shrewd move, especially when it comes at such a low relative cost.

But this isn't the whole story. There are two undisputed truths in the streaming landscape today. One is that companies in this space have abysmal levels of churn. Hulu, HBO, and Netflix all struggle with getting people to stay subscribed on the platform. But while everyone struggles, Netflix is clearly better at retention (and this lead is even more pronounced when you look at three year retention data) which strongly suggests that they also have less inactive accounts (as a percentage of total accounts).

Netflix understands that if they can pressure other streaming services to adopt a similar pro-consumer cancellation policy that the rest of the industry will suffer much more then they will. This combined with the fact that they are bumping up against the limits of new subscriber growth in the U.S. have led them to take a strong stance on cancellation that while immaterial to their bottom line might reflect badly on other public companies who would see a much larger dip in net subscriber additions should they be forced to implement a similar measure.

In Other Words

The decision costs Netflix a pittance (39M vs 20B 2019 revenue) and helps with two strategic aims. The first is that as they saturate the U.S. market growth increasingly comes from reactivations of lapsed subscribers and this move helps keep that relationship positive. The second is that they are the best at retention (and thus have lower churn than other services) and this puts pressure on other streaming services to adopt similar behavior at what they assume will be higher costs.

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That’s all for this week. Thanks for making it this far and I hope you found these answers as interesting to read as I found them interesting to write.

As always,
Roosh → You