5 ms·

> turning risk into money is what a company, any company, does. I must say that's one of the most unorthodox description of what a company does I've seen. How

> turning risk into money is what a company, any company, does. I must say that's one of the most unorthodox description of what a company does I've seen. How is a bread factory or a plumber "turning risk into money"? It sounds like you're describing an insurance company or a bank, not, you know a company like Google who produces free software & services to billions of people in exchange for monetizing their attention. Focusing on risk mitigation in a company is explicitly optimizing for protecting existing income stream at the expense of innovation, customers, and new income streams. It's not what "any company does": it's what uninspired companies who have lost their ways focus on. It sounds like what a consultant used to "financialize" everything would say to solve Google's problems and slowly turn it into an intangible conglomerate like GE who is just the shadow of its previous self. But maybe this time has arrived for Google?

maxfurman 4y ago
A bread factory takes on risk by holding the ingredients for bread (which might expire, and cost money to store), paying bakers to make the bread (who might get sick or do a bad job), and on and on. It takes on and manages these risks, and if it is successful it makes enough bread to turn a profit and if not it goes out of business.
- nwiswell 4y ago
  That's kind of absurd as a construction. It may be literally true that a bread factory accepts various kinds of risk in the ordinary course of business, but it's plainly not the primary reason that a bread factory turns a profit. Does a bread factory that hedges its future wheat purchases with wheat futures have a lower expectation profit than one which does not? You can think about arbitrarily risk-neutral enterprises that are profitable. For example, what risk is a residential REIT taking, especially one whose properties are all insured? By contrast, you can look at a business like a casino (or a catastrophe reinsurer), where it is legitimately the case that operating income is predominantly the result of risk-taking. But when you put the two side by side, there is not a huge difference in ROIC (Return on Invested Capital), which you might've expected if profits were fundamentally a risk premium.
  - aetherson 4y ago
    Your question about what futures is weird. Yes? It does have a lower expected profit? But a mitigation of downside risk. You seem to think the answer is "no."
    - nwiswell 4y ago
      That's because the answer is 'no', unless there's an underlying reason to expect that the expectation price of wheat will be less in the future. The only impact to profits is the actual transaction cost of the wheat futures, which is de minimis.
      - aetherson 4y ago
        Since this is what you think, you should definitely go into some kind of real inventory heavy business and use futures to hedge against all your inputs going up in price. It'll be a real competitive advantage for you, since you seem to think it's all upside.
        nwiswell 4y ago
        A lot of businesses actually do hedge their inputs, this is not a crazy idea I've just come up with. For some industries it's de rigeur (jewelers typically hedge even the value of their inventory and WIP), in others it seems to be a matter of preference (jet fuel for airlines). That's perhaps the single biggest justifying reason for the existence of commodity futures in the first place -- because producers and consumers want to reduce price risk. Agreeing on a fixed future price achieves that goal for both parties. Why would either the producer or the consumer need to pay anything to reach such an agreement? Why would it reduce expectation profits for either party? The futures markets simply provide a low-friction venue.
        aetherson 4y ago
        I agree that lots of businesses do hedge their inputs! Just as lots of people buy insurance. Reducing catastrophic downside risk of something is indeed worth a loss of expected value. But insurance has negative expected value, just like hedging their inputs. If you believe that it's costless or near-costless to hedge your inputs, you should do it literally everywhere to everything that you possibly can, and anyone who doesn't is just leaving money on the ground for you to pick up. And while lots of businesses do hedge their inputs to some degree, it is not the case that everyone does it to the maximal possible extent.
- WalterBright 4y ago
  This and the responses should be required reading for all the folks who claim that the free market requires perfect information. Well done!
  - baq 4y ago
    Efficient markets require perfect information. Free market is nowhere near efficient.
    - WalterBright 4y ago
      > Efficient markets require perfect information No, they don't. I'm wondering where people get these ideas.
      - baq 4y ago
        From the definition, if you squint a bit at 'perfect'.
        WalterBright 4y ago
        Making up your own definitions of things is creating a strawman.
- mochomocha 4y ago
  I do not disagree with you, but that's exactly what the author of the blog post emphasizes: focusing on the "risk -> money" is an example of missing the forest for the trees. It's not the company raison d'être (unless you're talking about an insurance), you're just summarizing how a company operates under a very specific lens, the same way you could describe a company as something converting paycheks into human labor. A company makes products satisfying customers: that is its core purpose. Focusing on the process instead of the product is exactly why mega-corporations fail, which was the main point of the blog post.
nostrademons 4y ago
The bread factory and plumber turn a little bit of risk into a little bit of money. A company like Google or Goldman Sachs turns a lot of risk into a lot of money, if they manage the risk so it pans out, or a lot of risk into losing a lot of money otherwise. GP's description is actually quite astute. The legal concept of a "corporation" exists solely to pool risk and limit downside; it originally came from shipping voyages in the early age of colonialism, where a significant portion of vessels simply sank with all hands, but one successful voyage would make everyone involved wealthy beyond belief. Basically every business endeavor you do involves some risk, because the future is unknowable. The plumber might fall into the sewers and drown, the bread factory might be contaminated with E-coli and get shut down by public health after getting sued by all the customers it got sick. But certain endeavors, the ones like the plumber or the bread factory, have largely been studied, systematized, and structured to maximize the chance of success. These are low risk, but they're also low reward, because low risk invites lots of competitors. Other endeavors like writing complex software systems or predicting financial markets fail all the time, and that's why succeeding at them is so lucrative.
- kortilla 4y ago
  No, this falsely equivocates risk with innovation and just regular opportunity. It’s not a given that low risk with low innovation required will have high competition. This is especially true the smaller the market. On the other end of the spectrum, there are very high risk businesses with no innovation and stiff competition (e.g. dealing illegal drugs). Your argument is just about investment diversity, not about the purpose of a company.
  - thworp 4y ago
    > On the other end of the spectrum, there are very high risk businesses with no innovation and stiff competition (e.g. dealing illegal drugs). This made me laugh out loud. I'd say drug dealing is one of the most innovative businesses around. At the high level, cartels are constantly inventing new methods of smuggling and money laundering. At a low level, dealers were first adopters for text messengers, crypto messengers, cryptocurrency marketplaces etc. I'd say this makes them more innovative than most startups (who often just re-invent traditional business but done online). Dealers even make profits!
baq 4y ago
This is basic economics. Taking on risk in expectation of a reward sometimes pays money, sometimes risk becomes realized and you lose money. This applies to Google and your plumber in the same way.

maxfurman 4y ago

A bread factory takes on risk by holding the ingredients for bread (which might expire, and cost money to store), paying bakers to make the bread (who might get sick or do a bad job), and on and on. It takes on and manages these risks, and if it is successful it makes enough bread to turn a profit and if not it goes out of business.

nwiswell 4y ago
That's kind of absurd as a construction. It may be literally true that a bread factory accepts various kinds of risk in the ordinary course of business, but it's plainly not the primary reason that a bread factory turns a profit. Does a bread factory that hedges its future wheat purchases with wheat futures have a lower expectation profit than one which does not? You can think about arbitrarily risk-neutral enterprises that are profitable. For example, what risk is a residential REIT taking, especially one whose properties are all insured? By contrast, you can look at a business like a casino (or a catastrophe reinsurer), where it is legitimately the case that operating income is predominantly the result of risk-taking. But when you put the two side by side, there is not a huge difference in ROIC (Return on Invested Capital), which you might've expected if profits were fundamentally a risk premium.
- aetherson 4y ago
  Your question about what futures is weird. Yes? It does have a lower expected profit? But a mitigation of downside risk. You seem to think the answer is "no."
  - nwiswell 4y ago
    That's because the answer is 'no', unless there's an underlying reason to expect that the expectation price of wheat will be less in the future. The only impact to profits is the actual transaction cost of the wheat futures, which is de minimis.
    - aetherson 4y ago
      Since this is what you think, you should definitely go into some kind of real inventory heavy business and use futures to hedge against all your inputs going up in price. It'll be a real competitive advantage for you, since you seem to think it's all upside.
      - nwiswell 4y ago
        A lot of businesses actually do hedge their inputs, this is not a crazy idea I've just come up with. For some industries it's de rigeur (jewelers typically hedge even the value of their inventory and WIP), in others it seems to be a matter of preference (jet fuel for airlines). That's perhaps the single biggest justifying reason for the existence of commodity futures in the first place -- because producers and consumers want to reduce price risk. Agreeing on a fixed future price achieves that goal for both parties. Why would either the producer or the consumer need to pay anything to reach such an agreement? Why would it reduce expectation profits for either party? The futures markets simply provide a low-friction venue.
        aetherson 4y ago
        I agree that lots of businesses do hedge their inputs! Just as lots of people buy insurance. Reducing catastrophic downside risk of something is indeed worth a loss of expected value. But insurance has negative expected value, just like hedging their inputs. If you believe that it's costless or near-costless to hedge your inputs, you should do it literally everywhere to everything that you possibly can, and anyone who doesn't is just leaving money on the ground for you to pick up. And while lots of businesses do hedge their inputs to some degree, it is not the case that everyone does it to the maximal possible extent.
WalterBright 4y ago
This and the responses should be required reading for all the folks who claim that the free market requires perfect information. Well done!
- baq 4y ago
  Efficient markets require perfect information. Free market is nowhere near efficient.
  - WalterBright 4y ago
    > Efficient markets require perfect information No, they don't. I'm wondering where people get these ideas.
    - baq 4y ago
      From the definition, if you squint a bit at 'perfect'.
      - WalterBright 4y ago
        Making up your own definitions of things is creating a strawman.
mochomocha 4y ago
I do not disagree with you, but that's exactly what the author of the blog post emphasizes: focusing on the "risk -> money" is an example of missing the forest for the trees. It's not the company raison d'être (unless you're talking about an insurance), you're just summarizing how a company operates under a very specific lens, the same way you could describe a company as something converting paycheks into human labor. A company makes products satisfying customers: that is its core purpose. Focusing on the process instead of the product is exactly why mega-corporations fail, which was the main point of the blog post.

nostrademons 4y ago

The bread factory and plumber turn a little bit of risk into a little bit of money. A company like Google or Goldman Sachs turns a lot of risk into a lot of money, if they manage the risk so it pans out, or a lot of risk into losing a lot of money otherwise. GP's description is actually quite astute. The legal concept of a "corporation" exists solely to pool risk and limit downside; it originally came from shipping voyages in the early age of colonialism, where a significant portion of vessels simply sank with all hands, but one successful voyage would make everyone involved wealthy beyond belief. Basically every business endeavor you do involves some risk, because the future is unknowable. The plumber might fall into the sewers and drown, the bread factory might be contaminated with E-coli and get shut down by public health after getting sued by all the customers it got sick. But certain endeavors, the ones like the plumber or the bread factory, have largely been studied, systematized, and structured to maximize the chance of success. These are low risk, but they're also low reward, because low risk invites lots of competitors. Other endeavors like writing complex software systems or predicting financial markets fail all the time, and that's why succeeding at them is so lucrative.

kortilla 4y ago
No, this falsely equivocates risk with innovation and just regular opportunity. It’s not a given that low risk with low innovation required will have high competition. This is especially true the smaller the market. On the other end of the spectrum, there are very high risk businesses with no innovation and stiff competition (e.g. dealing illegal drugs). Your argument is just about investment diversity, not about the purpose of a company.
- thworp 4y ago
  > On the other end of the spectrum, there are very high risk businesses with no innovation and stiff competition (e.g. dealing illegal drugs). This made me laugh out loud. I'd say drug dealing is one of the most innovative businesses around. At the high level, cartels are constantly inventing new methods of smuggling and money laundering. At a low level, dealers were first adopters for text messengers, crypto messengers, cryptocurrency marketplaces etc. I'd say this makes them more innovative than most startups (who often just re-invent traditional business but done online). Dealers even make profits!

baq 4y ago

This is basic economics. Taking on risk in expectation of a reward sometimes pays money, sometimes risk becomes realized and you lose money. This applies to Google and your plumber in the same way.