It's at least twenty years ago that I had a notion: the mathematical and statistical worlds of statistics, mathematics, physics, astronomy, biology and chemistry must have a lot to teach the world of accounting and business. Due to a lack of knowledge of these areas and a lack of time and opportunity to garner such knowledge, I let it lie.
Now, I have been proven prophetic and, I suppose, impotent at the same time. I still know very little of the areas I have just mentioned but articles have appeared over the last twenty years that show how right I was.
For example, I have just read this mini article, officially called a conversation starter, ‘Power curves’: What natural and economic disasters have in common from the McKinsey Quarterly journal. It shows the relationship between frequency and magnitude and so on in terms of power curves. Accountants are wont to use straight lines, with some justification I should add, whilst those of us more gifted can work with power curves, logarithmic curves, exponentials and so on.
Here's one such curve to whet your appetite: the corporate bankruptcy curve
Where X = rank by size of assets; and Y = size of 15 largest US public company bankruptcy filings by assets, 2001 - 2008 in billion real 2000 Dollars
See
http://www.mckinseyquarterly.com/Strategy/Globalization/Power_curves_What_natural_and_economic_disasters_have_in_common_2376 for a much larger version and the whole conversation starter. Forgive me if you need to be a subscriber to the McKinsey site to see this in full ... I am so I never get a message telling me to sign up!
If you can access that page, you can join in the conversation ... one or two very interesting points being made there!
You should also read Using ‘power curves’ to assess industry dynamics. I am pretty sure you need to be a subscriber to read this one. http://www.mckinseyquarterly.com/Using_power_curves_to_assess_industry_dynamics_2222
Gradely as we say in Yorkshire!
DW
I have joined the conversation on the McKinsey site as you will see if you follow my first link in this thread. I made a general point there and then wrote this:
ReplyDeleteAs a follow up to my earlier, general response, I feel it's important to add a few things.
Firstly, I have been using/analysing databases such as the Forbes Global 2000 and the S&P 500 for many years now and the power curve is more than evident in such databases. Many companies form a blob at one end and very few are in isolation at the other end: the power curve.
Secondly, some of what we are seeing here is not really new: Vilfredo Pareto took us there in the middle of the 19th century or so. Pareto or 80:20 or 70:20:10 or even ABC analysis has been with us since then. These power curves demonstrate the Pareto function perfectly.
Thirdly, taking a look at the article Michael Zanini wrote with Lowell L Bryan, "Strategy in an era of global giants" (McKinsey Quarterly Number 4, 2005), I am also reminded of the part that hidden costs might play in some aspects of this conversation. In that article they talk about how one company can grow so much and yet restrain costs/build on profitability. By extension, we can ask how other companies don't do that!
Fourthly, I present many seminars to many business people these days and when I talk about financial and non financial analysis, I always talk about rates of growth or rates of change: Bryan and Zanini talk about this too. Rates of change can be dressed up as first order derivatives (I think!) but I find them so revealing. Taking a five or ten year view of a company via its income statement, for example, is one thing. But taking another view of the same company from the same data but by calculating rates of change and you will see a completely different company as often as not. Try it and see what I mean.
Taking what accountants call ratio analysis one or two steps away from simple ratios is not difficult to do but it is so powerful ... hence, power curves!
Duncan Williamson