ITIL and Economic Value

I just completed ITIL foundations training.  I’ll let you all know later, when I find out, if I passed the test.  [Update: I did.]

What caught my attention most during training is that the ITIL library writers, in my opinion, correctly identified economic value as a combination of both (marginal) utility and warranty (irreversibility).  Somewhere along the line, I/T practitioners discovered what few economists (save for some, like Hernando de Soto Polar) bothered to factor into so many economic formulations: utility is fine, but if the economic actor fails to perceive that their utility is theirs to keep, then the sense of economic value falls.  While property rights (de Soto) alone do not economic value make, they are necessary prerequisites for any functioning economy.  In information technology a service like Google provides great utility, but if it were perceived as an unreliable service its overall economic value would drop through the floor.

Of course, the ITIL “utility + warranty” model is itself a little simplistic.   Max Neef breaks up utility further:

  • affection
  • creation
  • freedom
  • identity
  • leisure
  • participation
  • protection (security, warranty)
  • subsistence
  • understanding

Max Neef provides a nice balance of qualities, certainly, but I feel that protection/security/warranty/irreversibility plays a very specific role in economic transactions because of the way our brains are built.  I believe it remains useful to break out qualities associated with irreversibility (security, protection, warranty) into a separate, analyzable category of study.  For me, ITIL’s “utility + warranty” description of economic value is a great model to use.

The Endowment Effect and Irreversibility

The (disputed) endowment effect in economics is the observed phenomenon where most people tend to value the same thing more once they own it than before they owned it.

This is one example of the cognitive value of irreversibility in economic transactions. The case of the endowment effect is a phenomenon where irreversiblity is sought to be maintained rather than obtained. Interestingly, the endowment effect seems to attenuate with a little education; those who understand that buying prices and selling prices ought to converge are more likely to thwart what otherwise seems like a default bias with human beings.

Human Thermodynamics

Human thermodynamics is a fascinating topic, which might be “unifying” across not only physics but also across economics, history, politics, sociology and human psychology!  Consider “irreversibility” in economics not as a by-product of economic trade, agreement, contract, property rights and general rule of law, but a feature which reduces the cognitive load in the human brain.

What if it turns out we humans are built to seek “cognitive irreversibility”?  What if irreversibility in human affairs is not an epiphenomenon but part of our cognitive goal-seeking repertoire?

I am not certain of the utility of applying thermodynamic analysis to human behavior and economics, and I certainly to not wax ergosophic, but I can certainly see the utility of including “irreversibility-seeking” as a goal to be optimized in game theory.

Update (25 June 2011): The actual work at the web site I consider bull.  The theorists, I believe, do not understand the degree to which they are merely borrowing an analogy.

Transactions, Auctions and Economic Value

An important aspect of any economic transaction is that it represents the conclusion of an auction, however simple, however formal, however significant or trivial its outcome.  “Economic transactions” are the name we give to the human process by which multiple people arbitrate economic value.  The successful conclusion of an economic transaction represents a difficult-to-reversecognitive commitment by the participants to a balance of trade-offs, or economic utility.

Trade-off balancing in real life is not always easy.  You and I know what it is like to “waffle”, to be uncertain about a choice in the face of uncertainty, to fear the impact of difficult decisions.  You and I know what it is like to put off these difficulties, sometimes for the rest of our lives, because we are uncertain which choice would lead to greatest happiness or least pain.  I am sure you know what it is like to stand before two expensive products you like, perhaps two similar automobiles you wish to buy or two homes, and fret over the uncertain of which choice would be best.  The result of a successful economic transaction however is the act of committing to one decision or another, “placing your money where your mouth is” and coming to a decisive conclusion.  Anyone who has ever been in a difficult choice situation should immediately recognize the true value of intellectual commitment in the face of uncertainty.  Without an actual trade between individuals, without committing to a transaction which is difficult to reverse, decisions can waffle forever and die on the vine.  Goods may never be created.  Services never executed.  Resources never harvested.  Precious time in the lives of humans never put to good use.  The commitment aspect of the economic transaction is the root of economic value.

Mathematicians, engineers and computer programmers are painfully familiar with the difficulty of developing machinery to perform trade-off optimization.  While tools such as linear programming have been introduced over time to tackle problems which cannot be solved exactly through methods of strict analysis, we human beings bring our unique capacity of inductive reasoning to bear to perform this work ourselves with amazing efficiency.  While inductive reasoning, value optimization and in fact the very ability to identity values which ought to fall in to any economic trade-off scenario are the lifeblood of human societies and individuals alike, the occurrence of these phenomena are often neglected by the business and even information technology architect.  The reason is, simply, that deductive-analytic exercises are relatively simple to do while inductive exercises are, if not difficult to identify, difficult-to-impossible to describe and analyze.

Difficulty in analysis however is no excuse to ignore sources of true economic value in any architectural description.  After all what is the purpose of any business or I/T architecture other than to create an environment where economic value can be optimized?  At the very least, armed with an understanding of what economic value is, the architect could develop “heat maps” of potential economic value.  Difficulty of analysis can used as an indicator of trade-off difficulty.  Where trade-off decisions are difficult, their potential committed solutions can be sources of some of the greatest economic value in any human collaboration.  This idea is also explored in disciplines such as information economics, business measurement theory and quality attribute theory in information technology.

In future posts I will write about the applicability of the “transaction” metaphor to quantum mechanics, as well as the use of heat maps in risk analysis.

No Deal is Done Until it is Done

There is an old saying in business,

No deal is done until it is done.

This aphorism reflects the observation that any economic transaction is at its highest risk of failure at the time it ought to conclude.  The moment of “closing” is the point at which all relevant information—good or bad—ought be known to all participants.  Of course the information most likely to sink a deal will most likely come to the fore at precisely the last minute, or as close to the last minute as possible.

In my quest to develop a unifying description of the transaction metaphor, I find this phenomenon both fascinating and useful.  This is similar to the idea in project cost estimation where the only time the true cost of a project can be known is when the project has been completed.  In other words, in the immortal words of Marcus M. Rommer,

It’s hard to make predictions, especially about the future.

Among her other failings, the inability (or unwillingness) to internalize this notion of transaction risk is what made one of my old business partners particularly dangerous.