Monday, December 15, 2008

The Incalculable ROI (Ode to the MBA and the Erie Canal)

Return on Investment (ROI) is a funny thing. It is deceptively easy to calculate but almost never comes out the way you expect. In many cases it doesn't work because what you can quantify will almost certainly pale in comparison to what you cannot.  These inestimable flows are, nonetheless, very real and very valuable.

I call this the incalculable ROI.

I was pondering such a thing when I read the recent Wall Street Journal article on Executive MBAs (EMBAs). Scott Thomas, a 31-year-old who was halfway through the EMBA at a Cleveland school dropped out to enroll at Ohio State University’s EMBA program. This doubled his tuition costs to $72,500 for the 18-month degree.

Later in the article the WSJ told us, based on their calculations, that this was probably a good thing for Mr. Thomas because the Ohio State program yields a 170% return on investment, third behind only Texas A&M and the University of Florida.

Here’s some of how the WSJ decided this:
We scoured the responses from our summer 2008 survey of EMBA graduates for data about salary, raises received after graduation, company-sponsored figures, tuition and out-of-pocket costs. . .To calculate the benefit, or return, we used the graduate-reported median raise after completion of the program as the first-year salary increase. We added a 5% annual increase over the following four years, based on the average annual increase expected by compensation specialists and executive recruiters.
This kind of heroic analytics can result in being terribly precise about great inaccuracies.  It is the kind of limited ROI that, hopefully, Mr. Thomas will be taught to avoid during his EMBA training.

In fact, there’s good indication that Mr. Thomas already “gets it.” One of his reasons for transferring to the Ohio State program was that “the alumni network is unbelievably large, and they’re unbelievably loyal.” That's one reason he agreed to double-down on tuition. He has in mind a potential inflow, a potential return, that is—at this point in Mr. Thomas’ life—incalculable. Because, by moving to a program with a terrific alumni network, Mr. Thomas might well connect with a future investor in some future start-up. Or his next boss. Or a partner who goes on to help him launch a world-beating product. Whatever the “incalculable inflow,” Mr. Thomas believes that it will potentially—and more than likely—dwarf the ROI carefully calculated by the WSJ.

Steve Jobs’ well traveled, oft-downloaded 2005 commencement address is another example of the incalculable return. When Jobs talks about dropping out of Reed College because he didn’t want to spend his parents’ life savings without having a clue what he wanted to do with his own life, he spent the next year visiting classes for fun. One was a calligraphy class, something he took because he admired the art and was interested in learning how it was done.
None of this had even a hope of any practical application in my life. But ten years later, when we were designing the first Macintosh computer, it all came back to me. And we designed it all into the Mac. It was the first computer with beautiful typography. If I had never dropped in on that single course in college, the Mac would have never had multiple typefaces or proportionally spaced fonts. And since Windows just copied the Mac, it’s likely that no personal computer would have them.
This is the incalculable ROI.  The quantifiable stuff is what you can see and reasonably anticipate, and it’s not unimportant or irrelevant by any means. But the real return almost always dwarfs the anticipated cash flows. The real return comes about because presumably smart, talented, ambitious people (like Scott Thomas) place themselves on a collision path with other smart, talented, ambitious people, or (like Steve Jobs) on an intercept course with interesting, engaging ideas.

And, the incalculable ROI applies especially to big ideas and huge initiatives.

Take the creation of the Erie Canal. On October 26, 1825, Governor DeWitt Clinton boarded the Seneca Chief at Buffalo, arrived in Albany nine days later, and then, with steamboats replacing horses, floated down the Hudson to New York harbor where he poured a keg of Lake Erie water into the Atlantic Ocean. It was, like the title of Peter L. Bernstein’s excellent book, a Wedding of the Waters.

The Erie Canal was 363 miles, 83 locks, 675 feet up and down, and cost $7,143,789 to build. A calculation of the ROI on the project would show that the construction cost was paid in nine years. In 1882, when tolls were finally abolished, the canal had produced revenue of $121 million, more than four times its operating costs.

On a micro level, a shipment of flour could, thanks to the Erie Canal, travel 2,750 miles by water before its transportation cost was equivalent to 130 miles of travel by road.

All things considered, this was a pretty darn good ROI.

But, what did the Erie Canal really do? How do we, in retrospect, measure the incalculable ROI?

Well, thanks to the Canal, Albany, Utica, Syracuse, Rochester and Buffalo all became boomtowns while ten brand new municipalities were founded between Syracuse and Buffalo alone. And, New York City became one of the world’s elite cities: In 1824 some 324 vessels were counted in New York harbor. With the Erie Canal completed, an observer counted 1,241 vessels in the harbor one day in 1836.

Many hitherto subsistence farms in New York began growing product for market. Farmers with new-found cash now joined their urban neighbors in the consumption of products from northern factories. Luxury articles became attainable by the working class. Thanks in large part to the Erie Canal, the cost of a wall clock dropped from $60 to $3 by midcentury, and a mattress from $50 to $5. Folks in Batavia were able to feast on Long Island oysters. Traders in New York City began buying commodity contracts ahead of the harvest, creating an early form of hedging and adding to the City’s financial clout.

The turmoil caused by the rapid development of western New York made it fertile ground for some of the greatest movements of the Second Great Awakening, changing forever religion in America.

The Erie Canal brought strong Yankee growth to Ohio, Indiana, and Illinois, keeping Southerners (arriving “up” the Mississippi) from dominating those states, a major factor in the years before the issue of slavery was settled. In fact, the Erie Canal changed the axis of American economic power from north-south to east-west, and would lead to an “age of canals”--especially in the North--that would provide a meaningful advantage during the Civil War.

The money generated by the Canal, the so-called Canal Fund, served as a kind of stabilizing central bank during the Crash of 1837 when no central bank existed.

The completion of the Erie Canal led to a sharp rise in patent applications along its route. New York State led the nation in new patents per capita in almost all sectors of the economy in the mid-nineteenth century, with only southern New England leading in manufacturing after 1830.

The Erie Canal meant Midwest food production would flood Europe, leading Great Britain in 1846 to repeal tariffs on food. This freed European labor for work in factories, reducing the cost of production around the world.   How do you calculate that ROI?

Scott Thomas believes in the incalculable ROI. So does Steve Jobs. So did Dewitt Clinton.  I have a personal belief in the incalculable ROI.

I once bought a plane ticket to fly from Boston to Denver, with a stopover in Chicago. It was for a job interview. I was upset because the ticket was last minute and too expensive and I wasn’t sure the hiring company would pay for it (and I didn’t have much money). I wasn’t happy about the stopover in Chicago. I wasn’t sure I wanted the job and, after I’d interviewed, I was sure I didn’t want the job.

I suppose I was thinking that it would be a good experience. I could practice my interviewing. I might meet some interesting people. I could see how another company worked. I’d get to see the Rocky Mountains.

My calculated ROI on that ticket was miserable. But how about my incalculable ROI?

Well, on the way home, after meeting the company I didn’t want to work for, on the stopover I didn’t want to make in Chicago, with the ticket I didn’t want to pay for, I met a woman. Twenty-five years, six addresses, four dogs and three children later, we’re still together.

How do you calculate that ROI?