
The "Wash my Ferrari" Problem: A Meditation on Risk - URSpider94
http://theothereight.wordpress.com/2012/09/08/the-wash-my-ferrari-problem-a-meditation-on-risk/
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chime
I have seen two predominant forms of risks factored in by the larger
incumbents waiting to be disrupted. One is, like the author puts it, the risk
due to breakage. Be very mindful of this risk and insure against it if
possible or change something to avoid/lower the risk (sorry, we don't wash
Luxury cars).

The other risk factor is pure CYA. Nobody wants to prepare a costing worksheet
for a customer quote where your cost is too low because you didn't factor in
the various overheads. Only after the annual financial statements are made
will you find out if you lost money on the product or not. Do you want to be
the guy who buys at $10 and sells for $20 only to find out before bonus-time
that overhead was $90 per unit? So you factor in the cost of capital,
inventory hold charges, shipping delays, warehouse pallet transfer cost,
foreign exchange currency buffer, and tons of other charges. This makes it
appear that your cost is high and so it is only natural to charge more for the
product. Boeing isn't going to sell an Arduino + LED light for $100. It will
be $500 because of risk of breakage and be $5000 by the time all the CYA risks
have been tacked on by six levels of middle-managers.

The wonderful thing about CYA risk factors is that they help justify your high
prices and if you are able to be lean, they give you a terrific margin. THIS
is what you want to disrupt. You can charge less than the incumbents because
they are playing it way too safe as nobody wants to lose their neck for
selling a product at a loss. But don't charge so low that risk of breakage
ends your business. The good thing is that the risk of breakage is not as
large as the CYA risks in most every costing sheet that I have seen. YMMV
depending on the industry/product.

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delano
Just a side note for people like me: CYA is cover your ass.

~~~
DeepDuh
Thanks. I always thought it's 'cover your assets' but I was wondering about
the 'a' all along ;).

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dkokelley
An interesting discussion on risk. Here's another consideration, you can self-
insure to an extent by changing processes to minimize risks. If you must
charge $10 to wash a Ferrari because your risk model says that it will cost
you $5 in mistakes, use a different process to lower mistakes. Let's say that
instead of the standard wash process you use for regular cars, you take extra
time on the Ferrari, using your best washers and new materials. Now, the risk
goes down from 1 in 2,000, your risk is 1 in 10,000. Now you can charge more
for the special, risk-averse treatment and only a $1 risk surcharge on top of
that.

Effective risk management doesn't just mean that you protect yourself against
"bad things". The ability to manage risks better than your competitors is a
competitive advantage. I heard it best described as the brakes on a sports
car. Good brakes let you take corners faster.

~~~
sukuriant
Just a nitpick, 'cause it was on my mind. 5$ might have been that "different
process to lower mistakes". I was wondering how it could still just be $5 to
manage risk of damaging a ferarri, myself.

~~~
dkokelley
I'm having a difficult time parsing your comment. The $5 from the article was
the cost of paying out $10,000 1 in 2000 times. If a different process costs
$5 to implement, then they might as well accept the risk as is.

~~~
sukuriant
I was trying to say: "What if they've already reduced their risk as much as is
reasonable, except for special cases that they see one day every three months:
that Ferrari."

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CodeCube
Wow, great discussion on risk. The only thing I would add to the discussion is
that before you try to model risk, you should read 'The Flaw of Averages', by
Sam Savage - <http://flawofaverages.com/>

Put simply, any real risk model should probably avoid being a 'single number',
but a range of probabilities. This models the distribution of possibilities
much better and helps you make better decisions.

~~~
TheCowboy
'Fooled by Randomness' by Nassim Nicholas Taleb is also a good book I
frequently recommend to people trying to comprehend probability or randomness.

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jiggy2011
I vaguely know somebody through work who is involved in high end legal
services.

Around a year ago he hired a webdesigner to redesign his website, apparently
the cost paid was around $20,000. Now bare in mind that this was for website
design _only_ (logo etc already existed).

The website itself was a relatively bog standard wordpress setup with about 10
pages of copy, a basic WP template and a handful of stock art images, no
custom code at all as far as I could tell; I could have done a better job
myself over a weekend most likely.

After hearing about this price I was curious as to who had been lucky enough
to get hired for such a contract, turns out it was a designer who had been
referred to him by others in the legal business.

So the question is, has whoever did this found a goldmine of customers who are
willing to pay such huge sums of money just because frankly $20K isn't a lot
to these people.

Or was it more to do with the risk of providing services to somebody who
specialises in suing the crap out of people?

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dkokelley
From what I (think I) know about the web development business, I'm guessing it
had more to due with the fact that this developer found a goldmine of
customers. Then again, maybe the developer is very concerned about clients
from hell so he can quote princely sums to clients he or she isn't sure are
worth the hassle. I suppose that's still a measure of risk. Not risk that you
will be sued, but risk that a demanding client will require special treatment
and hand-holding.

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nemilar
I realize that the post is making an analogy, but it's based on fact. I worked
in a car shop for a few months, and we charged a premium for "exotic" cars -
something like 2x the cost of normal service. The reason was entirely on the
insurance costs for handling those customers' vehicles.

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noonespecial
I always figured this was one of the "grey" advantages startups have. For a
very short time, a startup has so few assets that an entire class of risks
exist that will simply put it out of business. When you're brand new, it
doesn't matter if you damage a Honda or a Ferrari, either way, you're done.
This gives you a slightly evil and transient advantage that let's you
temporarily undercut the established players by just ignoring those risks
altogether.

~~~
sopooneo
But couldn't knowledge of this fact by your potential customers make them wary
of giving you much business, thus canceling out your advantage?

~~~
stickfigure
Yes and yes, but not necessarily. Customers do not have perfect information
about the market, and especially not about the inner workings of your company.

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zwischenzug
I've seen this happen first hand. I joined a lean startup full of smart
hackers building software in a fast-growing industry. It was great, and we
made a load of money. Then problems started happening, and we blamed people:
incompetent, tired, one-offs, whatever.

Then our customers started getting serious and regarded these events as
unacceptable, just as they became statistically certain, and impossible to
manage out. So costs have gone up, processes multiplies, checks increased. And
now lean startups are nipping at our heels...

Think medicine.

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turbulents
Last weekend, I was a little irritated when Southwest Airlines charged me an
extra $5 to get a glass jar in my luggage bubble-wrapped when I would have
preferred to save the $5 and take the risk of it breaking/leaking. The
Southwest agent's explanation boiled down to more or less the same point as
this article's. Kudos to her.

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Tycho
When people talk about risk (and return) I always feel like there's something
I'm missing, something I don't get. Can never quite put my finger on it.

I guess it's something to do with wilfully gambling vs. relying on your own
abilities. They seem like very different things but somehow get classified
together.

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robodale
This was a very good article. I have never thought about or considered looking
at potential costs this way. Thanks.

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khet
Just curious, how much of this risk can be mitigated by contracts (terms of
service) between the buyer and seller?

~~~
dbot
Agreed. I would be interested to hear thoughts on this as well. As an example,
if Coca-Cola uploaded its secret formula to a Dropbox, the damages resulting
from a data breach would seem to be immeasurable. But I'm sure Dropbox's TOS
limits damages to cost of the service (no extraordinary, consequential, etc.)
Is this amount what's at issue here, or is there something I'm missing?

~~~
lsc
eh, yeah, but you need to set expectations. I mean, people that will lose
thousands of dollars every minute you are down have... rather different
hosting expectations from people that are making a thousand dollars a month.

I mean, which would you rather have, assuming they were paying you the same
money (and using the same capital resources, e.g. both of them use a full low-
power dedicated server that costs $1,200 up front in parts and $20/month in
power. Both use about as much bandwidth.)

Customer A. who is hosting email, web and ftp for his family, and maybe has a
dev setup so she can test out the new webapp she's developing.

or

Customer B. who is running a website with $10,000 per day worth of sales.

Assuming they both have my phone number and can wake me up at 4am and yell at
me, I can tell you that I am going to want a lot more money to give customer B
the same service as customer A, because first, customer A isn't going to call
me at 4am very often, and if I do flub something up, I can give customer A a
free month, an apology and an explanation of what happened, and she is going
to think I'm okay.

Customer B? man, customer B is going to wake me up every time there is even a
little networking blip. And if I screw it up? they are going to have reason to
be really angry, and possibly sue me for a bunch of money. a free month is
unlikely to mollify them.

(also note, insurance might cover the payout if I get sued, but they certainly
won't cover the time and aggravation, even in the best case.)

So yeah, I can see how hosting customer B would be exciting, but I'd want a
whole hell of a lot more money to deal with those increased expectations.

If we want to go to the car wash example, when I was driving my maxima with
unrepaired body damage? my neighbour caved in the rear passenger door with her
land rover. "Don't worry about it," I said, "You did not significantly lower
the utility or value of my car." - I mean, the whole thing was probably worth
about as much as the bumper on her land rover.

If she had done the same to the new M3 in the next space over? you can bet her
insurance would be making it just perfect, for a price that could have bought
my jalopy several times over.

That's the thing. Nobody reads the legal bullshit until the knives are fully
out and the lawyers are at the table. When you think about it, it doesn't make
sense to spend the effort until then. I mean, you're talking about thousands
of dollars of effort to understand a contract, and that doesn't make any sense
on a contract that is worth two hundred bucks. Setting expectations is an
important part of avoiding the situation where the lawyers need to come out
and understand the contracts.

(Of course, this is why most contracts are as one sided as legally possible;
there is no advantage to giving quarter, as the counterparty won't really read
it until the relationship has soured and they are actively hostile.)

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pacaro
To the list of industries where there is a built in x10 on all quotes add
Weddings...

~~~
mcherm
But that is for a different reason... it's not increased pricing because of
increased risk, it's increased pricing because of increased willingness to pay
combined with a sense of "more costly must be more valuable".

~~~
kgermino
I would think that risk could be a part of it (or at least risk mitigation)...

If I were a photagrapher, I would likely want to charge more for a wedding
then say the engagement pictures (or other portraits) which have a similiar
amount of effort. If I have a problem with a portrait I might need to call
them back in to reshoot. If theres a problem with the wedding pictures I'm
stuck.

The workaround is better preparation, more people, more equipment, etc. All
this costs money.

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sonnyhe2002
Mr. car washer. By your argument, McDonalds should charge twice as much for a
big mac to fat people because they are more likely to get health problems and
sue McDonalds.

I think this model is just wrong and charging any customers more due to
profiling should not be practiced by any company. Assuming that your formula
is correct. Don't raise the price because of the probability and risk. You
should train your employees and improve your quality of service, so that the
probability is low enough, now you charge back the same $5 for a fararri
carwash.

~~~
callmeed
_> > Mr. car washer. By your argument, McDonalds should charge twice as much
for a big mac to fat people because they are more likely to get health
problems and sue McDonalds._

No, The consequences of faulty equipment or service are fairly acute–i.e.
someone dies or something is damaged _right away_. I think long-term consumer
risks like obesity and lung cancer are different than what the author is
referring to.

Also, most class actions suits against McDonalds have been thrown out [1].
Malpractice lawsuits and the like are very numerous, on the other hand.

* >> I think this model is just wrong and charging any customers more due to profiling should not be practiced by any company*

That's absurd. The entire insurance industry is based on this. As is any
financial product that takes your credit score into account.

[1] [http://www.bloomberg.com/news/2010-10-27/mcdonald-s-
obesity-...](http://www.bloomberg.com/news/2010-10-27/mcdonald-s-obesity-case-
judge-rejects-bid-for-group-suit-status.html)

~~~
sonnyhe2002
The McDonalds was just an example. Your points about lawsuits to being thrown
away against McDonald, is irrelevant. Whether people successfully sue McDs or
not, is not the point, McDs should not charge more to certain people. Do you
agree? Yes, the insurance industry do charge more depending on the person. But
my point still remain, The model is Bad. Besides if you have a SET price, you
should not change it because of probability or risk per person.

~~~
Dylan16807
McDonalds can certainly refuse to sell to groups like lawyers if they have a
persistent high cost from such a self-selecting group. I have no problem with
this.

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dfghsfjhfjxfxf
garbage article

~~~
monochromatic
Garbage comment; garbage account.

~~~
ComputerGuru
The best thing you can do for comments like that (esp. when they're made by
"green" accounts) is to just downvote and ignore. They'll be downvoted to
grey, then deleted. The accounts will be hellbanned in time (comments
autmotically deleted, posts only visible to poster). Replying only clutters
the discussion.

~~~
monochromatic
Never heard of hellbanning, but I'll keep that in mind. Cheers

~~~
TheAmazingIdiot
Hellbanning is precisely why I have showdead on. There have been some notable
users (creators of products and various websites) whom they were hellbanned
for no apparent reason. Having showdead on shows even them, however you still
cannot comment to them directly.

I think I've only seen 2 or 3 spam posts on dead. And a few 'special people'
whom are hellbanned. In a nutshell, the S/N does not get noticeably worse with
showdead on.

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brandoncapecci
The price of a car wash should take into account the aggregate probability for
_any_ car to get damaged. The idea that one would price discriminate via the
exact make and model is absurd and when I stopped reading...

~~~
sonnyhe2002
brandon, you are right. This article is just flawed.

~~~
brandoncapecci
Why am I getting downvoted for this? I am not making any commentary on price
discrimination but instead, saying that the artificially created scenario
could at least be more approachable for readers.

~~~
Dylan16807
Because you said the article was 'wrong' and that you stopped reading, without
actually doing anything to counter the point in the article.

That's a bad way to contribute to a discussion.

I didn't even realize your point was solely about the example. I thought you
were objecting to the entire argument. Bad examples are more common than
termites in a snowstorm and you should focus on the meat of the article.

~~~
brandoncapecci
I somewhat misspoke. I lost interest after when I read enough to deem the
article too artificial an example and lost interest. I wanted to give honest
feedback and see if other people perhaps thought the example was I contrived
as I did - not berate the article or the author. If I was writing myself, I
would want the same sort of feedback. Do you think I'm being unfair by giving
that sort of criticism?

To me not finishing something is a measure of persistent captivation. It's not
the first time I fell below my minimum. After I wrote the the comment, I
figured people would harass me about not finishing and that perhaps I was
being unfair to the author if I missed something redeeming at the end. I
finished it, wished to change the comment appropriately, but it had already
been downvoted. I should have known that it's very easy to look antagonistic
when you're not saying something positive but I did say explicitly what I
objected to. I really was just hoping to help by nature of sharing my opinion
and was totally open - hopeful even - that someone would change my mind rather
than just being looked upon as some asshole who just wanted to be holistically
critical.

~~~
Dylan16807
Well they can't change your mind if they don't know what it is. You never
commented on the meat of the article, so someone downvoted because of that.
It's easy to think of better examples, and the way to debate for learning as
opposed to winning is to either ignore non-critical flaws in arguments or even
fix them for your opponent.

