The Parlor Room is an official
podcast of Harvard Business School online. You go to a supplier
and you say, would you like to
do business with me? Here's how it's going to work. You're going to keep the
inventory until I call you at midnight the day before. And I'm going to say,
I need 1,000 iPads at the Fifth Avenue
store at 6:00 AM. And you're going to
deliver them to me. Wow. And they say, OK, and when
are you going to pay me? When I feel like it. What? And you say, yes, sir. Let's do that again. Welcome to The
Parlor Room, where business concepts come to life. My name is Chris Linnane. I'm the creative director of
Harvard Business School Online. So why is this show
called The Parlor Room? Well, parlor rooms were
meant for discussion, for telling stories. And that's what
we're doing here. I invite Harvard Business
School professors over to our parlor room, and
we learn business concepts through real life stories. On this episode I'm joined
by HBS Professor and business podcast royalty, Mihir Desai. Professor Desai
simplifies the complex by blending intellect
with storytelling. In a moment, you'll
hear him do just that. While helping him make
his HBS online course, Leading with Finance, I saw
firsthand the inaccessible become accessible. I'm no longer afraid of finance. Well, I'm no longer
as afraid of finance. We'll learn about the inner
workings of one of the world's most iconic brands,
and Mihir even talks me through unresolved
anxiety from a high school dance. It's sort of like a
tough love moment. So let's get started. Welcome to The Parlor Room. All right. So I know, I know
where I want to start. OK, let's do it. Finance, finance,
what's the difference? You know, I don't know, man. I should have the
answer to this question. And the reality is, I say
both and I interchange them, and I don't even know what
I'm using at different times. So I have no wisdom on that. I had a feeling that
if you said finance, you would know what
you're talking about. And if you said
finance, you were just trying to work with
your checkbook. Is that right? That's my perception of it. I think finance sounds fancier. For sure. And it throws people. So yeah, maybe I should use it. I honestly, I don't
have control over it. I just say it. But both are right,
you're saying. They are, exactly. There's no one way
in finance, Chris. Well, that's what
I've learned from you. So your book, Wisdom of Finance. I know we've talked
about this before, but I think one of
my favorite sections is the Jane Austen and the
Pride and Prejudice section. Can we go into
that a little bit? Yeah, sure. So I mean, the
premise of the book is that these big ideas of
finance that we were talking about, actually aren't
just unique to finance, they're about life. And in a way, I was
trying to take finance out of some big ivory tower and
put it into people's lives. And the way to do that
is with the humanities. Literature and religion
and philosophy. So for every big
idea in finance, I was looking for these analogs
in literature and history. And so for risk
management, which is a really, really
big idea in finance, it turns out Jane Austen is
just like a spectacular guide. So in Pride and Prejudice,
which is this classic novel about Lizzie Bennet. You know, she is basically
dealing with suitors. And one of the things that
Jane Austen thinks about deeply is that it's a risky
world for especially, young women who are
trying to make choices, in a way that it's
not risky for men, because it's easy for
a man to make a mistake and it's not easy
for a young woman to make a mistake in that era. And so she's got a big
risk management problem. And the really fun
part is as she's seeing these suitors come, one
is maybe handsome but a drunk, and another one is solid
but ugly, or whatever it is. She's got to try to
juggle these things. And the really fun part is
she basically gives voice to risk management strategies. Like she gives voice to the
idea of diversification. She gives voice to the
variety of options. She gives voice to all
these financial tools that people think are super
arcane and weird and developed in the 1970s. But in fact, have been
used throughout history. It's meant to be representative
of what that book tries to do, and what I like to do
more generally, which is bring finance down to Earth. Away from all the
trappings that people associate it with and bring
it down to people's lives. So can I run
something by you then? Yeah, sure. All right. Risk management. Yeah. You grew up in New Jersey. Yeah, after age eight, exactly. Yeah. Did you have a prom? Did you go to prom? I did go to prom. All right, first of
all, finance, finance. Prom, the prom. I think it's the
prom, but people just say I'm going to prom
which is maddening to hear. Yeah, no, I use the article. Yeah, I went to the prom. So risk management wise. So when I was going to a prom,
I think I have my own Pride and Prejudice moment here and
I want to see if this is it. So I had a plan to ask
a girl to the prom. Yeah. Then I had heard that
there was a girl that was going to ask me to the prom. Yeah. Different girl. Yeah. So what I had to do
was figure out how to not interact with that
other girl while trying to ask this girl to the prom. Yeah. Turns out that while I was
trying to potentially avoid this girl, that other girl
was trying to avoid me because I'm no catch. Right. So I finally got an opportunity
to ask this girl to the prom. Yeah. And there was a
very long silence, to a point where I thought, I'm
going to ask again, maybe she didn't hear me. So asked again, and then
she said no, I heard you. I'm just thinking. So it was followed
by more silence. Yeah. But then she responded
with, I guess so. Wow. Is that risk management? It's a deeply touching story. And I think we should
work through it. From her perspective, she was,
I think, implicitly Chris, and I hope I'm not
breaking any news to you, but you know, she was basically
deciding, should I settle? Yeah. Right. Or should I wait? Should I wait? Maybe there's a
better offer coming. Or should I settle for Chris? And I'm sorry, Chris,
this is, I know you haven't quite come to terms
fully with this experience. But that's kind of
what's going on, right? And that kind of
idea, which of course, is in Pride and
Prejudice, as well, when Mr. Collins
gives Lizzie Bennet basically an offer of marriage. And she's like, she says no. And her mother and
father think she's crazy. And so this young woman in your
life, basically decided, yeah, I'll settle. Which is kind of like it's an
optimal stopping problem, which we see in finance. And it has a lot to
do with optionality. She gave up a lot
of optionality. She gave up the
optionality to wait. And so she surrendered
her options. And now of course, you're
married and have three kids. And it's a great story. It's a great story. Anyway, I just wanted to let
that sit a little longer. I hate to break it to you, but
it's not all about you, Chris. Well, I just figured that out. It's the greatest
lesson in life, Chris. Yeah. So let's change
gears a little bit. Yeah. Why do people like me find
finance so intimidating? I think many people,
all too many people, find finance very intimidating. And what the course
has been about, what the books have been about,
and what my pedagogic career has been about is
disabusing them of that idea that finance is intimidating. It's not surprising that
people find it intimidating, because people in finance like
to intimidate other people. Like that's their
source of power. And so what this course does
and what all of these efforts do is try to make it clear that
finance is fully accessible. And actually, is just a
wonderful body of ideas. If you don't understand it,
it's hard to be an investor. It's hard to be an employee. It's hard to be a manager. It's hard to succeed, unless
one goes under the hood and starts to understand the
underlying financial engine of all these businesses. Can we take a look under
the hood of a big brand? I like to think about Apple a
little bit, which is obviously a company that many people love. It's arguably, the
most successful company of our generation. The market cap is now a
remarkable $2.8 trillion. It's almost hard to fathom. People think about
their products. People think about
their strategy. People think about all
kinds of things about Apple. What they don't
realize, is that they have just this remarkable
financial model. And it's been absolutely
critical to their success. But if you look
under the hood, they got a real financial machine. So just as one example. And this is a
little nitty gritty, but it's useful to think about. Obviously they're
profitable, but Apple's model is much more powerful than
just being profitable. They actually generate
a ton of cash, which has allowed them to build
themselves in a remarkable way, without ever getting
outside funding. So where does all
that cash come from? So it turns out that you have
to look deep inside Apple to figure this out. But what Tim Cook
built is a machine. To give you a sense of
what that machine is, Chris, try to guess
the following. So Apple is a retail store. You can go to Back
Bay or Fifth Avenue and you can go into
an Apple retail store. And they own those stores. In retail, one of the most
important things is inventory. If you want to run a good store,
maybe you worked in a store as a kid. I did, and it was all about
moving inventory, right? So in the Apple Store, guess
how long inventory hangs around? A month, two months? Yeah, so at a lot of
retailers that would be right. So for Apple, it's
about five days. Wow. Which is crazy. Now you might ask, wait, why? And why is that powerful? Well, let's put it together
with two other pieces. It turns out because they
are also now a retailer, and by the way, this was
not true 20 years ago, they were not a retailer. They also collect from their
customers pretty quickly. Right? Because when you go to
an Apple store, you pay. And they collect really
quickly, as opposed to using a distribution channel. Yeah. OK. So they're collecting
pretty quickly, they don't hang on to
inventory very long, and then the final piece
is, guess how long they take to pay their suppliers? 60 days. Apple has averaged
as long as 150 days. How do they do that? Well, because they're Apple. So that little virtuous machine,
which is what, wait a second, they keep inventory for
a really short period. They get paid really fast. And they pay their suppliers
like when they feel like it. Wow. What does that mean? Well, what that means is that
their operations actually generate cash. Because it's not
tied up in inventory, they're getting
paid pretty quick. And then they pay
their suppliers when they feel like it. Wow. And that means they have
a cash flow machine that drives their operations. Now, how do they
get away with it? Yeah. The answer is, well,
you go to a supplier, and you say would you like
to do business with me? Here's how it's going to work. You're going to keep the
inventory until I call you at midnight the day before. And I'm going to say,
I need 1,000 iPads at the Fifth Avenue
store at 6:00 AM. And you're going to
deliver them to me. Wow. And they say, OK and when
are you going to pay me? And Apple says,
when I feel like it. What? And you say, yes, sir. Let's do that again,
because they're Apple. Apple has been accused
at different times of bankrupting their suppliers. I'd imagine, yeah. I mean because they
are turning the screws. And this machine doesn't
get built easily. But you can see how powerful
it is, because effectively, who financed all their growth? Those suppliers. So that's the economic model
that is underneath Apple. And if you don't
understand that, it's hard to fully appreciate
Apple as a company. And it's hard to appreciate
how strong and resilient they can be. That's fascinating. I knew that they had the
ability to do what they wanted in a lot of situations. Indeed. But that's extreme. If someone just doesn't
want to meet those terms, they move on to the
next person who's willing to meet those terms. Exactly. And of course, everyone's
falling over themselves to do business with Apple. You can draw a parallel to
the way Dell pioneered this. Amazon has done this. Obviously,
software as a service is about this. It runs throughout the economy
in really interesting ways. So those suppliers, this
is kind of like their risk management for them. And it's also, for Apple, right? So you can't be too
dependent on any supplier. So you're managing
multiple suppliers, and yet, you're also
pressuring them in this way. And then, of course,
for Foxconn or Hon Hai, the question is, what do I do if
I don't do business with Apple? Yeah. What can I do if I don't
do business with Apple? Because then they're
marrying the good-looking guy who's a drunk. Or they're going to
the prom with Chris. Oh, Wow. I'm sorry. It's OK. Yeah. Tied it all back
together nicely. There you go. So, I've got some questions. Yeah. Our first question
is Matteas in Brazil. Wonderful. What skills or qualities
are crucial for success in today's financial landscape? Yeah, that's a great question. And let me say
what I think is not the right answer, which is
it's tempting today to think that the right answer is more
familiarity with data science and understanding
artificial intelligence and knowing how
to prompt ChatGPT. I think those are
relatively cheap skills. I think what is really
lacking in finance and what distinguishes
people who do really well, is judgment. And is really thinking
hard about value. So what the traits are
that really matter today are the same traits
that have always mattered in finance, which
are judgment, character, and its consistency. And in some sense, that sounds
like very old-fashioned advice. And I think it is very
old-fashioned advice. But that's what
mattered 100 years ago, I think that's
what matters today. And I think it matters
in most fields, but it matters,
particularly in finance. OK. With judgment, is that something
someone can develop over time? It takes a long time. And judgment-- How do they develop that? Well, so the wonderful
thing about finance is, you just keep
investing in it and it keeps getting
better and better. So judgment matters,
particularly in finance, because it's a very
fast-changing world. Markets are quickly moving. And you have to make sense of
tons and tons of information. And that's if
you're a CFO, that's if you're an investor,
that's if you're whatever you are in finance. Because you're going to
be embedded in financial markets perhaps
at a corporation. But there's going to be just
tons and tons of data coming. And you have to learn how
to respond to that data. And you have to do it
in a consistent way. And the great news
about it is, you learn. And you get better and better
at it, because judgment comes, by and large, from experience. And so with that
experience, you learn what you're doing right,
what you're doing wrong, and then maybe over
time you get better. It's a very, very
challenging field, because most people
don't have the patience to try to develop that judgment. But that judgment is what
really, really matters. Great. OK. So Rachel in Chicago. What are your
thoughts on the future of finance in the
light of technology and digital currencies? I'm going to give you a little
bit of a cranky old man answer to that. OK. On digital currencies, I think
they're really interesting. And I think when we have the
Federal Reserve or central banks around the world adopt
them fully and start to develop them, that'll be really,
really powerful. I'm not a big fan of
other digital currencies or cryptocurrencies. And in fact, I think
they're pretty pernicious. I wrote a piece for the
Times about five months ago about the magical thinking
that has infected finance. And I think of a lot
of cryptocurrencies as manifesting that. That somehow we need to tear
up everything and start anew. And I don't think
that's really true. So digital currencies,
and especially central bank digital currencies,
will be really powerful and really interesting. Technology will be at
the forefront of finance for all kinds of
reasons, because of the power of
computing, because of all that information
that are in these markets, there's always going
to be technology that is going to be
driving financial markets. And financial institutions
adopt technology really fast. And they spend on
technology a lot, because of that fundamental
nature of all that information they're trying to aggregate. And it will only become
more and more important. And so that's a great
intersection to be at. Ultimately, as we
discussed before, I think judgment is
the more precious asset than kind of technology. But being very secure
in your understanding of that technology
is a great way to build a career in finance. All right. Elizabeth in Boston
asks, how can we improve financial education
and empower individuals to make informed
financial decisions? It's a great question and
something close to my heart. My efforts so far, including
The Wisdom of Finance and How Finance Works and this
online course that we worked on together, are really to
basically demystify it. And to make it clear
that the ideas are totally accessible to anyone. And so that's the
first step in doing it. But the bigger step that
we need to do as a society, is do it at a younger age. And if we really are serious
about financial literacy, and we should be, then we need
to start at a younger age. It's actually quite
remarkable data. People exposed to financial
literacy at younger ages, end up amassing more wealth. Like there's good empirical
research on that now. Yeah. And so just like you might
think of health issues in K through 12 being taught,
we should be thinking about financial health. We should be thinking
about exposing people to those ideas at
a very young age. That's the real key
to getting people to understand finance better. If I look back at growing
up, I never learned anything until around 16, 17, 18
when you get your first job and you think oh, what do
I do with this money now? Yeah. That's the first time I
had to think about it. And that seems crazy. It is. I think it is a
little bit crazy. With the retail investing,
in a way, it's wonderful. Because a lot of young
people are investing. And that's fantastic. But it's also concerning,
because what they're learning is a lot closer to
gambling than investing. Yeah. It's a mixed bag, in
some sense, right? Like you've got to feel good about
people investing in stocks and learning about
finance at a younger age. That's got to be nice and good. But it has this a little bit
weird, weird twist today. There's the apps, but then
they also have now, especially in Massachusetts, they have
the sports betting apps. And it's the same thing
with a different cover. Exactly, right. And I think most
people are going to be more comfortable in the
gambling environment of that, because they have this
feeling of I know this team. Sure. I can make an estimate
of how much is going to happen in this game. Where when you say, well,
think about investing in this company, it's more of
a black hole for most people. Right. Well, what they've successfully
done for many of these folks have done, is gamify finance. Which again, is
wonderful if you want to get people into finance. Yeah. But it's also
really problematic, if that gamification is
happening in a way that is not really tethered to reality. Then it's really problematic. All right. This is Alex in Beijing. How do finance and
taxation intersect, and what impact do they have
on business and economies? That's a great question. So my two areas are
finance and tax. And I love them. They are really the lifeblood
of the capitalistic endeavor and of the state. And the way in which
the state and capitalism intersects is taxation. So they're hugely influential. They're only rising
in importance. And they are about, in some
very deep sense, who gets what and why. So in the finance side it's
about who gets capital, why they get capital, and
who should get capital, and how do we get returns from
those investments in capital? And in taxation, it's about
why does the state get to take my stuff, and
how much of my stuff do they get to take? Think about capital gains
taxation or dividend taxation or even
income taxation. Think about how it changes
an entrepreneur's willingness to invest in new businesses. Think about how it might
impact a founder who has to get rid of some shares. It just runs through everything. And the wonderful
thing is, I think people understand
that it's important, but they don't like to
think about it too much. And it's really fun to be
somebody who actually enjoys thinking about those topics. Well, I'm glad
you understand it. Because sometimes it can
overwhelm a lot of people. And it's overwhelming. Both those topics
are overwhelming. That's exactly right;
they're both overwhelming. Which is also why
demystification is so important. Because people being
overwhelmed by these things is not good for anyone. It's not good for
us as a society. And the choices we make,
especially on the tax side. But in finance,
they're really going to be important in the
next decade or two. And they're going
to be big decisions. And if people do it without
sufficient knowledge, I think that's really a problem. Thank you, Mihir. Oh, it's great to see you again. I hope you had an OK time. I had a great time. It was really great. If you'd like to learn
more about finance, or Professor Desai, you can pick
up one of his outstanding books or check out his HBS Online
course, Leading with Finance, at theparlorroompodcast.com. Don't forget to follow us on
LinkedIn, Facebook, Instagram, TikTok, and X for more
exclusive content. I'm Chris Linnane. Thanks for listening.
