Strategizing for NASA, Part 5: Veridian and the Role of Reputation and Culture

A case study1 of a former company called Veridian shows that reputation and culture when treated as strategic resources can be critical for developing and maintaining a competitive edge. Yet culture can have its darker side, as we in the space business know all too well: culture was a contributing factor to both the Challenger2 and Columbia3 accidents. How is it that reputation and culture can be regarded as strategic resources, rather than as obstacles to overcome in strategy?

Veridian points the way. According to the CEO of Veridian, David Langstaff, the leadership team built a culture on values, promoting “why we choose to do the things we do.” By emphasizing values-based leadership, this strategy brought to the forefront the longer-term interests of Veridian’s customers, employees, suppliers, and shareholders. Such an approach does not arrive overnight or by decree. In the case of Veridian, it required time, nurturing and conscious cultivation by its leaders as the company evolved in pursuit of new business opportunities. From its roots as a company of former rocket scientists to a solutions business, Veridian’s leadership placed a premium on its value proposition and held true to it throughout its existence, even after numerous acquisitions and mergers. As a result, reputation and culture became a competitive advantage for Veridian.

Looking inside NASA, I’ll talk about one human spaceflight organization with a reputation and culture that is familiar to many: the Flight Operations Directorate (FOD), home of the astronaut corps, Mission Control, and the men and women who plan, train, and fly in NASA’s human spaceflight vehicles. FOD’s reputation is as a can-do organization, built upon the legacy of its Apollo forbearers such as Gene Kranz of Apollo 13 fame, and through the astronaut corps who are the rock stars of human spaceflight. The culture of FOD was built over fifty years, where the “steely-eyed” men and women of FOD dealt and lived daily with “numbers that can kill people.” To this day, each person in FOD recognizes that decisions – or lack thereof – can have ultimate consequences.

The Veridian example shows that such a reputation and culture developed over time and with careful nurturing by leadership can become a strategic resource that provides a competitive advantage, when it is built upon the foundation of “why we choose to do the things we do.” Likewise, any strategy for human spaceflight to be successful must recognize that reputation and culture can be a powerful strategic resource if treated properly. Such a treatment must resist the temptation to use reputation and culture as a justification to pursue business as usual, under the premise that “we’ve always been successful doing things the way we do.” Our own experiences in human spaceflight show the fallacy of that argument. The example of Veridian shows that the “why’s” rather than the “what’s” are critical to overcoming organizational inertia and providing a competitive advantage. A future human spaceflight strategy would be wise to heed that.

Next time: Walmart in China and the strategic impacts of cultural, administrative, geographic, and economic differences.

Previous entries in this series:
Part 1: The United States Postal Service and the Porter Five Forces
Part 2: Disney and the Resources Based View
Part 3: DARPA, Kodak, and Wiring Innovation
Part 4: The FBI and Transformational Change

 


1Elias, J., Khurana, R., & Poldony, J. (October 16, 2006). Veridian: Putting a Value on Values. HBS 9-406-028. Boston, MA: Harvard Business School.

2Vaughan, D. (1996). The Challenger Launch Decision: Risky Technology, Culture, and Deviance at NASA. Chicago: University of Chicago Press.

3Columbia Accident Investigation Board. (August 2003). Report Volume I. Washington, DC: Government Printing Office.

 

Strategizing for NASA, Part 4: The FBI and Transformational Change

In response to the terrorist attacks on the World Trade Center on September 11, 2001, the Federal Bureau of Investigation (FBI) began a strategic transformation from a law-enforcement to a threat-focused intelligence agency. A case study1 of the progress in the transformation at the FBI shows how strategic resources propelled by inertia, along with the psychology of loss, can get in the way of executing a transformational strategy. The FBI is still coping with the transformation a decade later, struggling with a shift in emphasis from reactive response by field agents to predictive threat assessments by analysts.

In some sense, the transformation at the FBI loosely resembles the strategic change in human spaceflight at NASA. Under the new strategy for NASA proposed as part of the fiscal year 2011 President’s budget, NASA was directed to discontinue development of the Constellation program (an in-house led program consisting of rockets, capsules, and landers to return humans to the moon) and instead focus its energies on the development of “game-changing technologies” for deep space exploration with no need for a firm destination or mission. This strategy would transform NASA from a destination and mission agency to a technological development agency. This is as big of a shift in strategy and strategic resources as that faced by the FBI over a decade ago.

Drawing parallels from the FBI case, it is clear why human spaceflight is struggling with a transformative change in strategy. Inertia in strategic resources within NASA and Congress, amplified by the sense of loss with the cancellation of the Constellation program, worked as a resistive force to the new strategic direction for human spaceflight. The result of the resistance is clear: the Congress adjusted the strategy and directed NASA to develop a next generation heavy lift rocket called the Space Launch System and a crew capsule called Orion, and the Executive Office shifted policy to direct NASA towards its next deep space human spaceflight mission – an asteroid by 2025. This strategic line still relies upon old business models built around large programs and large operations infrastructures with high fixed costs and low flight rates. To say that this approach is continuing the status quo is putting it lightly, and one could reasonably conclude that this is an outright counteraction to the attempted transformative change in strategy for human spaceflight.

Yet on the flip side, one could point at the commercial cargo and crew programs, where NASA is investing in several commercial companies to provide US domestic space transportation services as examples of transformative change that is actually happening in human spaceflight. Although these are not complete replacements for the activities that a technological development agency would undertake, they are aspects of completely new business models that have the potential to alter how the US accesses space. Recalling from Transactional, Transitional, and Transformative Change that transformative change is complex in number and unpredictable in outcomes, the commercial crew and cargo programs are examples of steps for enacting transformative change in human spaceflight.

Therefore, we have a “glass is half empty / glass is half full” situation, depending on the narrative you wish to support. One could conclude that the new strategic direction for NASA was counteracted due to the inertial forces and sense of loss within the strategic resources, which the leadership failed to account for. One could also rightfully conclude the opposite – that the strategic change in human spaceflight is actually underway and will require a lot more time, perhaps several decades if the FBI example is any indicator. It will be messy, frustrating and expensive to overcome the inertial forces and sense of loss when the status quo is challenged. It may result in something different than the “technological development agency” outcome originally envisioned in 2011.

The lesson here is that inertial effects and the sense of loss with strategic change are powerful resistive forces. A successful strategic direction must take these into account and realize that a lengthy, concerted, and continuous effort by the leadership, rather than “change by proclamation”, is vital to success.

Next time: Veridian and the role of reputation and culture in strategy

Previous entries in this series:
Part 1: The United States Postal Service and the Porter Five Forces
Part 2: Disney and the Resources Based View
Part 3: DARPA, Kodak, and Wiring Innovation


1Gulati, R., Rivkin, J., & Roberto, M. (March 9, 2010). Federal Bureau of Investigation, 2007. HBS 9-710-451. Boston, MA: Harvard Business School.

 

Strategizing for NASA, Part 3: DARPA, Kodak, and Wiring Innovation

DARPA is a wonderful example of an organization designed for innovation and creating value. The Defense Advanced Research Projects Agency (DARPA) is an agency of the United States Department of Defense responsible for the development of new technologies for use by the United States military. DARPA has funded the development of the Global Positioning System (GPS), stealth capability, unmanned vehicles – and where would we be without the ARPANET? You wouldn’t be reading this in all likelihood.

How is DARPA designed for innovation and creating value? Case studies1 of DARPA at the Naval Postgraduate School conclude that wiring innovation directly into the DNA of an organization is a tremendous engine of value. Here are examples of how DARPA is wired to innovate:

  • Through its organizational structure – DARPA only has about 100-ish full-time employees organized in a very flat reporting structure
  • Through shortened tenure of its project managers – the average length of a project, and hence a project manager at DARPA, is four years
  • Through challenges and incentives – DARPA uses a variety of prizes and competitions as incentives to produce results

Contrast that against human spaceflight at NASA. Most of NASA’s current human spaceflight projects and programs are extremely long, crossing the boundaries of multiple Presidential administrations, with large organizational structures spread across the country. I can’t help but wonder if the tendency for such a structure is to exacerbate the inertial effects of an organization – leading it to play it safe and perpetuate the status quo – rather than innovate. DARPA shows that quicker turnover of projects and programs and leaner organizations provide a greater engine for innovation.

In thinking further about how innovation is wired into an organization, I also wonder about innovation efforts that are on the organizational periphery, or are relegated to the “grass-roots.” Does such an approach heighten the likelihood that innovation efforts will be ignored in the daily routine of the big programs and projects? I think so.

As a case in point, I offer Kodak. Although Kodak invested in research and development, it failed to exploit its discoveries such as in digital imaging, partly out of fear of what those new discoveries would mean to its core film business. The failure at Kodak highlights the critical need to figure out how to move forward with innovations while maintaining the core business, and readying those innovations to become the “new” core business.

Think about how such an approach at NASA might revolutionize human spaceflight.

For instance, put an “innovation office” in key organizations as part of the formal organizational structure, reporting to the director of that organization. Give the innovation office access to resources and “grand challenges” from the director to create innovative approaches that drastically reduce cost or greatly improve performance in the products and services of that organization. Each of these challenges could be turned into a short-duration project and run from the innovation office with managers whose tenure lasts for the duration of the project. Recognizing that many, perhaps even most, of the projects will fail is to be expected, even applauded. But for those that succeed, they might displace the old way of doing business, and serve as the engine of new ideas.

It seems to me that wiring innovation into the organizational structure of human spaceflight within NASA is worth a conversation for creating a meaningful, sustainable strategy for human spaceflight.

Next time: The FBI and Transformational Change

Previous entries in this series:
Part 1: The United States Postal Service and the Porter Five Forces
Part 2: Disney and the Resources Based View


1See Dew, Nicholas, “The ‘As’ in DARPA: Advanced or Applied?”

 

 

Strategizing for NASA, Part 2: Disney and the Resources Based View

Disney and a Resources Based View (RBV) analysis illustrate the conditions under which organization-specific resources provide a sustained competitive advantage.  Specifically, Disney through its beloved character Mickey Mouse shows that an organization can sustain a competitive advantage if it has available to it resources that are inimitable (unique), durable, appropriated to where the organization captures most of the value, non-substitutable (can’t be trumped by another resource), and are clearly superior.  Disney has all of these with Mickey Mouse.

Think about it for a minute.  Mickey Mouse is very unique – children recognize Mickey Mouse even in a silhouette form.  Mickey Mouse as a character dates back to his first appearance in Steamboat Willie in 1928, nearly 90 years ago.  Mickey Mouse doesn’t go on strike, do drugs, or otherwise create employment strife.  There is only one Mickey Mouse, and nothing else comes close to representing what Mickey represents for Disney.  Even with a very superficial RBV analysis I just did, it is clear that Mickey Mouse represents a tremendous competitive advantage for Disney.

What about NASA?  Candidate enduring strategic resources are its facilities and workforce, created in the high-stakes crucible of the race to the moon during the 1960’s.  These resources, assembled during Mercury, Gemini and Apollo, were leveraged afterwards to the Space Shuttle and the International Space Station.  An RBV analysis leads to the following observations:

  1. For most of the last fifty years, it was difficult for others to imitate the facilities and workforce of NASA simply due to the unforgiving nature, demands, and opportunities afforded by pioneering human spaceflight to the moon and reusable spacecraft to low Earth orbit.  This implies a degree of past inimitability of these resources.  However, this inimitability is being challenged today by other governments (such as the recent Chinese mission to land a rover on the moon) and soon by commercial firms who will provide routine access to low Earth orbit within the next few years.
  2. People at NASA spend 40, even 50 years in their careers, pointing to the durability of the workforce.  In 2009, the average age of a NASA employee was 50 with 25 years of service.  Many of the facilities built at the dawn of the space race are still in service today.  Therefore, both of these resources have proven durability.
  3. From an appropriability standpoint, NASA captures much of the value provided by these resources.  Many of NASA’s employees can get higher-paying jobs in other industries.  As a former NASA administrator told me, “People self-select into NASA because they believe in its mission.”  However, many of the new, emerging commercial human spaceflight companies are drawing similar, dedicated talent, and thus are capturing much of the value of their respective workforces in a similar way.   Regarding facilities, NASA is providing its facilities to commercial firms on a cost reimbursable basis, so this permits NASA to continue to capture the value from the facilities, even if they are being under-utilized by NASA itself.  On the flip side where commercial space firms choose to use NASA facilities instead of building their own, this permits them to obtain value from those facilities without having to invest in high fixed costs for development of similar facilities.  This means they are capturing more value from that arrangement than they would otherwise.  Overall, I offer these resources are providing less of a distinctive edge today for NASA from an appropriability standpoint.
  4. What about substitutability?  In principle, the building blocks of these resources have always been obtainable elsewhere.  Military space is a potential source for these resources, and NASA has always relied heavily upon contracting from the aerospace industry.  Therefore, NASA’s workforce and facilities are substitutable.
  5. Whose resources are clearly better?  Critics will point out that NASA has managed to kill seventeen of its astronauts despite its workforce and facilities, whereas commercial resources have yet to be proven.  Until proven otherwise, NASA’s are better, although it may be challenged soon.

Therefore, RBV analysis of NASA’s workforce and facilities leads me to point to (2) durability and (5) clearly being superior, along with (1) inimitability and (3) appropriability as explaining why NASA had a sustained competitive advantage.  Unfortunately, the analysis reveals some erosion in the latter two, and perhaps a challenge soon to superiority.  Therefore, a future strategy for NASA’s human spaceflight must take into account a way to restore the inimitability and appropriability of key strategic resources, along with ways to maintain the durability and providing clear superiority, for the strategy to be enduring.  Figuring out a way to make them non-substitutable will help, too.

Next time:  DARPA, Kodak, and what happens when innovation is wired (or not) into an organization.

Previous entries in this series:
Part 1: The United States Postal Service and the Porter Five Forces

Strategizing for NASA, Part 1: The United States Postal Service and the Porter Five Forces

In June 2014, the National Research Council (NRC) released its report on the future of human spaceflight, “Pathways to Exploration: Rationales and Approaches for a U.S. Program of Human Space Exploration.”  At its heart is a question of strategy – what should it be to move forward with a meaningful and successful path?  In contemplating the way forward, some very basic elements of strategy need to be brought to the forefront and discussed.  Over the next few postings, I’ll share some of the elements of strategy that caught my eye in recent studies, and how they might apply to NASA.  Most of these elements arise from case studies of other entities in the public and private sectors that faced questions of strategy.  Some were successful – others not.  There is something to learn in each case, and it is my goal to show how these lessons apply to NASA.

First of all, I’ll start with the United States Postal Service (USPS), which is an independent agency of the United States federal government that provides postal service.  The USPS once had a monopoly by law for the delivery of parcels and packages within the United States.  An analysis of the USPS situation via the Porter Five Forces shows the erosion of competitive advantage that can occur even for government monopolies that ignore the landscape of change around them.  Similar to the USPS situation, NASA had a “competitive advantage” as a United States government monopolist, and with time that competitive advantage eroded.  The morphing of the human spaceflight industry from government-dominated in the twentieth century into a commercial industry for the twenty-first century can be analyzed using the same Porter Five Forces analysis:

  1. Historically, internal rivalry in human spaceflight has been within the domain of governments competing for “soft power” advantages.  With the emergence of multiple commercial firms, this rivalry will shift from soft power to economic rivalry.  Both lead to a high degree of rivalry and an unfavorable force to the industry.
  2. For human spaceflight, barriers to entry that were once sky high (forgive the pun) are slowly coming down. Although capital requirements remain high, the advancement of technology, and various state and federal government policies to license and invest in the commercial space industry, are helping to drive down the barriers for new entrants. This poses an unfavorable force to incumbents within the industry.
  3. Consolidations in the aerospace industry, a major supplier, have shifted power slightly from the human spaceflight industry to suppliers over the last fifty years.  The emerging nature of the commercial side of the industry, driving new kinds of relationships with new suppliers, counteracts the consolidation trend somewhat.  Therefore, the industry is probably in a neutral position today regarding supplier power.
  4. Similarly, buyer power for human spaceflight capabilities has shifted slightly away from the industry.  In the past, governments were self-serviced buyers based on national policies with essentially no price sensitivity.  Today, governments remain as potential customers with some degree of price sensitivity due to budget constraints, although governments are not as price sensitive as non-government buyers.  Hence, this is probably a neutral position for the industry today.
  5. The threat of substitutes is high.  From a government standpoint, it can choose to develop its own human spaceflight services if commercial ventures fail. Likewise, commercial firms threaten government-provided capabilities.

The lesson from the USPS case is that monopolies within the government can lose their competitive edge if they attempt to coast on the momentum of the past, while the landscape of the industry changes underneath them.  That happened in package delivery for USPS, and is happening today in human spaceflight for NASA.  I also offer from the Porter Five Forces analysis that human spaceflight as an industry is unfavorable, indicating the tremendous strategic challenge for anyone wishing to compete in that space.

Next time: Disney and the Resources Based View

“Stupid Space Tricks” Meets “Innovation the NASA Way”

In a recent blog post, Dr. Paul Spudis discusses the state of human spaceflight policy implementation – the Asteroid Retrieval Mission, and the human Mars flyby formerly known as Inspiration Mars – which he likens to “stupid space tricks:”

Viewers of the David Letterman Show (before it went to pot) probably remember a running gag where people would bring their pets to perform a variety of silly or dumb acts for the amusement of the audience. Letterman called this segment “Stupid Pet Tricks.” Although each particular trick was silly, the pet owners sincerely believed that their pets were gifted and were proud to showcase their animals’ various abilities. In fact, the whole exercise allowed the host and audience to smirk knowingly at the owners’ pride in their pets’ seemingly “human” abilities. This bit of low comedy has now been adapted as the central principle of our federal civil space program. The object now seems to be who can come up with the silliest idea for a human spaceflight mission. And boy, is the competition for that title fierce!

Elsewhere on The Space Review, Jeff Foust reviews the book, Innovation the NASA Way, by Ron Pyle. In the review, Foust notes the following:

The NASA of today, Pyle acknowledges, is different from the one that landed humans on the Moon 45 years ago: “it has grown up (some would assert that it has grown old).” Yet, he argues it’s still an innovative agency, in part because it’s able to harness what he considers to be three key elements of any such organization: creating bold plans, perform daring execution of those plans, and support a passionate workforce. The message of Innovation the NASA Way is that other companies and organizations can enjoy similar success by following those core tenets of innovation. It may even be a good reminder for NASA itself.

Is it any wonder why we are struggling with charting a course for human spaceflight?

Graduation

A few weeks ago I walked the stage at the Naval Postgraduate School in Monterey, CA after completing the requirements for the school’s Executive MBA program.

10151841_10203815438090952_2054550472_n

Now that I’m returning to full-time duty status at NASA’s Johnson Space Center, it’s time to find my newest challenge.  I’ll share how that goes here on LeadingSpace.

What is a Public Budget?

“Budgets are not the solution to a multivariate resource allocation optimization problem.  Rather at each decision point, they represent a temporary equilibrium of the views of the salient actors and salient voices at that stage of the process.”
–Professor Phil Candreva, Naval Postgraduate School

 

Today, the President released his budget for fiscal year 2015.  In it, NASA is “budgeted” for $17.5 billion.  Now is as good of a time as ever to talk about what a “budget” is, and what it is not.

Most of us think about budgets in terms of our household finances.  That is, we categorize our past expenses into categories, such as food, mortgage, gas for the car, whatever.  The process of building a good household budget is rooted firmly in economic decisions.  How much did I spend last year on gas for the car?  How much do I think I will drive next year?  And so on.  The purpose of a household budget is to guide our spending so that we stay within the limits we established, so that we can achieve the goals we set forth in the budget (such as save for a new car, or to go on a vacation).  Used in such a manner, a household budget is a very powerful personal finance tool.

A public budget created by the federal government is not like this.

Instead, a public budget such as NASA’s serves many purposes.  According to the Navy Budget Guidance Manual, a budget is defined as “a document that expresses in financial terms the plan for accomplishing an organization’s objectives for a specified period of time.”  Furthermore, a public budget serves as “an instrument of planning, performance measurement, decision-making, and management control, as well as a statement of priorities.”

That’s a mouthful.  What does that mean?  Basically it means that the functions of a public budget are different and more nuanced than a household budget[1].  First, a public budget serves as a contract between the legislative and executive branches of government once it is enacted.  It also serves as a contract between layers of the executive branch (for instance, between the White House and NASA). A public budget is also an expression of expectations and aspirations – you have no farther to look than the introduction to the NASA budget for fiscal year 2015 to see an example of this.

A public budget, for better or worse, also establishes a precedent that influences future decisions, because once something gets budgeted, it is extremely difficult to remove it from the budget.  A public budget is also a call to stakeholders to mobilize support for what is in the budget.  It is a reflection of choices, priorities, and relative power of the stakeholders and influencers of the budget.  Lastly, a public budget is an influencer of the economy.

Does your household budget do all that?  (Mine doesn’t.)

There is one more important difference between a household budget and a public budget.  As I mentioned earlier, a household budget is built based mostly on economic decisions.  We’d like to think that a public budget also results from a similar comprehensive, rational economic process.

But if we thought that, we’d be wrong.

Instead, because of all the functions of a public budget, the decision process is much more complicated.  Sure, there is an element of economic decisions in the process.  However, those economic decisions are often overshadowed by other concerns.  Public budgeting is primarily political.  It is a group decision-making process where members of the group represent competing and often conflicting interests.  Yet somehow, every year, we have a public budget.

So as we listen to the various opinions on the President’s budget for fiscal year 2015, I urge you to keep in mind that a “budget” is more than a “budget.”

 

 


[1] I’m indebted to lecture notes from Professor Phil Candreva.

LED Versus Incandescent Bulbs

Have you switched to LED bulbs for your indoor lighting?

I was giving this question some thought recently as I pulled out the ladder once again to change one of the indoor floods in the kitchen.  I seem to be constantly replacing these bulbs, since the center of my family’s home life revolves around the kitchen.  Those lights are among the most heavily used in the house.  The prices of LED bulbs have dropped, and the light quality from LED bulbs is quickly approaching what we are accustomed to with incandescent bulbs.  Among all the considerations that factor into the decision of incandescent versus LED bulbs, I decided to apply my MBA skills and focus on one: does it make economic sense to switch to LED bulbs?

To answer this question, let’s examine the underlying total cost for a bulb.  First, there is the “fixed cost” of buying the bulb itself.  Browsing on Amazon, I found a typical 65-watt BR30 incandescent flood that outputs 635 lumens (think of “lumens” as the brightness over an area) at a color of 2700K (this is the warm color I prefer) that costs $28.47 for a 12-pack.  That equates to about $2.37 per bulb.

Pretty cheap.

I found an equivalent LED BR30 flood that requires 10.5 watts to operate, outputs 730 lumens at a color of 2700K, for $19.98.  From a brightness and color standpoint, these are comparable bulbs.  Obviously, the LED bulb costs more to purchase, but because of the lower operating power required – 10.5 watts versus 65 watts – it is cheaper to operate than an incandescent bulb.

This is a classic tradeoff problem between the combinations of fixed and variable costs.  In the case of a bulb, the variable cost is driven by the electricity cost and the amount of power necessary to operate the bulb.  If I have the resources to invest up front in a larger fixed cost to gain a lower variable cost, I will come out ahead in the longer term.

I pay about 12 cents per kilowatt-hour for electricity.  Typical regional average costs for residential power range from about 10 cents per kilowatt-hour to 18 cents per kilowatt-hour.  Let’s suspend credulity for a moment and compare the totals costs of a “magic” incandescent bulb that never burns out versus an LED bulb.  At the lower operating cost for an LED bulb, when do I “break even” on its higher fixed cost?  Basically, we need to find the operating time required where the total cost of an incandescent bulb is the same as an LED bulb when all costs are taken into account.

At 12 cents per kilowatt-hour, the breakeven occurs at 2692 hours of operation.  Beyond 2692 hours of operation, the LED bulb is more cost effective.  Conversely, it does not make economic sense to replace working incandescent bulbs that are used so infrequently that the total operating time falls below 2692 hours.

bulb-1

Depending on where you live, your electricity rate may be something other than $0.12 per kilowatt-hour.  Different rates shift the breakeven point; higher rates move the breakeven point sooner, lower rates move the breakeven point later.  If your rates are a lot higher then mine, you’ll reach the breakeven point a lot sooner.

bulb-2

That is the short-term view.  How about the long-term view?  Doesn’t the high price of LED bulbs somehow cause the economics to work out differently?  To address this, we need to recognize that bulbs have a lifetime, and factor in bulb replacement into our analysis.

An incandescent bulb has a mean time to failure that is expressed as lifetime hours.  Let’s suspend credulity in another way.  Let’s pretend our incandescent bulb lasts until the rated lifetime exactly, then burns out and must be replaced.  The typical 65-watt BR30 incandescent floods are rated for 2,000 hours.

What about LEDs?  The equivalence to lifetime for an LED is when its brightness degrades to 70% of original, at which point the degraded LED performance becomes perceptible.  The LED BR30 floods I found are rated for 25,000 hours.  Some other LED bulbs are rated for 50,000 hours and even higher!  I’ll use 25,000 hours for the next step.

The long-term analysis shown next takes into account replacement of incandescent bulbs every 2,000 hours of operation, and replacement of LED bulbs every 25,000 hours.  When the cost to operate each bulb is taken into account, it is clear that the long-term cost of using LEDs is well below the long-term cost of using incandescent bulbs.

bulb-3

 The lifetime of an LED bulb would have to be much shorter – less than 4,000 hours – for the LED not to be more cost effective than incandescent bulbs.

bulb-4

What do I conclude from this analysis? Based on an economic viewpoint, for bulbs that see medium to high usage the LED is superior to the equivalent incandescent bulb.  I consider high usage as 6 hours per day or more, such as my kitchen and home office.  At 6 hours per day, 2,000 hours is reached in less than a year.  Medium usage is cited on bulb packages – 3 hours per day.  For 3 hours per day, 2,000 hours is reached in a little less than two years.  One to two years to reach the breakeven point sounds very reasonable.

For low-usage bulbs, it does not make sense to replace them with LEDs unless the price per bulb drops even further. Low-usage bulbs are those that might see a few minutes per day.  Assuming 10 minutes per day of usage, 2,000 hours is not reached until after 30 years have elapsed.  That is a long time to wait to get close to the breakeven point.

What’s my plan?  A few weeks ago, the 40-W incandescent bulbs in a desktop lamp located in my home office burned out.  As I mentioned earlier, lamps in the home office see a lot of operating time.  I replaced the burned-out bulbs with a pair of 7-W A19 LEDs I bought from Amazon for $14.20 each.  I purposely picked LEDs with ratings in lumens and color to mimic the incandescent bulbs they replaced, and waited to see if anyone noticed anything different.  Other than noticing the lamp was working once again, no one has said anything.

In all fairness, I have a few bulbs around the house that see very little operating time.  Bulbs in the garage and bathrooms around the house are still original and going strong after 9 years.  I see no sense in replacing them with LED equivalents while the current bulbs are still operating.  Economic reasoning says that I’ll probably never reach the breakeven point on them at the current cost of LED bulbs.

However, my next target is to slowly replace the floods in the kitchen, which get the most use of any lights at my house, with LEDs as the current bulbs burn out.  I‘ll continue by replacing other medium- to high-usage bulbs in the house as they burn out.  Low-usage bulbs I won’t touch.  Given the current brightness and color output qualities of LED bulbs, I bet no one notices the difference with the replaced bulbs – that is, except for me since I pay the electricity bill!

Do you have a Flexible Spending Account?

Perhaps you are like me, and don’t. My excuse for not having one is that my medical expenses vary from year to year, and therefore I’m reluctant to set aside dollars into an FSA, only to lose those dollars if I don’t spend them.

Is that the situation you are in as well?

While conducting research on my part of the capstone project for completing the Executive MBA program at the Naval Postgraduate School, I had an epiphany that is changing my mind about the FSA. My new insight is that the FSA problem resembles in many respects the kind of resource management decision I encountered several times in the EMBA program. The decision of how much to invest in an FSA is related to a classical problem in resource management called the newsvendor problem.

The newsvendor problem is often described as the problem one faces when given a single buying opportunity where that choice maximizes profit in the face of uncertain future demand. This is often illustrated in the classroom with the situation faced by a paperboy, who buys a block of newspapers once per day (and only once per day) at a particular cost, and sells those papers for a profit. If he runs out, he is done for day and can’t buy any more papers until the next day, thus missing out on potential profit. Leftover papers are worthless, since they are yesterday’s news. How many papers should he buy at his one buying opportunity for the day if he wants to maximize his profit?

Some may say that he ought to buy the historical average. However, this assumption was shown in a different context in the late 1800’s not to provide the optimal solution. Instead, the best solution is found through a set of reasonable assumptions that the distribution of historical demand for papers (or whatever) follows the classical bell curve shape centered around an average value with a standard deviation that describes the width of the bell curve, and also by considering the relative cost of having too many versus the lost opportunity cost of not having enough.

The optimal solution for the newsvendor problem (which you can find on the internet, such as at Wikipedia) is found through a two-step process. First, we have to weigh the cost of overage (i.e., the cost of having too many) versus the cost of underage (i.e., the cost of having too little). The balancing probability P* that maximizes profit is found via the critical ratio:

​P* = Cu / (Cu + Co)

where Cu = cost of underage and Co = cost of overage. You can see with a little algebra that the only case for when the probability is fifty percent is when the cost of overage is equal to the cost of underage. For most cases, the cost of overage is different from the cost of underage. Therefore, this tell us that to get the optimal order quantity, we need to adjust away from the average by taking into account how the two costs relate to each other. The optimal order quantity is found by the following relationship:

​O* = average + z * standard deviation

where the average and standard deviation are determined from historical demand, and z is the number of standard deviations above the mean needed to meet all of the demand P* percent of the time, which we can find in a statistics table. Given that P* is a function of the cost of overage and underage, z represents the number of standard deviations we want to adjust from the average based on their relative weights.

Here is an example. Suppose that a paperboy buys a block of papers for 55 cents each, and sells them for $1.50 each. Suppose that history says that the average daily demand is 100 papers, with a standard deviation of 30 papers. To the paperboy, the cost of overage is 55 cents per paper – this represents the cost of not selling a paper, and thus what he has to cover from his profit for each paper he bought that was not sold. The cost of underage is 95 cents per paper – this represents the lost profit of not having a paper to sell to meet the demand for the paper he could have sold. Using the equation above,

​P* = 0.95 / (0.95 + 0.55) = 0.633

Therefore, taking into consideration the cost of overage versus the cost of underage, the paperboy ought to plan on selling enough papers to meet all the demand 63.3 percent of the time. So, how many papers is that? For that, we need to look up the z-value for 0.633 in a statistics table, or use the Microsoft Excel NORMSINV function. Doing that yields z= 0.34. Therefore, the optimal number of papers he should order is:

​O* = 100 + 0.34*30 = 110.2, rounded up to 111.

Hence, the paperboy ought to buy 111 papers to maximize his profit.

The situation of the paperboy is very analogous to what we face in deciding how much to set aside in an FSA. Similar to the paperboy, we are trying to maximize “profit” – in our case, it is tax savings. In contrast to the paperboy case, we aren’t concerned about having too many or few papers; instead, we are concerned about having too much in our FSA versus too little. How do we apply the newsvendor problem to this situation?

As an example, I pulled my financial records to see how much in medical and dental “eligible expenses” I spent each year for the last few years. (Eligible expenses are items such as doctor copays, prescription drugs, etc. Each FSA plan provides a detailed list of what are eligible expenses.) My historical average per year for the last 12 years is $678, with a standard deviation of $363. The highest I spent in any one year was a little over $1,300 and the lowest was a little less than $200. I point this out because that $1,100 spread was the basis of my concern as to why I chose not to invest in an FSA. My previous simple-minded thinking was telling me that if I saved more than $200 in my FSA, I risk losing the unspent funds. However, the newsvendor problem provides a different perspective, provided we can characterize the cost of overage versus the cost of underage. I’ll derive both for an FSA using marginal analysis.

The concept behind an FSA is to set aside pre-tax dollars to spend on eligible medical and dental expenses. In my case, I’m in the 25 percent marginal tax bracket. Let O* represent the ideal number of dollars I should set aside in an FSA to maximize my tax savings. If I let D represent the total amount of eligible medical and dental expenses in a given year, I note the following:

If O* is greater than D, I didn’t spend all the FSA dollars I had set aside. This is the cost of overage case (i.e., I had too many dollars in my FSA account). What is the overage? If I would have reduced O* by one dollar, that would have been a pre-tax dollar I could have kept, which converts to 75 cents after taxes because I’m in the 25 percent tax bracket. Therefore, the cost of overage is 75 cents – I lose 75 cents for each dollar I contribute but don’t spend in my FSA. (Said another way, you don’t lose a whole dollar in your unspent FSA since they are pre-tax dollars; instead, you lose 1 minus your marginal tax bracket for each unspent dollar.)

If O* is less than D, I didn’t have enough in my FSA account and thus am paying for expenses with after tax dollars over and beyond what was covered by my FSA account. This is the cost of underage case. What is the underage? If I would have increased O* by one dollar, I would have lost 75 cents in after tax dollars because it is now in my FSA account (again because I’m in the 25 percent tax bracket), but save the one dollar of pre-tax dollars I would have had to spend otherwise. Therefore, the cost of underage is 25 cents – I lose 25 cents for each dollar I don’t contribute to the FSA that I had to cover with after tax dollars, because I’m paying for that expense with after-tax dollars instead of pre-tax dollars from my FSA.

As you can surmise from the above, if your marginal tax bracket is different from mine, your cost of overage is found by taking 1 minus your tax bracket, and your cost of underage is your tax bracket.

In my case, the probability that balances the cost of overage and cost of underage in is found by plugging each into the P* equation from earlier. In my case, it results in the following:

​P* = Cu / (Cu + Co) = 0.25 / (0.25 + 0.75) = 0.25

This means that I will have leftover dollars in my FSA account 25 percent of the time, and that I will burn through my entire FSA allotment 75 percent of the time. Algebra reveals that no matter what your tax bracket is, Cu + Co always = 1. Therefore, the probability that balances the cost of overage and cost of underage is always equal to your marginal tax bracket.

Looking up the z-value for 0.25 yields -0.674. Yes, it is a negative number. That means that I want less in my FSA account than the historical average of my eligible expenses. The amount I want is therefore

​O* = $678 + (-0.674)*$363 = $433

Again, this means my chances are 25 percent that I’ll not spend the entire $433 in my FSA account in a given year and will have leftover dollars I lose. However, 75 percent of the time, I will burn through the $433 in my FSA account. Setting aside $433 in pre-tax dollars results in a tax savings of $108 in the 25 percent marginal tax bracket.

What about that other 25 percent of the time when I don’t use all my FSA dollars? To look at this situation, I’ll do a breakeven analysis. In my case, I’ll break even between what I gain in tax savings versus what I lose in unused FSA contributions if I have at least $325 in eligible expenses ($433 – $108 = $325). In other words, this is the point at which the amount I would lose in unspent FSA dollars equals the tax savings of $108. I want to find the z value that corresponds with $325, so that I can find the probability that I’ll spend less than $325 dollars. Rearranging the O* equation, dropping the * designation and solving for z yields

​z = (O – average) / standard deviation

With my average and standard deviation,

​z = (325 – 678) / 363 = -0.97

Looking up -0.97 in a statistic table for the corresponding probability, or using the Microsoft Excel NORMSDIST function, yields 0.165. This means 16.5 percent of the time, I will spend less than $325. A 16.5 percent chance is equivalent to a one-in-six chance of occurring. (This is corroborated from my previous expenses – I spent less than $325 per year twice in the twelve years comprising my data set). I’m willing to tolerate that risk.

I’ve provided a spreadsheet that will do the calculations for you.

Therefore, given these odds and what the newsvendor problem is telling me, the tax saving is worth the trade to me. I’ll be signing up next year.