11 things you should have learned in “Economics and Design”

It is spring break this week, so no DEMO class, and no discussion to add to this blog. So I have decided to post the “eleven lessons” from my Economics and Design class. A more descriptive title for this course would be Economics for Design. The goal is to introduce the students to important topics from the field of economics, and then demonstrate how these topics are relevant for designers. This class is followed by Professor Chris Conley’s “Economics of Design”, which takes a more micro view, focusing on the economics related to running a design firm, as well as design projects in a corporate setting.

In NO particular order, below are the eleven things I hope students learn in the class:

Incentives matter. A lot
Economists look at the world through the lens of incentives. Most outcomes, good and bad, can be explained though the application (or misapplication) of incentives. And, they believe, if you want to change behavior (invest more, commit less crime), you can create a set of incentives to trigger this behavior change. As designers, our work is also concerned with behavior change (making things easier, trying something new). We rarely, if ever, consider how to apply an incentive strategy along with our new design, or how our new design may work/not work with an existing incentive strategy. Design of incentives is a powerful new frontier for our profession, and should be integrated into our everyday work.

Gravity works the same everywhere. Market forces do not.
Much of Western economic thought was developed with the belief that, like gravity, basic economics formulas will work in any culture and for most problems (this is a gross oversimplification, but true none the less). Unfortunately, while gravity relies on fairly stable naturally phenomenon, economics relies on the individual decisions of people (which have proven, over time, to be less stable). This is not to say that free markets and free market theory can’t be applied everywhere, only that the applications have to be tuned for each culture. Designers can play very important role in the new global economy. Innovations in logistics have made it possible to get new products and brands anywhere in world (as well as be produced anywhere in the world). Our role is to ensure that these products and services are appropriate for each culture and country. We can’t assume that markets and products will work the same other places as the do here (in North America), we need to design these markets, interactions, and offerings to and for each market.

Cash is king
If your great new idea cannot produce enough cash to pay for its own development, plus a little extra for you and your friends, it may not be such a good idea after all. It is critical for designers to understand that businesses run on cash (meaning earned profits above expenses, or EBITDA for the accountants). Our job (as a professional designer) is to make things that make cash.

People do not always make “rational” choices
Quite a bit of recent economic research has focused on defining the “irrational” (irrational does not mean bad, just not driven by math) choices people make under uncertainty. There has been the dominant (although always challenged) thought in economics that people behave rationally and that this behavior can be quantified (game theory, the Nash equilibrium). But, we have come to learn, through the development of Prospect theory (as well as other advances in behavioral economics): people do not always make rational choices. For example, recent declines in the stock market have lead many to note that the market does overreact to current events. Wall street may be the only market where, when they put on a sale, all the shoppers leave. As designers, we should pay close attention to this convergence of psychology and economics; it can provide insight into the adoption and use of our offerings.

But somehow, over time, markets appear to be rational and most things regress to the mean
Despite the fact that markets are made up of millions of people making potentially irrational choices, from 40,000 feet, markets seem rational (the DJE has gone from 66 to over 12,000 fairly steadily over the last century). Regression to the mean is a powerful force (it is why, although average height has increased over the past century, people are not ten feet tall).

How a company is finances itself shapes its options and strategy (and how it approaches design)
Designers are not often interested in how the companies they work for are financed. However, financing choices lead to how willing (and able) a company is to take risks and spend money. We would prefer to work for companies that have plenty of available cash and are willing to take calculated risks. We have all worked for companies that seem stuck in the past, and are unwilling to innovate. It is important for us to know the financial condition and financial structure of the companies we work for. Too often, we propose design solutions that have no chance of being developed, not due to interest, but due to available investment money. We should adapt our design solutions to be compatible with the financial context of the company.

Design both creates and mitigates risk
Design is seen as a risk for companies. Moreover, it seems like a risk that the company cannot manage (compared to changes in exchange rates). As designers, we need to recognize that we are seen as a risk, and them demonstrate how our work can actually mitigate certain types of risk. In fact, the most potentially devastating risks a company faces (changes in customer preference, market forces, and technological change) can all be managed within the scope of a design project. We need to shift our position from creating risk to managing it.

Design creates and destroys value
Every time we put pen to paper, we are either creating or destroying value for customers and businesses. We destroy value by designing things that can never be implemented, or do not solve for real user needs. We also destroy value by creating “shelfware”, or design briefs that only serve to weigh down file cabinets. We create value by identifying opportunity spaces, and then providing real options for taking advantage of those opportunity spaces. We also create value by energizing and inspiring the organizations we work for. Designers should be obsessed with creating value; this frame of reference should guide everything we do.

Accountants have a hard time accounting for design
There are two reasons that accountants have a hard time thinking about design. First, like most R&D dollars, design is an expense, and as such, needs to be shown as a cost on the balance sheet in the year it was incurred. Compare this to a new machine for a factory, which can be “depreciated” over time, so a percentage of the cost is taken each year of the life of the machine. So, even though your design project may create insights and a product that has a life of ten years, the entire expense needs to be taken in the year the work was originally done. Second, accountants do not recognize value creation until a product has been ordered or shipped. Usually, by that time, design is long gone from the equation. The current practice of accounting makes it difficult to argue for the economics value of design.

The source of design value creation has shifted
Most design firms that I know of are trying to get into the “strategy” game. This means they want to have more input into product definition, not just product design. This trend results from a shift in economics – design development and production/construction drawings are not as lucrative (or time consuming) as they once were. Faster software and global competition are driving this change. So, in order to continue to remain in business, firms have had to shift the bulk of their billings to strategy work, which requires less “horsepower”, and more knowledge and domain expertise.

There is an investment curve for design
The old adage “you need to spend money to make money” is unfortunately relevant in the design profession. “Investment curves” are used to demonstrate the relationship between investment in a certain capability, and the return on that capability (unsurprisingly, it is rarely a linear relationship). In the case of design, companies will rarely see a great return on their investment if they just hire a designer firm every now and then. There is rarely true knowledge transfer, or enough time to really change a process, in this case. It is not enough just to show our managers the design investment curve, we need to make a coherent argument about why they should invest more in design, and clearly articulate the outcomes and benefits.

Reading list:
If you happen to still be awake, I recommend the following books for further reading:

Naked Economics: Undressing the Dismal Science by Charles Wheelan

Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein

Micromotives and Macrobehavior by Thomas C. Schelling

Why Most Things Fail: Evolution, Extinction and Economics by Paul Ormerod

On The Wealth of Nations (Books That Changed the World) by P. J. O'Rourke

Making Globalization Work by Joseph E. Stiglitz

Comments

[Mario Ruiz]

This is awesome, Jeremy. Thanks for posting. Regarding the last point, it seems fairly intuitive (to me, but maybe I'm being irrational) that adding capability and maintaining more consistent design resources in-house can increase the return on investment.

Sometimes, though, this is still hard to explain. I'm wondering how this graph was determined and if there's more 'data' behind it that can shed some more light on this interesting topic. Are there any specific case studies? SAP? Or other companies who are increasing their design capabilities?

I hope we get to discuss this more at the strategy conference!

[Christian Drehkopf]

Wow,

this quite exact the same what we asking ourselves daily. How can we measure design in cash with full force to increase the acceptance of our profession to a serious level for design-business. We didn´t even get one of these facts in our apprenticeship, killing our time over often more than 5 years, on a clear suiteable and above all presentable way. That´s more than a pity.

I ask myselft if it´ll be possible to give a currency to design, or if it has to be a mind change in business itself like in the past. "That design can bring you more value to your products and above all to the company"

I´ve got and and still have so many questions. Often IIT was able to give me a knock forwards, even though white-papers, and interviews cannot give you a full insight in the institutes lessons.

Perhaps Jeremy you can make a amazon book wish list for people interestet in business-design? This will be great.

Thanks a lot.
Greets from germany.

[Boris Knuf]

Hello my colleagues,

I would like to contribute some thoughts to your blog on design and accounting.
First you state that design expenses cannot be depreciated over time. That is correct, but a problem of US accounting rules. The Interantional Accounting Standard (IAS) which applies to the rest of the world, does require design and development costs to be capitalized. Design is considered an intagible asset which must be depreciated against sales revenues. (See also http://www.nysscpa.org/cpajournal/2003/1003/nv/nv14.htm

Second you state that accountants do not recognize value creation of design until product has been ordered. But isn't that true for any overhead planning activity? Advertising, factory planning, quality insurance, information technology even human resources are all company functions that cost lots of money and the returns are difficult to quantify.

The argument whether industrial design creates value or not seems very odd to me. I have only come accross this discussion in the academic world. It is probably because academics of engineering departments think that product design is maths and physics and industrial desigers constantly need to justify their existance.
If you want to analyze the value of industrial design for an organization, ask whether or not design is giving the organization a competitive advantage over its competitors. This competitive advantage can be measured in terms of higher prices and/ or higher sales volume.