Sunday, November 30, 2008

I've got a new job!

As some of you know, I've been looking for a new job for almost six months. Last week, I accepted an offer with a large, privately-held company outside Chicago, IL, USA. I'll be starting in mid-December, so I have to find a place to live, move and get settled in over the next two weeks. As a result, I'll be posting on this blog intermittently (if at all) for a while. Thank you for your patience!
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Thursday, November 20, 2008

Bankruptcy is looking ever more likely for one of the Big 3

The possibility of any kind of large-scale bailout of the U.S. automobile industry has been pushed back to December, according to this article from The Wall Street Journal, and may not happen before the Obama Administration comes into power on January 20th. Earlier today, it looked as though members of the Senate had crafted a compromise plan to use the $25 billion already allocated for the development of fuel-efficient vehicles for the bailout, but both Democrats and Republicans in the House of Representatives rejected the idea. It now appears that the U.S. automakers will have to come to the Congress with business plans that explain how they'll work themselves out of the situation they're now in before they can get the money.

Of the Big 3, GM appears to be the likeliest to fail, and Ford is the strongest, having borrowed a huge amount of money before the credit markets closed down. Chrysler is the hardest one to read, since it's a private company owned by Cerberus Capital Management. Of course, it's not clear that any of them will actually declare bankruptcy; GM's management still shuns the use of the word.

From everything I can see, legislators and their constituents who are opposed to a bailout believe some or all of the following:
  • The automakers don't deserve the money because their senior managers are incompetent, or because the union jobs that would be preserved pay so much more than what many other workers make
  • The automakers would waste the money
  • The automakers will soon be back with demands for more money
  • The banking bailout has turned out to be much less effective than originally advertised, so why should be believe that an auto industry bailout would be any different?
  • The ripple effects of one or more bankruptcies won't be as bad as the companies and their supporters are saying
  • The companies can survive bankruptcy, and will emerge stronger and more competitive
What these arguments miss, of course, is that once a company files for bankruptcy, its pension liabilities will be transferred to the Federal Government. The workers that were getting health care from their employers will have to get health care somewhere, and will overload already overburdened emergency rooms and hospitals. The ripple effect is quite real--as I wrote about in an earlier post, I saw it when the U.S. steel industry collapsed in the 1980s. Finally, given the frozen credit market, the risk is extremely high that any Chapter 11 bankruptcy would quickly degenerate into a Chapter 7 liquidation. In this market, who would, or could, acquire the assets of GM, Chrysler or Ford? In a growing market, you could argue that a Japanese, Korean, Chinese, Indian or European company might swoop in and buy them "on the cheap" for a quick foothold in the U.S. market, but we're in a worldwide recession, and everyone is hurting.

So everyone now waits as the Congress and automakers play a dangerous game of "Chicken."

Sunday, November 16, 2008

The Truth About Forecasting: Part Two--Obviousness

In the first part of this series, I wrote about the errors that make most forecasts meaningless, and gave examples of how I committed most of them in my very first job. Now, I'd like to tackle the one error that I didn't make at that time, the error of obviousness. A forecast that tells you what you already know isn't a forecast, it's redundant. This example comes from when I was working for Toshiba in the late 1980s. I had a conversation with my boss, Hank Yamamoto, about where the design of laptop computers was going. Keep in mind that the standard at this point was VGA (640 x 480) monochrome LCD displays, with Toshiba and Fujitsu also selling portable computers with monochrome plasma displays. Toshiba was already experimenting with pen computers, and was delivering a small number of them to customers.

Hank pointed out that there were several areas in which laptop design would change over time:
  • Processors would get faster
  • Displays would move from static to active-matrix thin-film LCDs (better for handling graphics), resolution would improve, and color would become affordable
  • Hard drives would get bigger and faster
  • Memory would also get bigger and faster
  • Battery capacity, and thus run-time, would improve
  • Everything would get cheaper
That was 1989, and all of that happened. Everything that Hank said was simply an extrapolation of the components and capabilities of existing laptop computers. He didn't try to forecast what prices would be for each of the components, or for the finished computers, at any given time, but Moore's Law could have provided guidelines for timetables. The same extrapolations can still be made today; the only component that we didn't consider back in 1989 was flash memory, which is now being used to replace hard disk drives.

There were plenty of companies in 1989 that were selling research reports and forecasts that stated essentially the same things that I just listed above, albeit with more charts, graphs and tables. These reports sold for thousands of dollars, and would have told us what we already knew. However, these reports usually added prices, dates and even sales quantities, most of which turned out to be wrong. Companies that bought those reports and relied on their forecasts were in worse shape than those that simply used the component breakdown and extrapolation method. Hank knew that he couldn't forecast prices, dates and sales quantities, but he could forecast the direction of development and its eventual payoff.

In the third and final part of this series, I'll revisit the five sources of error, examine what I consider to be the worst ones, and discuss a few ways to be a better forecaster and consumer of forecasts.

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The Truth About Forecasting: Part One--The Five Deadly Errors

I've been reading Nassim Nicholas Taleb's book "The Black Swan," which has gotten a lot of attention recently due to the financial meltdown. I may go into Taleb's core arguments in a future post, but one of his arguments is that forecasting of things that aren't physically based is all but impossible. Here's an example: We've learned how to forecast the weather fairly well, at least in general terms over short periods of time, because we increasingly understand the underlying physics. However, the five-year forecast that was undoubtedly assembled by product planners at GM last year has long since been shredded and recycled. The numbers, even for 2008, were useless because while the forecast might have had some allowance for the impact of $4/gallon gasoline, it certainly didn't allow for the possibility of a financial meltdown and complete collapse of the consumer credit market.

This brings me to my own experience as a forecaster over a nearly 30 year career in high tech. It's my belief that most forecasts aren't worth the paper they're printed on, because they're:
  • Obvious
  • Based on false assumptions
  • Biased to satisfy the audience
  • Cover too long a time horizon
  • Don't (and can't) take into consideration massive, but in hindsight predictable, discontinuities such as our current financial mess
Here's a case that demonstrates four of the five errors. In 1980, my first job out of business school was at Hewlett-Packard's Corvallis (Oregon) Division. At that time, Corvallis was responsible for HP's calculator product line, but they also had a line of personal computers called Series 80. The Series 80 machines were based on a processor designed by HP and derived from calculators. They were incompatible with any of the other PCs in that still nascent market, so software, hardware, peripherals—everything—had to be designed especially for them.

I was hired to be the Product Manager for Series 80 software, and part of my job was to forecast the potential sales of new software products. Since our software only worked on our computers, we had to start with sales of Series 80 machines, which were a few tens of thousands a month and growing, modestly. I was responsible for an array of software packages, each of which had its own appeal, including a database, a word processor, and even a Series 80 version of VisiCalc, the original spreadsheet. However, our primary market was engineers, the market for most of HP's products at the time. Were we going to branch out and try to reach consumers and businesspeople? That could make a big difference in the potential market size, and if our software was very successful, it could drive sales of computers.

One of my first questions was whether I could go out and poll current and potential customers to find out their receptivity to our new products. That idea was shot down, because we didn't have the budget for primary research. The industry was so new that there weren't any research services that we could subscribe to in order to independently gauge the market potential (and, as we'll see later, their own forecasts were likely to be of dubious value.) That's when I was introduced to the concepts of "WAGs" and "SWAGs" by one of our most experienced product managers.

"WAG" stands for Wild-Assed Guess, and "SWAG" stands for Silly Wild-Assed Guess. Neither WAGs nor SWAGs are entirely guesses, but they're close. When you don't have hard historical information, you have to estimate what percentage of the existing installed base will buy the product and how many new users will also buy, every month and every quarter, for five years. So, you start with a "rule of thumb"—say, 10% of your existing and new PC buyers over time will buy a particular piece of software, with that number going up to 15% in Year 2 and 20% in Year 3. What's your proof? You don't have any, but it sounds reasonable. By using WAGs and SWAGs, I committed the error of basing the forecast on false (or at least dubious) assumptions.

Once I completed the unit sales forecast, I then had to determine what price we should sell each product at. HP had sold software for "personal computers" over the years, but these were massive, specialized desktop computers that sold for many times the price of our Series 80 models. The company's prevailing model for pricing software for these models was to look at the software's manufacturing cost, and then mark it up by a given percentage. (Development costs were part of HP Labs' budget, and were not factored into product costs.) That's where I began with the pricing for Series 80 software, but it became clear in some cases that the software would be too expensive for buyers, and in other cases, the profit margins were simply too high. (Too high? In those days, HP management felt that charging too much for products—based on their costs—was unethical.)

Now I had a units forecast and a revenue forecast. I even used a WAG to estimate price changes over time. But before I could formally present them to management for approval, I had to calculate the overall rate of return on the product—too high, and the forecasts would go back to be redone with lower profit margins; too low, and the product would be scrapped. My first time through, the margins were too low, so I was told to go back and try again. I raised the units forecast over time, but it was unrealistic compared to separate forecasts for hardware sales, so I fiddled with initial prices and changes over time in both prices and market penetration until I got within the company's rate of return guidelines. (It turned out that competitors were selling comparable products for considerably more money, but those margins wouldn't wash within HP Corporate.)

So I had committed my second error, that of biasing the forecast to satisfy the audience. Virtually any connection between the approved forecast and reality was lost in order to meet HP's financial guidelines. But wait, there's more. My forecast had to cover five years. We now know that five years is a very long time in the personal computer business, but it was all new back then. So, I forecasted five years of growth, assuming updated versions of the software over time. What happened was that the next year, 1981, IBM introduced its first PC, which revolutionized the industry and created a new standard, and in 1984 the Apple Macintosh came out, helped in no small part by two PC product managers from HP Corvallis who went to work on the Mac in 1982. The Series 80 product line simply couldn't compete in this new world, and was discontinued altogether in 1984.

With my five-year forecast, I committed errors three and four: First, five years was far too long to forecast, given the rapidly changing nature of the PC industry. Second, there was an "unknown unknown" being developed in Boca Raton, Florida, which made my entire forecast and product plan moot. In hindsight, the flaws of the Series 80 platform made it very vulnerable to competition, but I was too entrenched with the nuts and bolts of getting my products out the door.

In Part Two of this discussion, I'll discuss the problem of obviousness.

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Saturday, November 15, 2008

A way to save the Big 3: Turn your clocks ahead one year

The cost for bailing out the Big 3 automakers (if they get everything they want) is now $75 billion and rising, yet the problem for the automakers is time as much as it is money. In John McElroy's column in Autoblog, he argues that the contract between the automakers and the United Auto Workers that goes into effect in 2010 will dramatically decrease the automakers' costs by shifting the burden for medical expenses to the UAW. In addition, a two-tier pay scale will be implemented, with new hires getting significantly lower salaries than existing workers. Therefore, a key goal of any government bailout should be to keep the automakers alive until the new contract goes into effect.

If McElroy is right, one way that the U.S. government could help the automakers would be to turn the clock ahead one year, figuratively speaking. Here's the idea: In return for Government financial aid, the contract scheduled to go into effect in 2010 would go into effect one year earlier, on January 1, 2009. The initial cash payments into the UAW's health care funds would be paid by the U.S. Government, not the automakers, in the form of loans to the automakers. (The money would go to the UAW directly from the U.S. Treasury, so that the automakers couldn't divert the money for other uses, just as banks are diverting funds that were supposed to be used for lending to other purposes.) This would save the automakers billions of dollars that they can use to finance their operations. The loans would be repaid by the automakers once they regain profitability.

This plan would give the Big 3 more flexibility to open and close plants as needed to meet customer demand, and it would also give them incentives to implement the kinds of cost-saving platform engineering strategies adopted by the Japanese manufacturers decades ago. With labor costs under better control, and with more flexible production, this plan would do many of the things that bankruptcies would do, with dramatically less "trickle-down" impact.

One other thing that the U.S. Congress could do would be to preempt car dealership franchise laws in the states. These laws require massive payments by car manufacturers to dealerships that they want to close. There's plenty of attrition in the ranks of car dealers today, but it would make much more sense for the car manufacturers to be able to take active control of their distribution strategies. This wouldn't cost the taxpayers a thing, although it would increase unemployment due to the closed dealerships.

The key is not to simply throw money at the problem, but to make business changes that will finally bring the U.S. auto industry into the 21st century.

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Wednesday, November 12, 2008

U.S. banks raise fees to record highs

The economy is tanking, you can't get a loan, your job is in danger (or you've already lost it,) and banks are still afraid of consumers pulling money out of their accounts, so what are the banks doing? According to the Wall Street Journal, U.S. banks are raising their fees to record highs, changing the rules on accounts so that fees are easier to incur, and increasing the minimum balances necessary to avoid fees. One statistic in the article took my breath away: According to Mike Moebs, chief executive of Moebs $ervices Inc., an economic research firm, approximately 90% of banks' consumer-fee income comes from overdraft and insufficient funds charges, and those fees could go as high as $40 per transaction from the current range of $32 to $35.

Overdraft and NSF (insufficient funds) charges are most likely to be incurred by consumers who are already financially strapped, and they can be incurred in ways that a lot of people don't think about. Automatic bill payments are a big one--the amounts are taken out automatically, but if there's not enough in a checking account to cover the withdrawl, and if funds from a savings account or an overdraft line of credit aren't available, the customer gets hit with a big fee. According to the WSJ article, Citibank intends to make money even if you do have funds in a backup account; they're charging some customers a $10 overdraft protection transfer fee for each such transaction.

What I truly don't understand is how the banks can justify these fees. After all, consider credit cards. If you go to a restaurant and you're over the limit on your credit card, the bank simply declines the transaction. There are no additional fees. Why does it cost nothing to decline a credit card transaction and $40 to decline a debit card transaction?

The article suggests that brokerage accounts, online banks and some community banks carry fewer fees, but in general, those institutions service higher-income individuals who are at less risk of incurring the fees in the first place. The major banks are driving customers out of the market, to prepaid debit card services such as Green Dot. For many people, it's become almost impossible to afford a checking account.

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Tuesday, November 11, 2008

Today's unnecessarily frightening headline: "Radioactive Beer Kegs Menace Public"

On today, I found a story with the frightening headline "Radioactive Beer Kegs Menace Public, Boost Costs for Recyclers." Could you get drunk and be sterilized at the same time? The answer is no. It turns out that the problem is that nuclear wastes are being dumped into the conventional metal recycling stream, resulting in radioactive metals. In the entire, long article, there's exactly one reference to beer kegs: "Abandoned medical scanners, food processing devices and mining equipment containing radioactive metals such as cesium-137 and cobalt-60 are often picked up by scrap collectors and sold to recyclers, according to the International Atomic Energy Agency, the UN's nuclear arm. De Bruin (Paul de Bruin, radiation safety chief for Jewometaal Stainless Processing BV in Rotterdam) said he sometimes finds such items hidden inside beer kegs and lead pipes to prevent detection." That's it. The headline could have read "Radioactive Lead Pipes Menace Public," and would have been just as accurate.

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Monday, November 10, 2008

Should bankruptcy be the price of bailing out GM?

The Wall Street Journal ran an opinion piece this morning on bailing out GM (and potentially Ford and Chrysler/Cerberus as well) that suggests the price that each company should pay in order to get more government money: The board and senior management should be fired, shareholders should lose their remaining equity, and a Government-appointed receiver should take over. The receiver should tear up contracts with labor, suppliers and dealers, shut plants as needed, and do whatever is necessary in order to return the company to profitability.

That's the definition of Chapter 11 Bankruptcy. So, what the writer is saying is that the price of bailing out GM should be bankruptcy. That argument makes sense, but I question whether a receiver can clean up the mess at GM and turn it back into a viable competitor post-bankruptcy. Let's remember that Cerberus Capital brought in a management "dream team" to turn Chrysler around, and now they're desperately trying to sell the company, in whole or in part. Given the current economy, a move into Chapter 11 reorganization is likely to slide into Chapter 7 liquidation, which would be catastrophic for the U.S. economy.

Even without driving GM into Chapter 7, a receivership could cause other unintended consequences. For example, the Big Three manufacturers won an agreement to turn over responsibility for retiree health benefits to the United Auto Workers, starting in 2010. That will save GM $3 billion a year. However, if the trustee eliminates GM's contributions to the UAW's Voluntary Employee Beneficiary Association fund, the fund will no longer be able to support GM's retirees without taking benefits away from Ford's and Chrysler's retirees. Further, GM's costs will decrease, which will put the company in a much better competitive position vs. Ford and Chrysler. That could drive Ford and Cerberus/Chrysler into bankruptcy. We could end up with three car manufacturers in bankruptcy, not just one.

I think that the best solution is one that nurses GM through this recession, keeping the company going until consumer demand picks up, but with major operational concessions on the part of GM's management and the UAW. The company must replace its Board of Directors. GM needs its own Louis Gerstner, and a new team of senior managers who haven't been innundated with GM's groupthink. GM has got to become the world's best manufacturer of automobiles, not just the biggest, but they won't get there with either the management team or Board of Directors currently in place.

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Friday, November 7, 2008

The words that GM executives dare not speak

What words? The first one is "Chrysler." In GM's earnings announcement today, the company said that it has decided not to pursue merger talks with an unspecified company at this time, and instead will focus on internal growth. In an interview with Rick Wagoner, GM's CEO, Phil LeBeau of CNBC asked him if the press release was referring to Chrysler, and Wagoner replied that he couldn't say.

The second word is "bankruptcy." LeBeau asked Wagoner if bankruptcy is a possibility, and Wagoner refused to use the word. It feels a little like the old Soviet Union or pre-Capitalist China, where certain words were banned, or their meanings were twisted beyond recognition. It doesn't reflect well on GM's management when they're frightened by words or afraid to acknowledge the truth. If the company truly wants help from the Federal Government, its management has to demonstrate that it won't waste the money, and they've got to start by speaking plainly and truthfully to the Government, press, investors and their employees.

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Thursday, November 6, 2008

How long with the lessons of our credit bubble last?

U.S. public radio's Marketplace ran a story today about how the sales of luxury goods are struggling, even with consumers that still have the money to buy them. It's become "unseemly" to buy more than you need, even if it means shopping at Target rather than Bloomingdale's or Nordstrom. The big question is whether this is a temporary shift that will reverse when the current recession ends, or whether this is a generational change that will persist for decades. My gut feeling is that it's the latter, but the only evidence that I can offer is what happened during and after the Great Depression.

Financial hardship causes long memories, and the deeper and more prolonged the hardship, the more entrenched the memories become. My parents both lived through the Depression. In the 1960s and 1970s they refused to do business with Mellon Bank, even though it was the largest bank in Western Pennsylvania, because Mellon had foreclosed on so many homes in the Depression and threw so many families out in the street. They paid cash for everything, financed their retail business out of their own pockets and didn't use trade credit.

Fast forward to this decade and the last. Credit was cheap and widely available, and using debt to leverage, or multiply, the amount of cash that an individual or business had was seen as smart. It worked for a while. It got many people who couldn't otherwise afford homes into homes. It convinced supposed "Masters of the Universe" on Wall Street to take on unbelievable risks. But now, the credit bubble has imploded, just as the Japanese asset value bubble imploded in 1990. Japan still hasn't fully recovered from its "bubble economy". How long will it take the U.S. economy to recover?

I think that it wll take long enough that the lessons of dependence on credit will be burned into a generation of consumers and business owners. Consumers will scale back their purchases to focus on items that they need and can afford. Businesses will again focus on cash flow and profitability, rather than growth and leverage. The quality of earnings, rather than their absolute size or growth, will become the most important factor. Personal savings will eventually swing upward as consumers work off their debt burdens.

I'm going through my own version of a credit bubble implosion, one that, frankly, I may not survive. If I do, I will be as changed as my parents were. I am not the man I was a few years or even a few months ago, but yet my lessons pale next to those of families who, through no fault of their own, have lost their homes and have no place to go. There is no longer any such thing as "good credit." Credit is a necessary evil in some cases, but it is an evil, and it should be avoided.
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Monday, November 3, 2008

More pain in autos for October

Autoblog's October "By the Numbers" survey is out, and the auto industry in the U.S. slid deeper into recession last month, with all makers except Audi and Mini showing year-over-year losses. GM was the biggest loser, down 45% from October 2007, and every GM brand except Saab was down at least 40%; HUMMER was down more than 60%, and Cadillac, GMC and Saturn were down over 50%. In September, GM was one of the better performers, due to its "Employee Pricing for Everyone" program, but it was discontinued at the end of that month. In addition, GMAC withdrew financing for all but the very best credit risks, which left GM's dealers with far fewer options for customer financing.

Of the major companies, Chrysler was down almost 35%, Ford fell over 30%, Nissan was down 33%, Honda was down over 25% and Toyota was down 23% (even with its annoying "Saved by Zero" ad campaign.) Only BMW was able to stay nearly even with last year, with a 5% year-over-year decline, and that was largely due to a big increase in production capacity and sales for Mini. In total, industry sales dropped 32.3% to approximately 821,000 vehicles (vs. 1.2 million in October 2007,) the lowest monthly count since February 1993, and adjusted for population growth, the worst monthly total since World War II.

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Video business news done better

I recently wrote about the problem that most of CNBC's anchors have with understanding that businesses are collections of people making and selling things, not pieces of paper to be bought and sold on Wall Street. Like a lot of people, I get ideas at 2 a.m., and last night, I wrote one down. Here's the elevator pitch:

The idea is a video news service that focuses on the needs of businesspeople, not investors. There would be multiple channels, with each channel focused on a single industry. Some of the potential channels include:
  • Automobile
  • Health Care
  • Retail (possibly multiple channels)
  • Agriculture
  • Banking
  • Insurance
Editors in a central location would assign and screen stories produced by a combination of full-time field editors and stringers (part-time and contract reporters.) Trade publications and newspapers that already cover these industries could participate by contributing stories; in return, they would share in ad revenues and have the right to republish the stories on their websites. Whenever viewers tune in, they would see the latest news report (continuously refreshed) and have access to longer, in-depth reports on a variety of industry-related subjects.

There would be a dual revenue model: Subscription fees (the service would be business, not consumer, oriented) and advertising.

Most importantly, the service would be available exclusively by phone, not PC. That means that mobile service providers, such as Verizon, AT&T, Sprint and T-Mobile would share in the subscription revenues and participate in marketing.

So, who should do this? Possibly CNBC (NBC Universal has all of the pieces to make it happen,) but they probably won't. Fox or Bloomberg would be better candidates, but in both cases, it would require a radical rethinking of their businesses, shifting from investors to business operators. One or more of the major trade publishers, such as Crain, Reed Business, Nielsen or United Business Media, could make it happen. The New York Times or Dow Jones are also possibilities. The point is that there are no technical limitations making this idea impossible, or even terribly difficult to implement.
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Sunday, November 2, 2008

Read Tom Friedman's column

Before you vote for any candidate in the U.S. Presidential election, read Tom Friedman's column in today's New York Times. Whether you're a liberal, centrist or conservative, it's the best advice I've read in a long time.

Saturday, November 1, 2008

You can check out any time you like, but you can never come back

My job search continues, and I've got some prospects outside Northern California, where I currently live. I haven't lived outside of California for 25 years, so I'm just becoming familiar with the real cost of living differences between this state and most of the country. (I've always known that there are big differences, I just never had to deal with them.) Depending on where I'd move, the differences can be enormous: Using's Cost of Living calculator, I'd have the same standard of living on a $72,000 salary in Chicago that I'd have on a $100,000 salary in San Jose, CA. In Denver, $68,000 would go as far as $100,000 in San Jose; in Austin, TX, a little over $61,000 would go as far as $100,000 in San Jose. About the only place in the country where I'd have to make more money to maintain the same standard of living is the New York City area.

That's great; my money will go a lot further, almost no matter where I go. But let's flip the situation around, and say that at some point in the future, I want to return to Silicon Valley. I'd have to make as much as 64% more to maintain the same standard of living. It's almost unheard of to get a 64% raise by changing jobs; in fact, many Silicon Valley start-ups actually pay less, and make it up with stock options. That's why the only people who can afford to move to California are recent college graduates already living on low incomes, immigrants that live incredibly frugally, and people who are already wealthy. In just about every other case, your standard of living will drop dramatically when you move to California. So, once you're gone, you're gone.
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