How does insurance work and why is it so complicated? We will begin to answer these questions and more in a three part series on insurance markets.

Simply put, insurance is the business of buying and selling risk. In many situations, businesses and individuals are risk-averse. This means that they would prefer to pay some amount of money to reduce the amount of uncertainty in a situation.

For example, consider a simple coin flip game. If the coin lands on heads, you receive $100,000. If it lands on tails, you receive nothing. The expected value of your winnings is 50% * $100,000 + 50% * $0 = $50,000

Would you prefer to play that game, or just get a guaranteed $50,000?

Most people would prefer the guaranteed $50,000. What about $49,000?

If you would prefer $49,000 we consider you to be risk averse. You are willing to pay a premium of $1,000 to eliminate the uncertainty in this situation.

Of course, this is a somewhat frivolous example. Instead, let’s consider one of the oldest examples of insurance in the real world: property/home insurance. Modern property insurance goes back to shortly after the Great Fire of London. There was a desire among individuals to reduce the financial risk of losing their homes to fire. And companies (i.e. insurers) were founded to meet this need.

Let’s look at the economics behind this:

Let’s assume someone owns an apartment valued at $500,000 and that the insurer only offers one type of insurance, total insurance. Essentially this insurance will pay for any damage done by fire over the next 5 years.

The probability of loss over that time period is as follows:

• 1% chance of total loss ($500,000 cost)
• 2% chance of minor loss ($100,000 cost)

From the individual’s point of view, their expected loss is 1% * $500,000 + 2% * $100,000 = $7,000. Since the individual is risk-averse they are willing to pay at least $7,000 for the insurance policy, but let’s say the insurer charges around $10,000. This cost can be thought of as three parts:

1. The actual expected payout to the individual = $7,000
2. The risk premium (the cost to the insurer for having additional risk) = $500
3. Overhead and administrative costs of providing insurance = $2,500

In this case, if the individual opts for the insurance coverage, they are willing to pay a $3,000 risk premium over the anticipated $7,000 in damages to insure against the risk of a greater loss. There is an important insight here: Insurers are better equipped to handle risk than individuals. As a result, that $500 risk premium the insurer faces is a lot lower than the $3,000 risk premium the individual is willing to pay. Why is this?

In fact, there are a number of reasons insurance companies can better handle risk (e.g. “floating” premiums until claims need to be paid), but the biggest reason comes down to simple probability.

Think back to the coin flip game from earlier. Imagine that the game is now a 50/50 chance at $10,000 and you get to play 10 times. The expected value is still $50,000. But now would you accept a guaranteed $49,000 over the game? Maybe not. That’s because by playing the game many times, you reduce the uncertainty. Since an insurance company can take on many customers, it can effectively reduce the amount of uncertainty it faces.

Below is a diagram showing the probability distribution of winnings in the coin flip game based on if you play once (individual) or if you play 10 times (insurance company). 

And now we can see what the graph looks like if the game is played 100 times. Here the insurance company would always get between $40,000 and $60,000. So that is very little risk compared to the 50/50 gamble the individual faces.

This very simple result shows how insurance companies are able to manage risk, allowing them to create value which is passed on to consumers. Of course in practice, some (or all) of that value is lost due the overhead costs associated with insurance companies (but that is a much more complicated topic).

One key assumption we are making throughout this post is that insurance companies and individuals have the same information and are aware of how likely a “loss” is to happen. What happens when individuals know more about their potential for loss than the insurer does?

The next post in this insurance series will look at exactly that, and more generally the topic of adverse selection.

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Interested in expanding your business vocabulary and learning the skills Harvard Business School's top faculty deemed most important for any professional, regardless of industry or job title?

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About the Author

Ben is a member of the HBX Course Development Team and works on the Negotiation Mastery and Economics for Managers courses. He has a background in economics and physics and enjoys card games, cooking, and discussing philosophy.

Courage is the quality that distinguishes great leaders from excellent managers.

Over the past decade, I have worked with and studied more than 200 CEOs of major companies through board service, consulting, and research as a member of Harvard Business School’s faculty. I’ve found the defining characteristic of the best ones is courage to make bold moves that transform their businesses.

Courageous leaders take risks that go against the grain of their organizations. They make decisions with the potential for revolutionary change in their markets. Their boldness inspires their teams, energizes customers, and positions their companies as leaders in societal change.

The dictionary definition of courage is “the quality of mind or spirit that enables a person to face difficulty, danger, pain, etc., without fear.” Courageous leaders lead with principles–their True North–that guide them when pressure mounts. They don’t shirk bold actions because they fear failure. They don’t need external adulation, nor do they shrink from facing criticism.

"COURAGEOUS LEADERS TAKE RISKS THAT GO AGAINST THE GRAIN OF THEIR ORGANIZATIONS."

Courage is neither an intellectual quality, nor can it be taught in the classroom. It can only be gained through multiple experiences involving personal risk-taking. Courage comes from the heart. As Buddhist monk Thich Nhat Hanh once said, “The longest journey you will ever take is the 18 inches from your head to your heart.”

It takes bold decisions to build great global companies. If businesses are managed without courageous leadership, then R&D programs, product pipelines, investments in emerging markets, and employees’ commitment to the company’s mission all wither. These organizations can slip into malaise and may eventually fail, even if their leaders can move on to avoid being held accountable.

Why do some leaders lack courage? Many CEOs focus too much on managing to hit their numbers. They avoid making risky decisions that may make them look bad in the eyes of peers and external critics. Often, they eschew major decisions because they fear failure. I know, because it happened to me.

In my first year as CEO of Medtronic, I passed up the opportunity to buy a rapidly growing angioplasty company because it faced patent and pricing risks. While those risks proved valid, Boston Scientific bought the company instead, transforming both enterprises and creating a formidable competitor for Medtronic. I didn’t have the courage to accept short-term risk to create long-term gain. It took Medtronic two decades of expensive research and development programs and additional acquisitions to become the leader in this field.

Let’s look at some recent examples of courageous leaders whose actions transformed their companies:

Alan Mulally

When Mulally arrived at Ford, he found a depleted organization losing $18 billion that year and unwilling to address its fundamental issues. To retool Ford’s entire product line and automate its factories, Mulally borrowed $23.5 billion, convincing the Ford family to pledge its stock and the famous Ford Blue Oval as collateral. His bold move paid off. Unlike its Detroit competitors, Ford avoided bankruptcy, regained market share, and returned to profitability.

Mary Barra

In contrast to Mulally, General Motors CEO Rick Wagoner and his predecessors refused to transform GM’s product line, even as the company’s North American market share slid from 50 percent in the 1970s to 18 percent. When the automobile market collapsed in late 2008, Wagoner was forced to ask President George W. Bush to bail the company out. Even so, GM declared bankruptcy months later.

Mary Barra, GM’s CEO since 2014, demonstrates the difference courage can make. Immediately after her appointment, she testified before a hostile Senate investigating committee about deaths from failed ignition switches on Chevrolet Camaros. Rather than make excuses, Barra took responsibility for the problems and went further to attribute them to “GM’s cultural problems.” Three years later, she is well on her way to transforming GM’s moribund, finance-driven culture into a dynamic, accountable organization focused on building quality vehicles worldwide.

Paul Polman

When Polman became Unilever’s CEO in early 2009, he immediately began transforming the company, declaring bold goals to double revenues and generate 70 percent from emerging markets. He aligned 175,000 employees around sustainability, publishing the Unilever Sustainable Living Plan with well-defined metrics the following year. Polman’s efforts in his first eight years returned 214 percent to Unilever shareholders. Nevertheless, Kraft Heinz, owned by Brazilian private equity firm 3G, made a hostile bid to acquire Unilever on February 17, 2017. Polman immediately wheeled into action, convincing KHC to drop its bid two days later. Then he announced seven bold moves to enhance shareholder value without compromising the company’s ambitious long-term plans.

In comparison, Kraft CEO Irene Rosenfeld quickly capitulated when confronted by activist Nelson Peltz in 2012. He wanted to split Kraft’s global business by spinning off its North American grocery products unit, which Rosenfeld wound up leading as an international business renamed Mondelez. Without the ability to access global markets, the old Kraft went into a period of decline, making it vulnerable to 3G’s 2015 takeover; meanwhile, Mondelez is adrift with declining revenues and earnings.

Indra Nooyi

Named CEO of PepsiCo in 2006, Nooyi foresaw the coming shift among consumers, especially the millennial generation, to healthier foods and beverages. She immediately introduced PepsiCo’s strategy “Performance with Purpose,” that focuses on complementing the company’s core soft drink and snack business with healthy foods and beverages. In 2013, PepsiCo was challenged by activist Peltz to split the company, but Nooyi steadfastly refused. Instead, she restructured her leadership team to deliver strong near-term performance while continuing to invest in her transformation strategy.

Nooyi’s arch-rival, Coca-Cola CEO Muhtar Kent, decided instead to concentrate on sugar-based soft drinks while ignoring these obvious trends. As a result, Coca-Cola’s performance has consistently lagged PepsiCo’s. Since 2011, PepsiCo stock is up 70 percent, while Coca-Cola’s has increased only 15 percent.

The courage cohort

There are literally thousands of competent managers who can run organizations efficiently using pre-determined operating plans, but few with the courage to transform entire enterprises.

The courage cohort includes Delta’s Richard Anderson, Starbucks’ Howard Schultz, Xerox’s Anne Mulcahy and Ursula Burns, Nestle’s Peter Brabeck-Letmathe, Novartis’ Dan Vasella, Tesla’s Elon Musk, Amazon’s Jeff Bezos, Merck’s Ken Frazier, and Alibaba’s Jack Ma. They join the growing list of authentic leaders that have made courageous decisions to build great global companies.

To quote poet Maya Angelou, “Courage is the most important of all the virtues, because without courage you can't practice any other virtue consistently.” Boards of directors need to examine their leaders carefully to determine if they have the courage to navigate their organizations through turbulent times while enduring hardship, risk, and criticism to ensure they are building sustainable enterprises.

With more courageous leaders like those cited above, the business world will be able to create enormous value for all its stakeholders.

Bill George is Senior Fellow at Harvard Business School, former Chair & CEO of Medtronic, and author of Discover Your True North.

This article originally appeared on Harvard Business School Working Knowledge, a great resource for anyone interested in learning more about hundreds of business topics. 

Each year almost 50,000 people apply to pitch their start-up businesses on Shark Tank. Only a few hundred of them are invited to Sony Studios for taping. And barely half of them actually appear on television.

Two of the lucky ones were my former Harvard Business School student Nate Barbera and his classmate Des Stolar. How they beat those odds offer great lessons for anyone pitching an idea, seeking investors, or courting potential business partners. Nate and Des’s was promoting their novel product—Unshrinkit—a potion that restores improperly washed wool garments to their original size.

They had developed it as part of an HBS requirement that MBA students launch a company and secure real customers. At the outset Nate and Des were mixing the stuff in their dorm room sinks. Even after finding an outfit to produce and distribute their product, sales online and in stores were small compared to the potential market. To build a real business they needed publicity—and what better way to get it than an appearance on Shark Tank.

Nate and Des did three things right to get on the show.

First, they understood that they had to pitch themselves rather than their product. After all, the show’s producers are in the entertainment business. They need entrepreneurs with distinctive personalities who will spark reactions from the panel of sharks. In reviewing applications, perhaps the producers expected Nate and Des to be stereotypical know-it-all MBA students, though that’s not how they come across at all. He is an earnest engineer and she is warm, confident, and ultra-smart. The sharks clearly would be intrigued by their personal story.

Second, Nate and Des prepared obsessively, reviewing all the prior episodes to see what makes a winning pitch and—even more important—how the sharks interact themselves. Nate and Des also dissected the pros and cons of various offers they might receive. They even drew elaborate decision trees mapping out different ways the process might unfold. Naturally they focused on Lori Greiner, the “queen of QTV,” a great platform for their household product.

Shark Tank tapings are grueling. What we viewers see is radically edited down. Nate and Des were on stage for two hours and three minutes without a break. When you’re in front of the camera, of course, things happen very fast.

Des recalls being peppered with demanding questions from the sharks and the futility of trying to answer them all. Midst it all, she told herself, “If I pretend that I’ve only heard the question that I like and I answer that, maybe just maybe, it will lead to a follow-up question I like even more.”

Once she did that, there was a “domino effect where every single question aligned with the story that Nate and I wanted to present, and they all thought we were doing well.” But then there was a crisis. Des describes it as “the most nerve wracking portion of the entire session.” Lori withdrew, saying, “I love you guys. I like the product. I don’t think the market size is there.”

In the heat of the moment, under the glare of the TV lights, Nate and Des let go of their plan and deftly pivoted. Lori’s statement was crushing, not only because she had been their top choice, but because her knowledge of home goods could sway the opinions of the other four sharks.

Des kept her composure and asked Lori to explain her thinking. Lori admitted that had been a long time since she had last done her own laundry, but she didn’t think many people would make the mistake of mishandling their woolen garments.

The other sharks—sensing that Lori had misjudged the market—started arguing with Lori, confessing that they make mistakes like that all the time. That allowed Nate and Des to step back and let the other sharks convince themselves of the product’s potential value.

In the end, three of them made offers, with Mark Cuban jumping in at the last moment with the best one. Having watched Cuban in all the prior episodes of the show, Nate and Des knew that he doesn’t like to haggle, so after quickly nodding to each other, they happily said yes.

They were glad to get his endorsement, of course, but even more important making that deal ensured that their segment would air—and not just once, but in reruns, too. Since it first appeared, sales of Unshrinkit are way up and it’s now available in Canada and Europe. (Nate and Des's whole story is also a cornerstone case in my HBX Negotiation Mastery course.)

Few of us will make it to national television, of course, but whenever we’re pitching a new idea, we’d be smart to remember that first and foremost we must win people’s confidence and generate excitement. Though we can’t anticipate everything, diligent preparation actually enhances our ability to improvise when things take an unexpected turn.

This article was originally published on LinkedIn Pulse.

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About the Author

Professor Mike Wheeler's current research focuses on negotiation dynamics, dispute resolution, ethics, and distance learning. He is the author or co-author of eleven books, and his self-assessment app—Negotiation360—was released early in 2015. Additionally, Professor Wheeler's new HBX course, Negotiation Mastery: Unlocking Value in the Real World, is now accepting applications.

There’s been a lot written about cognitive biases in the last decade. If you walk into the Psychology section of Barnes of Noble today or browse Amazon for “decision-making,” you’re sure to see a library of books on how irrational humans can be.

In my last two posts, I spoke about two of the most pernicious biases affecting businesses today—confirmation bias and over-confidence. But the most important, and troubling, error we make in our thinking just may be the Fundamental Attribution Error (FAE).

What’s the fundamental attribution error?

The FAE is our tendency to attribute another’s actions to their character, while attributing our own behavior to external situational factors. If you’ve ever chastised a “lazy employee” for being late to a meeting and then proceeded to make an excuse for being late yourself later that same day, you’ve made the FAE. It’s our tendency to cut ourselves a break while holding others 100% accountable for their actions.

But don’t feel too bad—the FAE is perfectly human. And similar to confirmation and overconfidence biases, its impact can be reduced by taking a number of measures.

FAE exists because of the way in which we perceive the world. While we have at least some idea of our own character, motivations, and the situational factors affecting us day-to-day, we rarely know all of the things going on with someone else.

In working with our colleagues, for example, we form a general impression of their character based on pieces of situations, but never see the whole picture. While it would be nice to give them the benefit of the doubt, our brains use limited information to make judgments. And thus we only have their perceived character available to us to chastise them for being tardy to the big corporate strategy review.

Within organizations, FAE causes everything from arguments to firings and ruptures in organizational culture. In fact, it’s at the root of any misunderstanding in which human motivations have the potential to be misinterpreted.

Think of the last time you thought a coworker should be fired or the last time a customer service representative was incompetent. How often have you really tried to understand the situational factors that could be affecting this person’s work? Probably not much.

FAE is so prevalent because it’s rooted in psychology, so completely overcoming it is impossible. However, one tool that I’ve found helpful in combating FAE is gratitude. When you become resentful at someone for a bad “quality” they demonstrate, try to make a list of five positive qualities the person also has—this will help balance out your perspective. 

Another method is to practice becoming more emotionally intelligent. Emotional intelligence has become a buzzword in the business world over the past 20 to 30 years, but all it involves is practicing self-awareness, empathy, self-regulation and other methods of becoming more objective in the service of one’s long-term interests and the interests of others. Practicing empathy, in particular, such as having discussions with coworkers about their opinions on projects and life out of the office, is a good first step.

FAE is impossible to overcome completely. But with a combination of awareness and a few small tools and tactics, you can be more gracious and empathetic with your coworkers.

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Interested in expanding your business vocabulary and learning the skills Harvard Business School's top faculty deemed most important for any professional, regardless of industry or job title?

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This post originally appeared on Fortune.com as part of the Leadership Insiders network. The Leadership Insiders network is an online community where the most thoughtful and influential people in business contribute answers to timely questions about careers and leadership. The question Patrick answered was, “What advice do you have for college graduates entering the workforce?” 

If you are graduating this month or next from a higher education institution, let me congratulate you. Generally speaking, you have increased the odds that your economic prosperity and well-being will be enhanced by this accomplishment.

I am sure you are tired of hearing old goats offer their advice through the written word or lofty commencement addresses, but I’d like to share my thoughts while you have a chance to breathe before entering that next period of your life: the employed adult phase.

Those who came before you know something too

I’m sure you’ve seen plenty of articles in which corporate leaders bemoan the expectations and demands of millennials. I think that many such criticisms of your generation are unfair. That said, I’ve read an equal number of articles about how corporations need to change to accommodate you.

As with most things in life, the truth is in the middle. There is little doubt that you will have the opportunity to shape the way work is conducted. But don’t forget that there are literally centuries of acquired knowledge about how to do things that came well before you were even born. Don’t throw all of those ideas out. Pick the best of your world and the “old” one.

Things won’t go according to plan

This is one I’m sure you’ve heard. But it bears repeating: You are not completely in charge of your own destiny. Finding a passion you didn’t expect, falling in love, getting sick or injured, being fired, losing a loved one, working for a horrible boss—all of these things and hundreds more can derail you. Plan for that.

I’m not arguing that you should expect the worst. But do train yourself to be nimble and comfortable with the idea that where you end up is likely not to be where you originally planned. Expect this in both your work and personal life. Jobs and companies come and go, so dive into what you are paid to do but think about how you would use your skills in another context.

Don’t worship money

I love money as much as the next person. I’d rather have more of it than less of it and you should negotiate like hell to get the best deal for yourself when getting that first “real” job. But never forget that one day you won’t be there. That’s so hard to keep in mind while you are still young. But it’s a truth that’s inescapable.

Experiences are much more important to humans than goods. So when you do get money, save for retirement and take care of your family. But also use some of it to travel with those you love, or skydive, or hike Mount Everest, or learn to fly. When you are taking your last breath, you won’t be saying to those gathered around you, “Remember that time I got a bonus and I bought 200 shares of Google?” You’re much more likely to say, “Remember the time we watched the sunrise from Haleakala on Maui?”

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It’s that time of year again: college graduation! When professors wear ridiculous robes, the band plays Pomp and Circumstance, and weepy parents watch their babies don caps and gowns and walk across the stage to get their hard-earned diplomas.

It’s a magical time, full of hopes, dreams, and, for many graduates, intense anxiety about what’s next.

After diplomas are handed out and the band plays its final tune, it’s time for newly minted graduates to head out into the real world. If you’re in this boat, this may be your first time living on your own, managing your finances, and doing your own grocery shopping. It’s an exciting (and scary) new chapter of life, full of responsibilities and big decisions. And, if you’re like me back in 2013, you’ll probably have little idea what to do or how to make those decisions.

Never fear, economics is here to lend a hand! You're probably thinking, “Economics? You mean that class I never took in college?” Yep, that’s the one!

Most people think economics has to do with investing or the stock market (that’s finance actually). But in reality, economics is mostly concerned with how people make decisions and the ways their choices interact. To that end, the field of economics contains several principles, tools, and frameworks that you can use to think about the decisions you’ll make after school (and those you face every day).

Few concepts are more important than the principle of opportunity cost.

After graduation, you’ll undoubtedly face many decisions: where to live, what to do for work, who to date, and countless others. In each of these choices, you will face trade-offs. If you take a job at a consulting firm, for example, you’ll likely have to travel a lot and won’t be able to sleep in your own bed. If you date Lily or James, you (presumably) won’t be able to date Arthur or Molly. No choice is the “perfect” one because you must always give up something else in order to get it.

Economists like to say that “there’s no such thing as a free lunch.” The idea is that even if someone offers to buy you lunch, the meal isn’t costless. You still “pay” for it in the form of the time you spend at lunch not doing other things (like reading the new book you brought to work or dining with someone more interesting).

In fact, you incur costs with every decision you make. The opportunity cost of a decision is the value of the next best thing you give up to make that choice. In other words, it’s what you sacrifice in order choose one course of action over another. 

Post-graduate life (and life in general) is full of opportunity costs that you should account for when making decisions. For example, suppose you’re thinking about going to graduate school. If you do, you’ll need to pay tuition, buy books, and incur other expenses. The full price tag? $100,000 over two years. But the actual cost of attendance is much higher than this!

Why? Because, if you do attend, you forego the salary you could have earned by working. If you could get a job paying $50,000 per year, for instance, the total cost of grad school (accounting for this opportunity cost of not working for two years) has just doubled! 

But opportunity costs don’t just factor into career decisions. For example, suppose you’ve gotten a job in a new city and are now looking for a place to live. Your salary is modest, so you are hoping to rent as cheap a place as possible. You look in the city, but the apartments are so expensive! You eventually find a place for $300 per month less than ones right by work, but it is an hour train ride away. Should you take the apartment?

Well, it depends how much you value your time. If you do take it, that’s 2 hours in the car each day. 30 days per month, and that’s 60 hours total of time lost to driving (more with traffic). Is 60+ hours of your time worth $300 dollars to you?

Economics can’t tell you whether or not to exchange time for money. But it can provide important principles and frameworks with which to help you make these decisions.

So when you’re making big decisions as a newly minted graduate, remember to consider opportunity costs—there’s no such thing as a free lunch!

Although, if you do value your time, you can always get lunch delivered.

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Interested in learning more about Economics, Financial Accounting, and Business Analytics? Our fundamentals of business program, HBX CORe, may be a good fit for you:

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About the Author

Pat is a member of the HBX Course Delivery Team and currently works on the Economics for Managers course for the Credential of Readiness (CORe) program. He is also currently working to design courses in Management and Negotiations for the HBX platform. Pat holds a B.A. in Economics and Government from Dartmouth College. In his free time he enjoys playing tennis and strumming the guitar.

As I begin another seemingly ordinary week, I can't help feeling extraordinary.

On this particular morning, I made my usual stop at Starbucks. I answered emails, as I routinely do first thing in the morning. And I prepared for the various meetings I have scheduled for today, as I typically do on Mondays. Nothing about what I’ve done so far today is different. However, I feel different.

My perspective is new and fresh. The feeling of change, in and of itself, is not new to me. I know transformative experiences well.

I spent much of my youth on stage learning how to perform in front of a live audience. I learned preparation, improvisation, failure and resilience in the face of failure. I once left my tightly-knit family life at home for college in Boston (Go BU!). I enrolled in law school and ultimately became an attorney. I argued a case (successfully) in front of a tribunal of Justices at the Massachusetts Appeals Court as a law student. I opened a company in order to transition from the traditional role of "attorney" to that of strategy consultant. And I have traveled as much as possible over the last few years, seeking out new opportunities to learn about other cultures and enhance how I perceive the activities of my own life.

HBX ConneXt now belongs on my list of transformative experiences.

This past weekend may not have been as intensive in nature or lengthy in duration as some of my other life experiences, but its impact was extremely powerful. Yes, being on campus at Harvard Business School is somehow simultaneously frightening and liberating. There is a unique amount of pressure to be the best version of yourself as well as a palpable feeling of confidence that you can change the world. Sitting in on an MBA-caliber class session (as I did in Professor Ethan Bernstein's classroom) is an absolutely electric feeling. And, having the opportunity to converse with some of the world's most renowned academic minds in the field of business is something many ambitious professionals wish they could do, but fail to realize.

If you considered any of the above reasons to be why I feel different today, I wouldn't fault you. Each is worthy on its own. You’d probably even be partially correct. The real reason, however, originates from something else. And perhaps this is why HBS continues to be the leading B-school in the world. The real reason is grounded in the numerous conversations I had with the talented people I am proud to call my peers. These people, as it turns out, come from all walks of life and all corners of the globe. The breadth of their experiences in the aggregate is unquestionably mind-boggling. This becomes increasingly evident as you move through a crowd at an event like HBX ConneXt.

I feel different today because I am aware, now more than ever, of the unpredictability of tomorrow’s possibilities. A relationship created during CORe, further reinforced at an event like ConneXt, may ultimately lead to a business venture in India. Some unforeseen project may be just around the corner, possible only because of a friendship I forged over the weekend with a classmate from a different cohort. This is what I imagine to be one of the top strengths of the MBA program: a magical mixture of diversity, talent and ambition. If I can sense it after a single weekend, I can only begin to comprehend the effect of the full-time MBA program.

Community can be a powerful platform for success. The HBX community is one such platform. Despite still being in its infancy, the program shows immense promise. Ever evolving, the HBX division of the school challenges the traditional medium of education. It provides a pathway to arguably the most influential professional network in the world, that of Harvard Business School. And most importantly, it fosters new relationships and sparks new ideas between like-minded, ambitious people looking to further their business acumen.

How fortunate are we to live in an age when we can be a part of such a program? The awesomeness of this is not lost on me. And while the HBX community is primarily based online, it’s almost preferable. Today, almost all network connections are sustained online. We are a community of doers with the ability to learn together, learn from one another, and connec(X)t. I look forward to cultivating more relationships and connections. I look forward to traveling the globe to visit new friends and peers. And I especially look forward to contributing to the HBX community in whatever way I can.

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Love 'em or hate 'em, sales calls are a necessary ingredient for organizational success. The sales process is full of nuances, so we turned to Wendy Casey from our HBX Business Development team for some tricks of the trade.

1. Do your research before calling on a prospect.

Learn as much as possible about their business, industry, and competitors. With this information you will be able to ask relevant questions and uncover their possible pain points.

2. Knowledge is power.

The more you know about your product or offering before you make the call, the better you will be able to understand whether you can provide a beneficial solution to your prospect.

3. As a sales person you should always be thinking about the next step in the process.

Go in to the call with a goal. Whether it is a cold call and your goal is to get an in-person meeting or it's a follow up conversation and you want to get a signed contract; set an end goal and then ask the closing question to get to the next step in the sales process.

4. Channel your inner Mary Tyler Moore – turn the world on with your smile!

Smile and be curious. These may seem like two separate things but they serve the same purpose. People buy from people they like and trust. Whether on the phone or in person, smile and ask open-ended questions to try to get to know your prospective client as an individual, don't just treat them as a potential sale.

5. Know what role your contact plays in the organization.

In the book The New Strategic Selling, authors Miller and Heiman list four types buying influences. Which of these categories does your contact fall under?

• Economic Buying Influence/Decision Maker: This is the person who signs the check! If this is not the person you are talking with, find out how your contact is connected to them and what the decision maker will need from your company to close the deal.
• User Buying Influences: These people have an interest in the product and/or service in question. It will directly affect their productivity.
• Technical Buying Influences: These people screen suppliers. Providing them with information to avoid possible barriers to close is key.
• Coaches/Champions: Coaches are allies inside the client organization that can help the sales person to move the order forward, mainly by giving advice on the people and processes in the organization. *

Knowledge of what role they play will allow you to navigate the sales process and to a quicker path to “Yes”!

Do you have any other tips for making sales calls? Leave a comment below!

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Earlier this week, we analyzed reports of Tesla's market capitalization passing both Ford Motor Company and General Motors, and found that these eye-catching headlines can mostly be explained by the different capital structure of Tesla compared to its older rivals.

Today, we’re taking things a step further and discussing why Tesla might be valued so highly, despite being a very small company. To do this, we’ll need to look at the ratio of Enterprise Value (a finance term meaning the total operational value of the company) to EBITDA, an acronym for Earnings Before Interest, Taxes, Depreciation and Amortization.

EBITDA

When examining earnings, financial analysts generally don't like to look at the raw net income profitability of a company because it's manipulated in a lot of ways by the conventions of accounting, and some of them can really distort the true picture.

To start with, the tax policies of a country seem like a distraction from the actual success of a company - they can vary across countries or across time, even if nothing actually changes in the operational capabilities of the company. Second, Net Income subtracts interest payments to debt holders, which can make companies look more or less successful based solely on their capital structures. That doesn't seem to make sense - so we add both of those back to arrive at EBIT (Earnings Before Interest and Taxes), which we call operating earnings.

Next, we look at depreciation and amortization. In normal accounting, if a company purchases equipment or a building, it doesn't record that transaction all at once - it charges itself an expense called depreciation over time. But the company isn't really spending any money on that depreciation; it isn't real. Amortization is the same thing as depreciation, but for things like patents and intellectual property; once again, no actual money is being spent on this expense.

In some ways, then, depreciation and amortization can take the earnings of a rapidly growing company look worse than a declining company, and that's definitely not right. This sort of distorted picture especially happens to companies like Amazon and Tesla.

Now that we understand how we arrive at EBITDA for each company, we can look at these ratios.

According to the Capital IQ database, Tesla has an Enterprise Value to EBITDA ratio of 36x. Ford's is 15x, and GM's is 6x. So what do these ratios mean?

Present Value of a Growing Perpetuity Formula

One way to think about these ratios is as a part of the growing perpetuity equation. A growing perpetuity is a kind of financial instrument that pays out a certain amount of money every year, and that amount of money grows each year as well. Imagine an annual stipend for retirement that needs to grow every year to match inflation. The growing perpetuity equation allows us to find out today’s value for that sort of financial instrument. Here’s the equation:

So, in our retirement example, someone who wanted to receive $30,000 every year, forever, with a discount rate of 10% and an annual growth rate of 2% (to cover expected inflation) would need $375,000 [30,000/(10%-2%)]. That’s the present value of that arrangement.

What does this have to do with companies? Well, we can imagine the EBITDA of a company as a growing perpetuity paid out every year to the capital holders (both debt and equity) of the company. If a company can be thought of as a stream of cash flows that grow each year, and we know the discount rate (which is that company’s cost of capital), we can use this equation to quickly value the enterprise value of a company.

To do this, we’re going to need some algebra to convert our ratios to this formula. Let’s take Tesla, with an Enterprise to EBITDA ratio of 36x. That means the Enterprise Value of Tesla is 36 times higher than its EBITDA. 

If we look at the growing perpetuity formula and use EBITDA as the Cash Flow and Enterprise Value as the value we’re trying to solve for in this equation, then we know that whatever we’re dividing EBITDA by (the Discount Rate – Growth Rate) is going to have to give us an answer that is 36 times what we have in the numerator. 

In other words, the denominator needs to be 1/36, or 2.8%. If we repeat this example with Ford, we would find a denominator of 1/15, or 6.7%. For GM, it would be 1/6, or 16.7%.

The Power of Growth

Plugging it back into the original equation, we know that the percentage is equal to the Cost of Capital - Growth Rate, so we could imagine that Tesla might have a cost of capital of 20% and a growth rate of 17.2%. Or it might have a cost of capital of 13% and a growth rate of 10.2%.

The ratio doesn't tell us exactly, but one thing it does tell us is that the market believes that Tesla's future growth rate will be very close to its cost of capital (unsurprisingly, Tesla's first quarter sales were 69% higher than this time last year).

If we repeat this with GM, we might imagine a cost of capital of 20% and a growth rate of only 3.3% - much less optimistic than Tesla.

In finance, growth is powerful. It explains why, despite being a much, much smaller company, Tesla carries a very high enterprise value. The market has taken notice that, though Tesla is much smaller than Ford or GM in total enterprise value and revenues today, that may not always be the case.

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Two University of Chicago psychologists, Kaitlin Woolley and Ayelet Fishbach, recently ran a set of experiments to see whether what people eat impacts trust and cooperation.

What the researchers discovered surprised me. And it should be food for thought for you next time you go to the bargaining table.

Woolley and Fishbach paired up 124 subjects—all strangers—to do a labor relations exercise that I assign in my MBA Negotiation course at Harvard Business School. Under the rules parties have to go through successive rounds of concessions to narrow the gap between management’s offer and the union’s demands. (Their article is forthcoming in the Journal of Consumer Psychology.)

The researchers added what might seem like an innocuous twist. With one group, they gave each negotiator sweets (Tootsie Rolls or a cookie). For another group, each negotiator got salty food (potato chips or pretzels).

Don’t jump to conclusions. You might have guessed that the candy sweetened up the first group, so that they reached agreement faster than the group that got the salty snacks. Nope. There was virtually no difference in how those two grounds negotiated.

But the experimenters had also a created a third group, where one negotiator in each pair was given sweet food and the other got something salty. These mismatched pairs took twice as long to reach agreement than the pairs in the first two groups who ate the same thing. It wasn’t merely that the pairs who ate different food wasted time. Under the rules of the game, the subjects lost real money! Everyone had been told in advance that the longer they took to resolve the dispute, the less they’d be paid for doing the experiment.

Remember, nobody in any group got to choose what they ate. It was entirely random. So this wasn’t a case of people with similar tastes somehow bonding together. The similarity (or difference) in the food people were given to eat was entirely subliminal. Nevertheless the impact on the negotiation process was significant.

What’s going on here? And what does it mean for us next time we negotiate in the real world?

Woolley and Fishbach relate their experiments to a broader body of research on social mimicry. Studies have shown, for example, that mirroring other people’s gestures and expressions can foster trust and bolster persuasion (though it must be done subtly). Parallel work on verbal mimicry likewise suggests that trust can be enhanced by speaking at the same rate as your counterparts and repeating some of the words that they use.

These effect are real, but don’t go overboard. At a business lunch, you’re not guaranteed to win over a prospective client merely by ordering the same drink or meal that she does. She has to perceive value what you propose and be convinced that you can deliver on your promises.

But in the back of your head you should be monitoring how well you two are connecting. Whether or not you’re in sync is a function of your particular personalities, emotions, and behavior. It’s what each of you do and say—and how each of you reads the other.

Woolley and Fishbach add to the evidence that interpersonal connection is more than that. External factors come into play, as well. Cooperation is also influenced by whether the sun shining or what music is playing in the background. Those kind of atmospherics are beyond our control, of course. If anything, though, that’s an argument for giving greater attention to those things that we can do to improve trust and cooperation.

So, after the server has taken your prospect’s order (and it’s something palatable), it wouldn't hurt to say, “You know, that sounds good. I’ll have that, too.”

This article was originally published on LinkedIn Pulse.

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