More on Leadership

Will Lockett
3 years ago
Tesla recently disclosed its greatest secret.
The VP has revealed a secret that should frighten the rest of the EV world.
Tesla led the EV revolution. Elon Musk's invention offers a viable alternative to gas-guzzlers. Tesla has lost ground in recent years. VW, BMW, Mercedes, and Ford offer EVs with similar ranges, charging speeds, performance, and cost. Tesla's next-generation 4680 battery pack, Roadster, Cybertruck, and Semi were all delayed. CATL offers superior batteries than the 4680. Martin Viecha, Tesla's Vice President, recently told Business Insider something that startled the EV world and will establish Tesla as the EV king.
Viecha mentioned that Tesla's production costs have dropped 57% since 2017. This isn't due to cheaper batteries or devices like Model 3. No, this is due to amazing factory efficiency gains.
Musk wasn't crazy to want a nearly 100% automated production line, and Tesla's strategy of sticking with one model and improving it has paid off. Others change models every several years. This implies they must spend on new R&D, set up factories, and modernize service and parts systems. All of this costs a ton of money and prevents them from refining production to cut expenses.
Meanwhile, Tesla updates its vehicles progressively. Everything from the backseats to the screen has been enhanced in a 2022 Model 3. Tesla can refine, standardize, and cheaply produce every part without changing the production line.
In 2017, Tesla's automobile production averaged $84,000. In 2022, it'll be $36,000.
Mr. Viecha also claimed that new factories in Shanghai and Berlin will be significantly cheaper to operate once fully operating.
Tesla's hand is visible. Tesla selling $36,000 cars for $60,000 This barely beats the competition. Model Y long-range costs just over $60,000. Tesla makes $24,000+ every sale, giving it a 40% profit margin, one of the best in the auto business.
VW I.D4 costs about the same but makes no profit. Tesla's rivals face similar challenges. Their EVs make little or no profit.
Tesla costs the same as other EVs, but they're in a different league.
But don't forget that the battery pack accounts for 40% of an EV's cost. Tesla may soon fully utilize its 4680 battery pack.
The 4680 battery pack has larger cells and a unique internal design. This means fewer cells are needed for a car, making it cheaper to assemble and produce (per kWh). Energy density and charge speeds increase slightly.
Tesla underestimated the difficulty of making this revolutionary new cell. Each time they try to scale up production, quality drops and rejected cells rise.
Tesla recently installed this battery pack in Model Ys and is scaling production. If they succeed, Tesla battery prices will plummet.
Tesla's Model Ys 2170 battery costs $11,000. The same size pack with 4680 cells costs $3,400 less. Once scaled, it could be $5,500 (50%) less. The 4680 battery pack could reduce Tesla production costs by 20%.
With these cost savings, Tesla could sell Model Ys for $40,000 while still making a profit. They could offer a $25,000 car.
Even with new battery technology, it seems like other manufacturers will struggle to make EVs profitable.
Teslas cost about the same as competitors, so don't be fooled. Behind the scenes, they're still years ahead, and the 4680 battery pack and new factories will only increase that lead. Musk faces a first. He could sell Teslas at current prices and make billions while other manufacturers struggle. Or, he could massively undercut everyone and crush the competition once and for all. Tesla and Elon win.

Mike Tarullo
3 years ago
Even In a Crazy Market, Hire the Best People: The "First Ten" Rules
Hiring is difficult, but you shouldn't compromise on team members. Or it may suggest you need to look beyond years in a similar role/function.
Every hire should be someone we'd want as one of our first ten employees.
If you hire such people, your team will adapt, initiate, and problem-solve, and your company will grow. You'll stay nimble even as you scale, and you'll learn from your colleagues.
If you only hire for a specific role or someone who can execute the job, you'll become a cluster of optimizers, and talent will depart for a more fascinating company. A startup is continually changing, therefore you want individuals that embrace it.
As a leader, establishing ideal conditions for talent and having a real ideology should be high on your agenda. You can't eliminate attrition, nor would you want to, but you can hire people who will become your company's leaders.
In my last four jobs I was employee 2, 5, 3, and 5. So while this is all a bit self serving, you’re the one reading my writing — and I have some experience with who works out in the first ten!
First, we'll examine what they do well (and why they're beneficial for startups), then what they don't, and how to hire them.
First 10 are:
Business partners: Because it's their company, they take care of whatever has to be done and have ideas about how to do it. You can rely on them to always put the success of the firm first because it is their top priority (company success is strongly connected with success for early workers). This approach will eventually take someone to leadership positions.
High Speed Learners: They process knowledge quickly and can reach 80%+ competency in a new subject matter rather quickly. A growing business that is successful tries new things frequently. We have all lost a lot of money and time on employees who follow the wrong playbook or who wait for someone else within the company to take care of them.
Autodidacts learn by trial and error, osmosis, networking with others, applying first principles, and reading voraciously (articles, newsletters, books, and even social media). Although teaching is wonderful, you won't have time.
Self-scaling: They figure out a means to deal with issues and avoid doing the grunt labor over the long haul, increasing their leverage. Great people don't keep doing the same thing forever; as they expand, they use automation and delegation to fill in their lower branches. This is a crucial one; even though you'll still adore them, you'll have to manage their scope or help them learn how to scale on their own.
Free Range: You can direct them toward objectives rather than specific chores. Check-ins can be used to keep them generally on course without stifling invention instead of giving them precise instructions because doing so will obscure their light.
When people are inspired, they bring their own ideas about what a firm can be and become animated during discussions about how to get there.
Novelty Seeking: They look for business and personal growth chances. Give them fresh assignments and new directions to follow around once every three months.
Here’s what the First Ten types may not be:
Domain specialists. When you look at their resumes, you'll almost certainly think they're unqualified. Fortunately, a few strategically positioned experts may empower a number of First Ten types by serving on a leadership team or in advising capacities.
Balanced. These people become very invested, and they may be vulnerable to many types of stress. You may need to assist them in managing their own stress and coaching them through obstacles. If you are reading this and work at Banza, I apologize for not doing a better job of supporting this. I need to be better at it.
Able to handle micromanagement with ease. People who like to be in charge will suppress these people. Good decision-making should be delegated to competent individuals. Generally speaking, if you wish to scale.
Great startup team members have versatility, learning, innovation, and energy. When we hire for the function, not the person, we become dull and staid. Could this person go to another department if needed? Could they expand two levels in a few years?
First Ten qualities and experience level may have a weak inverse association. People with 20+ years of experience who had worked at larger organizations wanted to try something new and had a growth mentality. College graduates may want to be told what to do and how to accomplish it so they can stay in their lane and do what their management asks.
Does the First Ten archetype sound right for your org? Cool, let’s go hiring. How will you know when you’ve found one?
They exhibit adaptive excellence, excelling at a variety of unrelated tasks. It could be hobbies or professional talents. This suggests that they will succeed in the next several endeavors they pursue.
Successful risk-taking is doing something that wasn't certain to succeed, sometimes more than once, and making it do so. It's an attitude.
Rapid Rise: They regularly change roles and get promoted. However, they don't leave companies when the going gets tough. Look for promotions at every stop and at least one position with three or more years of experience.
You can ask them:
Tell me about a time when you started from scratch or achieved success. What occurred en route? You might request a variety of tales from various occupations or even aspects of life. They ought to be energized by this.
What new skills have you just acquired? It is not required to be work-related. They must be able to describe it and unintentionally become enthusiastic about it.
Tell me about a moment when you encountered a challenge and had to alter your strategy. The core of a startup is reinventing itself when faced with obstacles.
Tell me about a moment when you eliminated yourself from a position at work. They've demonstrated they can permanently solve one issue and develop into a new one, as stated above.
Why do you want to leave X position or Y duty? These people ought to be moving forward, not backward, all the time. Instead, they will discuss what they are looking forward to visiting your location.
Any questions? Due to their inherent curiosity and desire to learn new things, they should practically never run out of questions. You can really tell if they are sufficiently curious at this point.
People who see their success as being the same as the success of the organization are the best-case team members, in any market. They’ll grow and change with the company, and always try to prioritize what matters. You’ll find yourself more energized by your work because you’re surrounded by others who are as well. Happy teambuilding!
Sam Hickmann
3 years ago
Improving collaboration with the Six Thinking Hats
Six Thinking Hats was written by Dr. Edward de Bono. "Six Thinking Hats" and parallel thinking allow groups to plan thinking processes in a detailed and cohesive way, improving collaboration.
Fundamental ideas
In order to develop strategies for thinking about specific issues, the method assumes that the human brain thinks in a variety of ways that can be intentionally challenged. De Bono identifies six brain-challenging directions. In each direction, the brain brings certain issues into conscious thought (e.g. gut instinct, pessimistic judgement, neutral facts). Some may find wearing hats unnatural, uncomfortable, or counterproductive.
The example of "mismatch" sensitivity is compelling. In the natural world, something out of the ordinary may be dangerous. This mode causes negative judgment and critical thinking.
Colored hats represent each direction. Putting on a colored hat symbolizes changing direction, either literally or metaphorically. De Bono first used this metaphor in his 1971 book "Lateral Thinking for Management" to describe a brainstorming framework. These metaphors allow more complete and elaborate thought separation. Six thinking hats indicate ideas' problems and solutions.
Similarly, his CoRT Thinking Programme introduced "The Five Stages of Thinking" method in 1973.
| HAT | OVERVIEW | TECHNIQUE |
|---|---|---|
| BLUE | "The Big Picture" & Managing | CAF (Consider All Factors); FIP (First Important Priorities) |
| WHITE | "Facts & Information" | Information |
| RED | "Feelings & Emotions" | Emotions and Ego |
| BLACK | "Negative" | PMI (Plus, Minus, Interesting); Evaluation |
| YELLOW | "Positive" | PMI |
| GREEN | "New Ideas" | Concept Challenge; Yes, No, Po |
Strategies and programs
After identifying the six thinking modes, programs can be created. These are groups of hats that encompass and structure the thinking process. Several of these are included in the materials for franchised six hats training, but they must often be adapted. Programs are often "emergent," meaning the group plans the first few hats and the facilitator decides what to do next.
The group agrees on how to think, then thinks, then evaluates the results and decides what to do next. Individuals or groups can use sequences (and indeed hats). Each hat is typically used for 2 minutes at a time, although an extended white hat session is common at the start of a process to get everyone on the same page. The red hat is recommended to be used for a very short period to get a visceral gut reaction – about 30 seconds, and in practice often takes the form of dot-voting.
| ACTIVITY | HAT SEQUENCE |
|---|---|
| Initial Ideas | Blue, White, Green, Blue |
| Choosing between alternatives | Blue, White, (Green), Yellow, Black, Red, Blue |
| Identifying Solutions | Blue, White, Black, Green, Blue |
| Quick Feedback | Blue, Black, Green, Blue |
| Strategic Planning | Blue, Yellow, Black, White, Blue, Green, Blue |
| Process Improvement | Blue, White, White (Other People's Views), Yellow, Black, Green, Red, Blue |
| Solving Problems | Blue, White, Green, Red, Yellow, Black, Green, Blue |
| Performance Review | Blue, Red, White, Yellow, Black, Green, Blue |
Use
Speedo's swimsuit designers reportedly used the six thinking hats. "They used the "Six Thinking Hats" method to brainstorm, with a green hat for creative ideas and a black one for feasibility.
Typically, a project begins with extensive white hat research. Each hat is used for a few minutes at a time, except the red hat, which is limited to 30 seconds to ensure an instinctive gut reaction, not judgement. According to Malcolm Gladwell's "blink" theory, this pace improves thinking.
De Bono believed that the key to a successful Six Thinking Hats session was focusing the discussion on a particular approach. A meeting may be called to review and solve a problem. The Six Thinking Hats method can be used in sequence to explore the problem, develop a set of solutions, and choose a solution through critical examination.
Everyone may don the Blue hat to discuss the meeting's goals and objectives. The discussion may then shift to Red hat thinking to gather opinions and reactions. This phase may also be used to determine who will be affected by the problem and/or solutions. The discussion may then shift to the (Yellow then) Green hat to generate solutions and ideas. The discussion may move from White hat thinking to Black hat thinking to develop solution set criticisms.
Because everyone is focused on one approach at a time, the group is more collaborative than if one person is reacting emotionally (Red hat), another is trying to be objective (White hat), and another is critical of the points which emerge from the discussion (Black hat). The hats help people approach problems from different angles and highlight problem-solving flaws.
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Muhammad Rahmatullah
3 years ago
The Pyramid of Coding Principles
A completely operating application requires many processes and technical challenges. Implementing coding standards can make apps right, work, and faster.
With years of experience working in software houses. Many client apps are scarcely maintained.
Why are these programs "barely maintainable"? If we're used to coding concepts, we can probably tell if an app is awful or good from its codebase.
This is how I coded much of my app.
Make It Work
Before adopting any concept, make sure the apps are completely functional. Why have a fully maintained codebase if the app can't be used?
The user doesn't care if the app is created on a super server or uses the greatest coding practices. The user just cares if the program helps them.
After the application is working, we may implement coding principles.
You Aren’t Gonna Need It
As a junior software engineer, I kept unneeded code, components, comments, etc., thinking I'd need them later.
In reality, I never use that code for weeks or months.
First, we must remove useless code from our primary codebase. If you insist on keeping it because "you'll need it later," employ version control.
If we remove code from our codebase, we can quickly roll back or copy-paste the previous code without preserving it permanently.
The larger the codebase, the more maintenance required.
Keep It Simple Stupid
Indeed. Keep things simple.
Why complicate something if we can make it simpler?
Our code improvements should lessen the server load and be manageable by others.
If our code didn't pass those benchmarks, it's too convoluted and needs restructuring. Using an open-source code critic or code smell library, we can quickly rewrite the code.
Simpler codebases and processes utilize fewer server resources.
Don't Repeat Yourself
Have you ever needed an action or process before every action, such as ensuring the user is logged in before accessing user pages?
As you can see from the above code, I try to call is user login? in every controller action, and it should be optimized, because if we need to rename the method or change the logic, etc. We can improve this method's efficiency.
We can write a constructor/middleware/before action that calls is_user_login?
The code is more maintainable and readable after refactoring.
Each programming language or framework handles this issue differently, so be adaptable.
Clean Code
Clean code is a broad notion that you've probably heard of before.
When creating a function, method, module, or variable name, the first rule of clean code is to be precise and simple.
The name should express its value or logic as a whole, and follow code rules because every programming language is distinct.
If you want to learn more about this topic, I recommend reading https://www.amazon.com/Clean-Code-Handbook-Software-Craftsmanship/dp/0132350882.
Standing On The Shoulder of Giants
Use industry standards and mature technologies, not your own(s).
There are several resources that explain how to build boilerplate code with tools, how to code with best practices, etc.
I propose following current conventions, best practices, and standardization since we shouldn't innovate on top of them until it gives us a competitive edge.
Boy Scout Rule
What reduces programmers' productivity?
When we have to maintain or build a project with messy code, our productivity decreases.
Having to cope with sloppy code will slow us down (shame of us).
How to cope? Uncle Bob's book says, "Always leave the campground cleaner than you found it."
When developing new features or maintaining current ones, we must improve our codebase. We can fix minor issues too. Renaming variables, deleting whitespace, standardizing indentation, etc.
Make It Fast
After making our code more maintainable, efficient, and understandable, we can speed up our app.
Whether it's database indexing, architecture, caching, etc.
A smart craftsman understands that refactoring takes time and it's preferable to balance all the principles simultaneously. Don't YAGNI phase 1.
Using these ideas in each iteration/milestone, while giving the bottom items less time/care.
You can check one of my articles for further information. https://medium.com/life-at-mekari/why-does-my-website-run-very-slowly-and-how-do-i-optimize-it-for-free-b21f8a2f0162

Pen Magnet
3 years ago
Why Google Staff Doesn't Work
Sundar Pichai unveiled Simplicity Sprint at Google's latest all-hands conference.
To boost employee efficiency.
Not surprising. Few envisioned Google declaring a productivity drive.
Sunder Pichai's speech:
“There are real concerns that our productivity as a whole is not where it needs to be for the head count we have. Help me create a culture that is more mission-focused, more focused on our products, more customer focused. We should think about how we can minimize distractions and really raise the bar on both product excellence and productivity.”
The primary driver driving Google's efficiency push is:
Google's efficiency push follows 13% quarterly revenue increase. Last year in the same quarter, it was 62%.
Market newcomers may argue that the previous year's figure was fuelled by post-Covid reopening and growing consumer spending. Investors aren't convinced. A promising company like Google can't afford to drop so quickly.
Google’s quarterly revenue growth stood at 13%, against 62% in last year same quarter.
Google isn't alone. In my recent essay regarding 2025 programmers, I warned about the economic downturn's effects on FAAMG's workforce. Facebook had suspended hiring, and Microsoft had promised hefty bonuses for loyal staff.
In the same article, I predicted Google's troubles. Online advertising, especially the way Google and Facebook sell it using user data, is over.
FAAMG and 2nd rung IT companies could be the first to fall without Post-COVID revival and uncertain global geopolitics.
Google has hardly ever discussed effectiveness:
Apparently openly.
Amazon treats its employees like robots, even in software positions. It has significant turnover and a terrible reputation as a result. Because of this, it rarely loses money due to staff productivity.
Amazon trumps Google. In reality, it treats its employees poorly.
Google was the founding father of the modern-day open culture.
Larry and Sergey Google founded the IT industry's Open Culture. Silicon Valley called Google's internal democracy and transparency near anarchy. Management rarely slammed decisions on employees. Surveys and internal polls ensured everyone knew the company's direction and had a vote.
20% project allotment (weekly free time to build own project) was Google's open-secret innovation component.
After Larry and Sergey's exit in 2019, this is Google's first profitability hurdle. Only Google insiders can answer these questions.
Would Google's investors compel the company's management to adopt an Amazon-style culture where the developers are treated like circus performers?
If so, would Google follow suit?
If so, how does Google go about doing it?
Before discussing Google's likely plan, let's examine programming productivity.
What determines a programmer's productivity is simple:
How would we answer Google's questions?
As a programmer, I'm more concerned about Simplicity Sprint's aftermath than its economic catalysts.
Large organizations don't care much about quarterly and annual productivity metrics. They have 10-year product-launch plans. If something seems horrible today, it's likely due to someone's lousy judgment 5 years ago who is no longer in the blame game.
Deconstruct our main question.
How exactly do you change the culture of the firm so that productivity increases?
How can you accomplish that without affecting your capacity to profit? There are countless ways to increase output without decreasing profit.
How can you accomplish this with little to no effect on employee motivation? (While not all employers care about it, in this case we are discussing the father of the open company culture.)
How do you do it for a 10-developer IT firm that is losing money versus a 1,70,000-developer organization with a trillion-dollar valuation?
When implementing a large-scale organizational change, success must be carefully measured.
The fastest way to do something is to do it right, no matter how long it takes.
You require clearly-defined group/team/role segregation and solid pass/fail matrices to:
You can give performers rewards.
Ones that are average can be inspired to improve
Underachievers may receive assistance or, in the worst-case scenario, rehabilitation
As a 20-year programmer, I associate productivity with greatness.
Doing something well, no matter how long it takes, is the fastest way to do it.
Let's discuss a programmer's productivity.
Why productivity is a strange term in programming:
Productivity is work per unit of time.
Money=time This is an economic proverb. More hours worked, more pay. Longer projects cost more.
As a buyer, you desire a quick supply. As a business owner, you want employees who perform at full capacity, creating more products to transport and boosting your profits.
All economic matrices encourage production because of our obsession with it. Productivity is the only organic way a nation may increase its GDP.
Time is money — is not just a proverb, but an economical fact.
Applying the same productivity theory to programming gets problematic. An automating computer. Its capacity depends on the software its master writes.
Today, a sophisticated program can process a billion records in a few hours. Creating one takes a competent coder and the necessary infrastructure. Learning, designing, coding, testing, and iterations take time.
Programming productivity isn't linear, unlike manufacturing and maintenance.
Average programmers produce code every day yet miss deadlines. Expert programmers go days without coding. End of sprint, they often surprise themselves by delivering fully working solutions.
Reversing the programming duties has no effect. Experts aren't needed for productivity.
These patterns remind me of an XKCD comic.
Programming productivity depends on two factors:
The capacity of the programmer and his or her command of the principles of computer science
His or her productive bursts, how often they occur, and how long they last as they engineer the answer
At some point, productivity measurement becomes Schrödinger’s cat.
Product companies measure productivity using use cases, classes, functions, or LOCs (lines of code). In days of data-rich source control systems, programmers' merge requests and/or commits are the most preferred yardstick. Companies assess productivity by tickets closed.
Every organization eventually has trouble measuring productivity. Finer measurements create more chaos. Every measure compares apples to oranges (or worse, apples with aircraft.) On top of the measuring overhead, the endeavor causes tremendous and unnecessary stress on teams, lowering their productivity and defeating its purpose.
Macro productivity measurements make sense. Amazon's factory-era management has done it, but at great cost.
Google can pull it off if it wants to.
What Google meant in reality when it said that employee productivity has decreased:
When Google considers its employees unproductive, it doesn't mean they don't complete enough work in the allotted period.
They can't multiply their work's influence over time.
Programmers who produce excellent modules or products are unsure on how to use them.
The best data scientists are unable to add the proper parameters in their models.
Despite having a great product backlog, managers struggle to recruit resources with the necessary skills.
Product designers who frequently develop and A/B test newer designs are unaware of why measures are inaccurate or whether they have already reached the saturation point.
Most ignorant: All of the aforementioned positions are aware of what to do with their deliverables, but neither their supervisors nor Google itself have given them sufficient authority.
So, Google employees aren't productive.
How to fix it?
Business analysis: White suits introducing novel items can interact with customers from all regions. Track analytics events proactively, especially the infrequent ones.
SOLID, DRY, TEST, and AUTOMATION: Do less + reuse. Use boilerplate code creation. If something already exists, don't implement it yourself.
Build features-building capabilities: N features are created by average programmers in N hours. An endless number of features can be built by average programmers thanks to the fact that expert programmers can produce 1 capability in N hours.
Work on projects that will have a positive impact: Use the same algorithm to search for images on YouTube rather than the Mars surface.
Avoid tasks that can only be measured in terms of time linearity at all costs (if a task can be completed in N minutes, then M copies of the same task would cost M*N minutes).
In conclusion:
Software development isn't linear. Why should the makers be measured?
Notation for The Big O
I'm discussing a new way to quantify programmer productivity. (It applies to other professions, but that's another subject)
The Big O notation expresses the paradigm (the algorithmic performance concept programmers rot to ace their Google interview)
Google (or any large corporation) can do this.
Sort organizational roles into categories and specify their impact vs. time objectives. A CXO role's time vs. effect function, for instance, has a complexity of O(log N), meaning that if a CEO raises his or her work time by 8x, the result only increases by 3x.
Plot the influence of each employee over time using the X and Y axes, respectively.
Add a multiplier for Y-axis values to the productivity equation to make business objectives matter. (Example values: Support = 5, Utility = 7, and Innovation = 10).
Compare employee scores in comparable categories (developers vs. devs, CXOs vs. CXOs, etc.) and reward or help employees based on whether they are ahead of or behind the pack.
After measuring every employee's inventiveness, it's straightforward to help underachievers and praise achievers.
Example of a Big(O) Category:
If I ran Google (God forbid, its worst days are far off), here's how I'd classify it. You can categorize Google employees whichever you choose.
The Google interview truth:
O(1) < O(log n) < O(n) < O(n log n) < O(n^x) where all logarithmic bases are < n.
O(1): Customer service workers' hours have no impact on firm profitability or customer pleasure.
CXOs Most of their time is spent on travel, strategic meetings, parties, and/or meetings with minimal floor-level influence. They're good at launching new products but bad at pivoting without disaster. Their directions are being followed.
Devops, UX designers, testers Agile projects revolve around deployment. DevOps controls the levers. Their automation secures results in subsequent cycles.
UX/UI Designers must still prototype UI elements despite improved design tools.
All test cases are proportional to use cases/functional units, hence testers' work is O(N).
Architects Their effort improves code quality. Their right/wrong interference affects product quality and rollout decisions even after the design is set.
Core Developers Only core developers can write code and own requirements. When people understand and own their labor, the output improves dramatically. A single character error can spread undetected throughout the SDLC and cost millions.
Core devs introduce/eliminate 1000x bugs, refactoring attempts, and regression. Following our earlier hypothesis.
The fastest way to do something is to do it right, no matter how long it takes.
Conclusion:
Google is at the liberal extreme of the employee-handling spectrum
Microsoft faced an existential crisis after 2000. It didn't choose Amazon's data-driven people management to revitalize itself.
Instead, it entrusted developers. It welcomed emerging technologies and opened up to open source, something it previously opposed.
Google is too lax in its employee-handling practices. With that foundation, it can only follow Amazon, no matter how carefully.
Any attempt to redefine people's measurements will affect the organization emotionally.
The more Google compares apples to apples, the higher its chances for future rebirth.

Theresa W. Carey
3 years ago
How Payment for Order Flow (PFOF) Works
What is PFOF?
PFOF is a brokerage firm's compensation for directing orders to different parties for trade execution. The brokerage firm receives fractions of a penny per share for directing the order to a market maker.
Each optionable stock could have thousands of contracts, so market makers dominate options trades. Order flow payments average less than $0.50 per option contract.
Order Flow Payments (PFOF) Explained
The proliferation of exchanges and electronic communication networks has complicated equity and options trading (ECNs) Ironically, Bernard Madoff, the Ponzi schemer, pioneered pay-for-order-flow.
In a December 2000 study on PFOF, the SEC said, "Payment for order flow is a method of transferring trading profits from market making to brokers who route customer orders to specialists for execution."
Given the complexity of trading thousands of stocks on multiple exchanges, market making has grown. Market makers are large firms that specialize in a set of stocks and options, maintaining an inventory of shares and contracts for buyers and sellers. Market makers are paid the bid-ask spread. Spreads have narrowed since 2001, when exchanges switched to decimals. A market maker's ability to play both sides of trades is key to profitability.
Benefits, requirements
A broker receives fees from a third party for order flow, sometimes without a client's knowledge. This invites conflicts of interest and criticism. Regulation NMS from 2005 requires brokers to disclose their policies and financial relationships with market makers.
Your broker must tell you if it's paid to send your orders to specific parties. This must be done at account opening and annually. The firm must disclose whether it participates in payment-for-order-flow and, upon request, every paid order. Brokerage clients can request payment data on specific transactions, but the response takes weeks.
Order flow payments save money. Smaller brokerage firms can benefit from routing orders through market makers and getting paid. This allows brokerage firms to send their orders to another firm to be executed with other orders, reducing costs. The market maker or exchange benefits from additional share volume, so it pays brokerage firms to direct traffic.
Retail investors, who lack bargaining power, may benefit from order-filling competition. Arrangements to steer the business in one direction invite wrongdoing, which can erode investor confidence in financial markets and their players.
Pay-for-order-flow criticism
It has always been controversial. Several firms offering zero-commission trades in the late 1990s routed orders to untrustworthy market makers. During the end of fractional pricing, the smallest stock spread was $0.125. Options spreads widened. Traders found that some of their "free" trades cost them a lot because they weren't getting the best price.
The SEC then studied the issue, focusing on options trades, and nearly decided to ban PFOF. The proliferation of options exchanges narrowed spreads because there was more competition for executing orders. Options market makers said their services provided liquidity. In its conclusion, the report said, "While increased multiple-listing produced immediate economic benefits to investors in the form of narrower quotes and effective spreads, these improvements have been muted with the spread of payment for order flow and internalization."
The SEC allowed payment for order flow to continue to prevent exchanges from gaining monopoly power. What would happen to trades if the practice was outlawed was also unclear. SEC requires brokers to disclose financial arrangements with market makers. Since then, the SEC has watched closely.
2020 Order Flow Payment
Rule 605 and Rule 606 show execution quality and order flow payment statistics on a broker's website. Despite being required by the SEC, these reports can be hard to find. The SEC mandated these reports in 2005, but the format and reporting requirements have changed over the years, most recently in 2018.
Brokers and market makers formed a working group with the Financial Information Forum (FIF) to standardize order execution quality reporting. Only one retail brokerage (Fidelity) and one market maker remain (Two Sigma Securities). FIF notes that the 605/606 reports "do not provide the level of information that allows a retail investor to gauge how well a broker-dealer fills a retail order compared to the NBBO (national best bid or offer’) at the time the order was received by the executing broker-dealer."
In the first quarter of 2020, Rule 606 reporting changed to require brokers to report net payments from market makers for S&P 500 and non-S&P 500 equity trades and options trades. Brokers must disclose payment rates per 100 shares by order type (market orders, marketable limit orders, non-marketable limit orders, and other orders).
Richard Repetto, Managing Director of New York-based Piper Sandler & Co., publishes a report on Rule 606 broker reports. Repetto focused on Charles Schwab, TD Ameritrade, E-TRADE, and Robinhood in Q2 2020. Repetto reported that payment for order flow was higher in the second quarter than the first due to increased trading activity, and that options paid more than equities.
Repetto says PFOF contributions rose overall. Schwab has the lowest options rates, while TD Ameritrade and Robinhood have the highest. Robinhood had the highest equity rating. Repetto assumes Robinhood's ability to charge higher PFOF reflects their order flow profitability and that they receive a fixed rate per spread (vs. a fixed rate per share by the other brokers).
Robinhood's PFOF in equities and options grew the most quarter-over-quarter of the four brokers Piper Sandler analyzed, as did their implied volumes. All four brokers saw higher PFOF rates.
TD Ameritrade took the biggest income hit when cutting trading commissions in fall 2019, and this report shows they're trying to make up the shortfall by routing orders for additional PFOF. Robinhood refuses to disclose trading statistics using the same metrics as the rest of the industry, offering only a vague explanation on their website.
Summary
Payment for order flow has become a major source of revenue as brokers offer no-commission equity (stock and ETF) orders. For retail investors, payment for order flow poses a problem because the brokerage may route orders to a market maker for its own benefit, not the investor's.
Infrequent or small-volume traders may not notice their broker's PFOF practices. Frequent traders and those who trade larger quantities should learn about their broker's order routing system to ensure they're not losing out on price improvement due to a broker prioritizing payment for order flow.
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