Professional Documents
Culture Documents
http://photos.prnewswire.com/prn/20100927/NY71523
Table of Contents
No.
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.
Topic
Summary Introduction Type I Behavior: Single year Profits-Revenues Growth Type III Behavior: Single year Profits-Revenues Growth Type III Behavior: Multi-year Profits-Revenues Growth Type I, Type II, Type III, Multi-year Profits-Revenues Growth Transitions in Profits-Revenues Growth Maximum Point on Profits-Revenues Graph Brief Discussion Einsteins Photoelectric Law and the Business World Data sources: Links to the Annual Reports Consulted Bibliography of related articles
Page No.
3 4 6 10 13 15 17 18 21 28 37 38
1. Summary
A recent article by Seth Stevenson, in the Slate magazine, on Southwest Airlines, caught my attention. It mentioned that Southwest Airlines has reported a profit year after year, for 39 years in a row. This got me interested since I have analyzing been the financial performance of companies, big and small, using a new methodology, which will be described here, shortly. I was able to obtain all of the profits-revenues data for Southwest all forty-one (41) years, from 1971-2011. During this study, I also found out that Southwest has recently acquired Air Tran, which was founded in 1993. Although they reported a profit for seven years, they also reported losses (for 6 out of 16 full years of operation) with the highest loss being in 2008. This article is about this Air Tran history since it will be a big part of the future of Southwest as the two airlines integrate their operations. I have studied all of the available profits-revenues data for Air Tran from 1993-2010, up until the merger in 2011. The results tell an interesting story and provide some clues about why the company was eventually faced with a merger as the solution to its longer term viability. It has not yet been generally appreciated that all businesses follow a universal, and actually a very simple, mathematical law, which can be shown to be a consequence of the classical breakeven analysis for profitability of a company. In the real world, this manifests itself as a simple linear law y = hx + c where x is revenues and y is profits and h and c are constants that can be deduced from the financial data. The constant c can be related to the fixed costs and the constant h to the unit variable cost in the breakeven model. Depending on the numerical values of h and c (positive or negative), we have three types of profits-revenues graphs, which lead to what may be called Type I, Type II, and Type III behavior. Thus, ALL businesses can be evaluated in terms of three basic types of profits-revenue graphs. Air Tran is a good example of a company which has exhibited all these three types of behavior over its brief sixteen year history. As we will see here, the Type III behavior is to be avoided since it usually leads to bankruptcy (as it happened with General Motors, outside the scope of the present discussion) or a merger (as it happened with Air Tran, which will be discussed briefly here).
Page 3 of 40
2. Introduction
A recent article in the Slate magazine by Seth Stevenson, on Southwest Airlines http://www.slate.com/articles/business/operations/2012/06/southwest_airlines_prof itability_how_the_company_uses_operations_theory_to_fuel_its_success_.html ) caught my attention. The article mentioned that Southwest Airlines, which was founded in 1971, has reported a profit, year-after-year, for 39 consecutive years. This got me interested since I have been studying the financial performance of companies, big and small, using a new methodology that is quite commonly used in science and engineering, but rarely seems to find its use in business, finance, economics, or the management sciences.
Airline Southwest Air Tran LUV AAI Stock Symbol June 18,1971 Oct 26, 1993 Founded Dallas, Texas Orlando, Florida Headquarters 34,636 8,083 Employees 547 138 Fleet (Active, as of Sep 27, 2010) http://www.getfilings.com/o0000931763-98-000779.html http://www.airtranairways.com/about-us/history.aspx A nice summary may be found here about history of Air Tran and its merger with Southwest Airlines During my study, I learned that Southwest has recently completed its acquisition of Air Tran, another low-cost carrier, founded in October 1993. Air Tran reported a nice profit in its first full year of operation in 1994, see Table 1. Both profits and revenues increased in 1995. Then tragedy struck in 1996 in the form of the ValuJet Flight 592 crash on May 11, 1996 (ValuJet had merged earlier with Air Tran) and the company reported its first loss. The losses increased and continued through 1999 and Air Tran finally returned to profitability in 2000. However, the huge loss reported in 2008, probably triggered Air Trans decision to seek a suitor. It is of interest to note that the sum total of all its revenues from 1993-2010 was $19.05 billion but the sum total all the profits and losses was a net loss of $46.5 million!
Page 4 of 40
Table 1: Air Tran Profits-Revenues data 1993-2010 Compiled from various Annual Reports
Year 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 Sum total Revenues, x $, millions 2619.712 2341.442 2552.478 2309.983 1892.083 1450.544 1041.422 918.04 733.37 665.164 624.094 523.468 439.307 211.456 219.636 367.757 133.901 5.811 19,049.67 Profits, y $, millions 38.543 134.662 -266.334 52.683 14.714 1.722 12.255 100.517 10.745 -2.757 47.436 -99.394 -40.738 -96.663 -41.469 67.763 20.732 -0.894 -46.477 Costs (x y) $, millions 2581.169 2206.78 2818.812 2257.3 1877.369 1448.822 1029.167 817.523 722.625 667.921 576.658 622.862 480.045 308.119 261.105 299.994 113.169 6.705
The merger with Southwest was approved overwhelmingly by shareholders on March 23, 2011. http://travel.usatoday.com/flights/post/2011/03/airtranshareholders-ok-southwest-merger/148989/1. A Single Operator Certificate (SOC) was issued in March 2012. Air Tran has thus ceased to exist. ****************************************************************** This article is about Air Tran since it will be a big part of the future of Southwest Airlines. The results are presented here without much discussion with the x-y profits-revenues graphs telling the story for us. Let us consider first the following classical breakeven analysis for the profitability of a company making and selling N units of a product (this could be airline seats in the case of Southwest or Air Tran). If p is the unit price, the
Page 5 of 40
revenues generated R = pN. Let a denote the fixed cost and b the unit variable cost. Then the total cost C = a + bN, the sum of the fixed cost and the total variable cost. Hence, the profits P = R C = (p b)N a, or eliminating N using R = N/p, we get the relation P = [(p b)/p] R a . This can be restated as a linear law relating revenues, lets call it x, and profits, y. Thus, y = hx + c Linear law for profits and revenues Slope h = 1 (b/p) ... determined by unit price p and unit variable cost b. Intercept c = - a ... determined by the fixed costs of the operation. Interestingly, however, the linear law y = hx + c, implied by the breakeven analysis, also suggests three different possibilities. Type I: Positive slope, negative intercept (h > 0 and c < 0, positive intercept on revenues-axis). Type II: Positive slope and positive intercept (h > 0 and c > 0, positive intercept on profits-axis). Type III: Negative slope, positive intercept (h < 0, c > 0, positive intercepts on both the profits and revenues axes, rarely negative intercepts on both axes!). Examples of companies obeying these three types of linear laws have been discussed in another recent study (see Refs.[1-3] cited at the end of this article). With this background, let us consider the results for Air Tran. As we will see shortly, all the three types of behavior suggested here are observed with Air Tran.
follows here we will discuss both the evolution of profits and revenues during a single year (intra year) and also over many years (inter year or multi-year). The following table compiles some of the intra-year data for Air Tran which enables us to test the validity of this simple profits-revenues law just mentioned. Table 2 Air Tran Quarterly Profits-revenues Growth during a single year Quarter Revenues, Profits, Cum. Rev, Cum Profit, quarterly quarterly x y $, millions $, millions $, millions $, millions 605.141 -12.025 605.141 -12.025 1Q2010 700.557 12.380 1305.698 0.355 2Q2010 667.934 36.263 1973.632 36.618 3Q2010 645.540 1.925 2619.172 38.543 4Q2010 All slopes h obtained from the lowest and highest (x, y) pairs. 541.955 28.707 541.955 28.707 1Q2009 603.653 78.438 1145.608 107.145 2Q2009 597.402 10.426 1743.01 117.571 3Q2009 598.432 17.091 2341.442 134.662 4Q2009 Graphs were prepared in all cases, even if not included here. 208.002 2.036 208.002 2.036 1Q2003 233.901 57.191 441.903 59.227 2Q2003 237.311 19.613 679.214 78.84 3Q2003 238.826 21.677 918.04 100.517 4Q2003 1Q1995 2Q1995 3Q1995 4Q1995 60.747 9.071 60.747 9.071 86.913 16.860 147.66 25.931 109.296 22.661 256.956 48.592 110.801 19.171 367.757 67.763 Slope h from the lowest and highest (x, y) pairs P-R equation For growth in the year h = 0.0251 c = -27.22 y = hx + c x0 = - c/h = 1084.1 h = 0.0589 c = -3.204 y = hx + c x0 = - c/h = 54.41 h = 0.1387 c = -26.81 y = hx + c x0 = - c/h = 193.32 h = 0.1912 c = -2.542 y = hx + c x0 = - c/h = 13.298
The results are quite revealing. Consider the results for 1995 and 2010. We find profits increasing with increasing revenues. The x-y graphs reveal the expected linearity, see Figure 1. This is Type I behavior. Notice, however, the huge difference in the level of profits between 1995 and 2010. The revenues for any one quarter in 2010 were greater than the total revenues for all of 1995. Yet, profits were lower in 2010 compared to 1995. The difference can be understood in terms of both the slope h and the intercept c.
Page 7 of 40
The graphs for both 1995 and 2010 reveal a positive intercept on the revenues-axis, the x-axis (since intercept on y-axis c < 0). This is the minimum revenue, or the breakeven that must be exceeded for the company to report a profit and is related to the fixed costs. This fixed cost has clearly increased between 1995 and 2010 and this explains the lower profits. More importantly, the slope h has also decreased between 1995 and 2010. Nearly 20% of the additional revenues (h = 0.1912) were being converted into profits in 1995 compared to just about 2.5% in 2010.
90
80 70 60 50 40 30 20 10 0 -10 0 50 100 150 200 250 300 350 400 450 500
Type I behaviors 1995 and 2010 compared y = 0.1912x 2.54 = 0.1912 (x 13.3) x0 = 13.3 in 1995 and h = 0.19
y = 0.025x 27.2 = 0.025 (x 1084) x0 = 1084 in 2010 (higher fixed cost) and h = 0.025 (lower slope means higher unit variable cost)
500
1000
1500
2000
2500
3000
3500
Page 9 of 40
While the ValuJet crash of 1996 no doubt played a role in the losses reported in 1996, this continued in subsequent years. A careful study of the data in Table 2, however, shows that the slope h has been decreasing progressively year after year, suggesting increasing costs (especially the unit variable costs). Furthermore, there is an unmistakable increase in the intercept, or the fixed costs, as well.
The profits-revenues graph is now entirely in the fourth quadrant and reveals the Type III behavior. Although the first and fourth quarter results have been used to determine the slope h and the intercept c, in this case, the 2nd and 4th quarter results also beg attention, see Figure 3. Type III behavior is also observed with the data for 1996 and 1997, see Figure 4.
Page 10 of 40
500
1000
1500
2000
2500
3000
50 0 -50 -100
x0
-150
-200 -250 -300 -350
Type III behavior y =-0.122x + 38.07 Solid line y = -0.178x + 182.01 Dashed line 2008 Evolution of Revenues-Losses Cumulative Revenues, x [$, millions] Growth during a single year
Figure 3: A very unique Air Tran Type III profits-revenues graph, which lies entirely in the fourth quadrant, with losses reported for every single quarter during the year, in 2008. The cumulative quarterly loss was -$273.83 million (slight discrepancy with the annual value given, -$266.33 million). The solid line joins the cumulative values for first and fourth quarters but the Type III dashed line begs attention. This joins the second quarter to the fourth quarter. The general trend is what is important here, not the exact numerical values. Type III behavior we see here seems to be the precursor for either a merger (if someone is interested) or a bankruptcy filing (when no suitors are available, as with General Motors. When GM publicly announced its willingness to sell off some of its money losing foundries, back in 1990s, which produce many critical automotive castings there were no buyers! The latter is based on recollection of published reports during that time.)This should be compared to the graph for 1995 when Air Tran was able to report profits with very small revenues. The annual revenue for 1995 was only
Page 11 of 40
$367.757 million, between 50% to 60% of the revenue for any one quarter in 2008. Still, Air Tran could not report a profit in 2008.
200
1995
100
-100
1996
-200
2008
-300
1997
-400 0 500 1000 1500 2000 2500 3000
Page 12 of 40
single year. It may be the precursor to either bankruptcy filing (if no one wants to take over the company) or a merger with a willing suitor.
We see a very interesting pattern in the time-evolution of profits and revenues. This can be described by three straight line segments all with a negative slope. For 2007 and 2008: For 2008 and 2009: For 2009 and 2010: y = -1.315x + 3092 y = -1.315x + 3092 y = -0.345x + 943.43
The revenues increased between 2007 and 2008 but the profits decreased so much that AirTran actually reported a huge loss! This is what was classified as Type III behavior and is indicated by the line with the negative slope (h < 0, c > 0). Using the ormulae given earlier, for the equation of a straight line connecting any two points, we get y = -1.315x + 3092. The arrow shows the direction of time. Next, revenues decreased between 2008 and 2009 but now AirTran reported a nice profit. The dashed line, with the negative slope, indicates this and takes us to the point above the red line. This is an interesting variant of the Type III behavior,
Page 13 of 40
with profits increasing with decreasing revenues. (This is observed with other companies as well, see Yahoo discussed in Refs. [1-3].) The equation for the new Type III line is y = -1.315x + 3092. Next, revenues increased between 2009 and 2010 but profits decreased once again but a loss was avoided. This too is Type III behavior, similar to that observed between 2007 and 2008. The equation of this line is y = -0.345x + 943.43.
200 150
Page 14 of 40
6. Type I, Type II, and Type III Behavior Multi-year Profits-Revenues Growth
A successful company must report a profit every year. By that measure, AirTran has reported a profit for 8 out of 10 recent years, with a small loss in 2001 and a much bigger loss in 2008. But take a careful look at the profits-revenues graph in Figure 6. No clear pattern is revealed. Contrast this with the profits-revenues graph for Southwest, for the period 1992-2010, which reveals a clear Type I behavior. This is presented in Figure 10. However, the following alternative view of Air Trans financial performance is possible if we ignore the loss for 2008.
200 150
180 160
140
120 100 80 60 40 20 0
-20
-40
Page 16 of 40
Type II
Type I
Type III
500
1000
1500
2000
2500
3000
along the curve, past the maximum, are for 2007-2010 which led to the interesting criss-crossing Type III behavior discussed earlier.
suggests the existence of an earlier Type I behavior and also a maximum point on the profits-revenues graph. The general equation, y = mxn [e-ax /(1 + be-ax) ] + c, or its simplified version, y = mxne-ax + c, with appropriate values of the constants m, n, a, b and c, can be used to model this overall behavior. The fundamental significance of this mathematical equation is discussed briefly in 9.
0.8
0.6
0.4
0.2
-0.2 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 8.0
and profits decreasing, year-after-year, as revealed by the decreasing slopes h and increasing values of the intercepts (breakeven revenue) made on the revenue axis. Revenues, x Profits, y Costs (x y) $, billions $, billions $, billions 2.62 0.0385 2.581 2010 2.34 -0.2663 2.819 2009 2.55 0.1347 2.207 2008 2.31 0.0527 2.257 2007 1.89 0.0147 1.877 2006 1.45 0.0017 1.449 2005 1.04 0.0123 1.029 2004 0.92 0.1005 0.818 2003 If business and finance majors prefer NOT to use the designation Costs for the quantity in the last column, we can call it the work function of the company; see discussion of Einsteins photoelectric law in 10. Year This may also be appreciated by considering the costs in the last column of the tables, which were computed from the basic equation Profits = Revenues Costs or P = R C. The mini-table above considers the data for 2003-2010. In 2003, with revenues of almost $1 billion ($0.92 B, exactly) the profits were $0.10 billion, which means the costs were about $0.9 B ($0.82 B, exactly). In 2006, when revenues had doubled to nearly $1.89 billion, profits were actually lower than in 2003, which means the costs given in the last column had more than doubled. In 2010, with a near tripling of revenues to $2.62 billion, the profits were again lower than in 2003. The costs had more than tripled compared to 2003. In 2008, the year of maximum profits, the revenues were about 2.5 times the revenues in 2003 but the profits went up only by about 35% (from $100 million to $135 million). A more detailed analysis of the costs-revenues relation is provided in the separately in the article on Southwest Airlines, see bibliography.
Page 20 of 40
150
100 50 0 -50
1995 07
2007
2010
-100 -150 -200 -250 0
1999 07
2,500
5,000
9. Brief Discussion
The simplest equation for a straight line, passing through the origin (we ignore the intercept c for the moment), is y = mx and the simplest equation for a curve with a changing slope is y = mxn where n = 1 gives the straight line and n > 1 yielding a curve with increasing slope (acceleration of y) and n < 1 yield a curve with
Page 21 of 40
decreasing slope (deceleration of y), see Figure 12. This is called the power law and n is called the power law index. Frictional, or air, resistance (or the drag), experienced by a moving object such as a golf ball, car, truck, aircraft, or a rocket is often expressed using the power law.
3.50 3.00 2.50 y = 0.1x1.15 m = 0.1 and n = 1.15 y = 0.1x m = 0.1 and n = 1
Profits, y
2.00 1.50 1.00 0.50 0.00 0.0 5.0 10.0 15.0 20.0 y = 0.1x0.85 m = 0.1 and n = 0.85
25.0
Revenues, x
Figure 12: Simple illustration of the power-law behavior, y = mxn for the three cases, n = 1 (linear law), n >1 yielding accelerating growth of profits with increasing revenues and n <1 yielding decelerating growth of profits with increasing revenues. In all three cases, there is NO limit to the maximum revenues or profits. This situation is certainly far more desirable than the situation where a maximum point appears on the profits-revenue curve (see Figure 13). The graph of speed versus time, in road tests routinely performed to assess the performance of vehicles, can also be described by a power law. (I have confirmed this with several vehicle road test data.) The acceleration a = v/t is the slope of the graph of speed (or more correctly velocity, hence the symbol v) versus time t. Road tests show that the acceleration is not a constant but actually decreases with time (or increasing speed). This is due to the air resistance (aerodynamic drag) just
Page 22 of 40
mentioned and gives the nonlinear power law curve for v-t relation. Many other examples of such nonlinear laws can be cited.
8 7 6
Profits, y
5 4 3 2 1 0 0 5 10 15 20 25 30 35
see any acceleration in the growth of profits with increasing revenues. At best we see a linear law (Figure 10). This is also true if we study the data for many other companies (see discussion of Apple in Refs. [1] and [2]). There is no company that I am aware of, based on many such studies of hundreds of companies since 1998, that has consistently shown an acceleration (n > 1), for a sustained period of time, in the profits-revenue space. Should we expect to see a maximum point on the profits-revenue graph? While it is easy to speculate about this point, why would one expect to see a maximum point? This is so counterintuitive to the whole idea of always trying to maximize profits. Alas, over this past month (since the Facebook IPO), I find that many real world companies do show a maximum point on their profits-revenues graph. Air Tran (and also Southwest Airlines, to be published separately) are just the latest examples of this behavior. The others are Ford Motor Company, Verizon, Yahoo, and Kroger. Each one of these companies is seemingly profitable but each one is struggling. Perhaps, there is some as yet undiscovered natural law (of behavioral economics and finance) that is responsible for the maximum point. Also, think about the indefinite increase in profits with increasing revenues. In mathematics, we can say, and we often do, as x , y . This might be true as long as we are dealing with purely conceptual mathematical entities. Now, apply it to finance or money and we are dealing with an untenable double infinity of sorts, isnt it? How can infinite revenues yield infinite profits? Unless, of course, costs go to zero! May be now we have stumbled upon a simple (mathematical?) explanation for the maximum point in the profits-revenues graph. So, now, going a step further, the simplest equation for a curve with a maximum point is y = mxne-ax. This is called the power-exponential law and is the simple product of the purely rising power law (y = mxn) and purely falling exponential decay law (y = e-ax). If a = 0, the maximum point disappears and we get the power law. If a = 0 and n = 1, we get the simple linear law or straight line. But, alas, straight lines are nice but they do not always pass through the origin. Hence, we must add the nonzero constant c to our equations. As seen here, the nonzero c in the profits-revenues graph is due to the fixed costs. The general equation for a
Page 24 of 40
straight line is y = hx + c. Such a nonzero intercept appears in some well known physical laws, especially Einsteins photoelectric law, to be discussed shortly. However, instead of the simpler y = mxne-ax, it is more appealing (at least intellectually speaking) to consider the slightly modified power-exponential equation y = mxn [e-ax /(1 + be-ax) ] since this is nothing more than the generalized statement of the famous equation from blackbody radiation, first derived by Max Planck in December 1900. Plancks original equation can be written as u = (82/c3) U where, and, giving, U = [ e-/kT /(1 e-/kT) ] = h u = (8h/c3) 3 [ e-/kT /(1 e-/kT) ] (1)
We do not have to understand everything about equation 1 (especially all the subtleties of the physics that led to the discovery of this law) except to note that the frequency is our variable x and the radiation energy density u is our variable y. The frequency is raised to the power 3 which is to be replaced by the general power law index n. The exponential factor within the square brackets is easily recognized. In the original Planck equation a = h/kT (where T is the temperature and k is a constant, called the Boltzmann constant). The constant m which precedes all is given by (8h/c3). In Plancks theory c is the speed of light and h is another universal constant which is now called the Planck constant. (Planck only uses the symbol h, in his December 1900 paper, without giving it a name.) This modified form of the power-exponential equation is preferred since we can readily derive Plancks equation using the same statistical arguments that Planck used in 1900 and apply it instead to the problem of profits or revenues get distributed among many different products that a company produces and sells. Thus, the power-exponential equation y = mxn [e-ax/(1 + be-ax)] + c is the simplest mathematical law relating x and y which also reveals a maximum point. The significance of this law may be understood quite simply, as follows, by considering various special cases.
Page 25 of 40
Linear law: For n = 1, and a = b = 0, the power-exponential law reduces to the linear law y = mx + c. Power law: For a = 0 we get the simple power law, y = Mxn, where M = m/(1+b) is a new constant that replaces m and absorbs the nonzero b in the denominator. In this case, there is NO maximum point. The derivative dy/dx = n(y/x) is nonzero for all values of x. Hence, the profits y will increase indefinitely without limit, with increasing revenues x either at an accelerating rate (for n > 1) or at a decelerating rate (for n < 1) with increasing revenues (see Figure 12). For n = 0, we get pure exponential behavior (e.g. radioactive decay, charging of batteries, etc.) Power-exponential law: A maximum point appears only when a > 0, however, small. This can be appreciated by considering the simpler case of b = 0 and c = 0, for which y = mxne-ax. The derivative dy/dx = (n- ax)(y/x). Hence, there is a maximum point on the graph at x = n/a. For x < n/a the derivative dy/dx > 0 and y increases with increasing x. For x > n/a, the derivative dy/dx is negative and y decreases with increasing x. This is the type of behavior that we are witnessing with Air Tran (see schematic graphs in Figures 9 and 13). This simple nonlinear Planck equation, with a maximum point, may be used to explain the appearance of the maximum point on the profits-revenues graph for Southwest Airlines. Or, one might think in terms of the Maxwell-Boltzmann type of distribution in the financial and economic world. Exactly, similar observations, regarding the maximum point, have also been made (since I began this recent study after the disappointing Facebook IPO on Friday May 18, 2012) with several companies, most notably Ford Motor Company. The Ford data reveals a maximum point, like we see here, again with a lot of scatter. In many ways, both Ford and Southwest Airlines are similar. The Southwest data is being discussed separately in more detail. Both these companies are currently profitable and appear to be doing quite well. However, they are not able to report consistently high level of profits. There are too many wild fluctuations. Also, the negative (Type III) relation established (for Air Tran, as discussed here, and also Southwest, since 2007) between profits and revenues is a cause for some concern. This point has been discussed in more detail in Ref. [1]. Many other companies, notably Ford, Verizon, Yahoo, and Kroger, also reveal this toxic Type III
Page 26 of 40
behavior. This seems to be a precursor to company reporting a continued losses even as revenues increase or, as with GM, the filing of bankruptcy after a long period spent in the Type III mode, or, as with Air Tran, becoming a target for merger/acquisition. (A discussion of the old GM financial data, from 1991 to 2008, before the bankruptcy filing in June 2009 will be presented separately.) This is what both Ford and Southwest can learn from the old GM. Type III behavior is the recipe for eventual failure and should be reversed at the earliest.
http://1.bp.blogspot.com/_R2yHiPgsajA/SsFIHuETLaI/AAAAAAAAB5k/iaFISjQ 9pK8/s400/southwest+airlines+1981.bmp
Page 27 of 40
momentum mv (m is the mass of each particle and v its speed or velocity). The color light depends on the momentum of its particles. In spite of Newtons tremendous prestige, the corpuscular theory of light was abandoned since it was not supported by experiments. So, Einstein reintroduced the particle view with a new twist. Instead of assigning a fixed momentum to each particle of light, Einstein said that (actually showed that, using Plancks radiation law) each photon must have a fixed amount of energy, the energy quantum = h, the bold new idea that had just been proposed by Planck in 1900 (the foundation of quantum physics, as just discussed). We will use E = hf, instead of the Greek symbols. Here h is the Planck constant and f is the frequency (of the light wave!). Einstein was actually saying that light has dual nature, it is both a wave and also a particle! When light shines on the metal surface, photons with energy E are bombarding the surface and knock out electrons from within the metal. The electron which appears will have a maximum (kinetic) energy K. This must be less than E because some of the energy must be given up to do the work needed to overcome the forces that bind the electron to the metal. The rigorous calculation of this work that must be done, or the energy that must be given up, to produce the electron is a very difficult and complex problem. It will also depend on the nature of the metal upon which the light is shining. Einstein circumvented these difficulties and proposed a simple solution. He said, lets just call this the work function W, which will be a unique characteristic of the metal. Hence, K = E W = hf W = h [ f (W/h)] = h(f f0). Einsteins focus was on K and E or the K-f relation, not the work function W, although it does affect the whole process (via the cut-off frequency f0, see below). Einsteins law is a linear law y = hx + c where x is the frequency of light and y is the maximum kinetic energy of the electron. The graph of K versus f must be a straight line with a slope equal to the universal constant h and an intercept c = - W. Einsteins explanation for the photoelectric law thus also provided a new method of determining h and testing Plancks theory critically. The idea of a work function W also explains the cut-off frequency f = f0 = W/h. Only light with frequency f > f0 will produce an electron with energy K. It was this empirical fact, the existence of a cut-off frequency, which had puzzled physicists and could not be explained on the basis of the wave idea of light.
Page 29 of 40
Einsteins photoelectric law served as the impetus to get Plancks idea of an energy quantum more widely accepted among physicists. Millikan confirmed Einsteins law K = (hf W) in his Nobel Prize winning experiments demonstrating the exact linear K-f relation predicted by Einstein. Millikans experiments were conducted with lithium and sodium. He had planned experiments with potassium but these were abandoned since there was a failure of this experimental apparatus. However, the results with lithium and sodium were quite conclusive and confirmed the linear K-f relation predicted by Einsteins theory. Millikans raw data (in table form) are still available for analysis. His results can be expressed as follows (but are not given in this form by Millikan, see why below): For lithium V0 = 0.4126 f 3.593 For lithium V0 = 0.4223 f 3.922 For sodium V0 = 0.4069 f 4.288 1st paper published in 1916 in 2nd paper published in 1916 in 2nd paper published in 1916
It should be remembered that electrons ejected from the metal surface have a range of kinetic energies. Only the maximum kinetic energy K is of interest. This is what Einstein had emphasized and Millikan understood that. (Lithium and sodium are the first two simplest metals in the periodic table, each having a single valence electron in the outermost orbit.) He talks about this maximum K in the introduction to his 1916 papers, and the possible failure to accurately determine this maximum K, as the reason why others who had tried to test Einsteins theory (before him) might have failed. In Millikans experiments, a copper cup surrounding the metal acted as a collector of the electrons. By applying an opposing voltage to repel the electron, he tried to stop them from being collected and producing the electric current in an external circuit. Thus, Millikan actually measures the stopping potential V0 which is directly proportional to the maximum K of the electron. The relation is K = qV0 where q is the electrical charge on a single electron. (At what point is the current actually zero? Did Millikan actually measure a zero current? Is there a leakage of electrons beyond the cut-off point imagined by Millikan? These have been favorite topics of debate and controversies among the critics of Millikans work.) Millikan had determined the charge q on a single electron, a fundamental constant of nature, in a series of elegant experiments, called the oil-drop experiments,
Page 30 of 40
reported over the period 1909-1913. This still gets voted as one of the most beautiful experiments in physics. Millikan managed to isolate a single oil drop (from a mist, produced using a common perfume atomizer) in the region between two electrically charged plates. Then he exposed the drop to ionizing radiation produced by a radioactive source. Thus, electrons (beta particles from the radiation source), or electrical charges, sometimes even a positive charge (alpha particle), got attached to the oil drop. Then, by manipulating the strength of the electric field, Millikan was able to move the drop up or down, or even remain stationary, and observe the whole process using a telescope. Against the dark background that he used to observe its motion, Millikan says that the oil drop looked like a shining star in the heavens! (In those good old days, before modern BIG SCIENCE, scientists actually personally conducted many of their experiments! Carl Anderson, who got the Nobel Prize for the discovery of the positron, the twin of the electron except that it has a positive charge observed the track of the first positron personally in his cloud chamber experiments. There is even a famous picture of Anderson doing this. Millikan was Andersons mentor, see http://www.aps.org/publications/apsnews/200408/history.cfm and also http://www.encyclopedia.com/topic/Carl_David_Anderson.aspx . Millikan also nominated Anderson for the Nobel Prize.) Only because Millikan knew the value of q, he was able to turn his attention to Einsteins photoelectric law. In fact, Einstein himself had suggested the experiment performed by Millikan in his 1905 paper. However, the exact numerical value of q was not known in 1905. The numerical value of the slope given in the above equations equals h/q and since q is known, h can be calculated. I deduced the above equations using Millikans raw data after performing a linear regression analysis. Millikan does not use this method. Why? That may be a philosophical question. Instead Millikan simply determines the various slopes h = (y2 y1)/(x2 x1) where x is frequency and y is the stopping potential. He then uses the average value of the slopes determined by considering various (x, y) pairs. There are a total of 5 data points, i.e., 5 different values of frequency f, or light of five different colors were used in the lithium experiments and 6 data points in the sodium experiments. In the 1st paper of 1916, with lithium, only two points are given and a slope h determined from just two measurements!
Page 31 of 40
Millikan published this first paper to establish scientific priority and also to announce the new and the most direct technique to determine h and promised more detailed results in the future, see http://physics.aps.org/story/v3/st23. Millikans h obviously agreed with the value deduced by Planck, in his December 1900 paper, using blackbody radiation data. (Note in the above also the historians view of how Millikan changed his own views about the meaning of the energy quantum. The same applies for what Plancks views were about the meaning of the energy quantum and also Einsteins view. Both Planck and Einstein had friendly disagreements on the significance of E = hf, years after they received their Nobel Prizes for this discovery!) Anyway, with this digression (perhaps of some value as we understand the new methodology being advocated here), just like some of the E of the photon must be given up to produce an electron with energy K, some of the revenues R must also be given up by a company to produce the profits P. The equation P = R C is an exact analog of Einsteins K = E W where money now plays the same role as energy in physics. The costs C is just like the work function W. Just like the focus is on the K-f relation in Einsteins law, our focus is on the profits-revenues, P-R, relation. The costs in the last column of our tables is thus deduced from profits and revenues, and is exactly like W in Einsteins law. Also, the breakeven revenue x0 = - c/h can be appreciated as being exactly analogous to the cut-off frequency f0 = W/h. Profits are produced only when x > x0. Electrons are produced only if f > f0. For f < f0 the photocell will shut down and there is no current. For x < x0 no profits are produced (and eventually the company is forced into bankruptcy or a merger). The analogies are too compelling to overlook. And, following Millikan, instead of using linear regression analysis, we can simply use the formula for the slope h = (y2 y1)/(x2 x1) and determine the slope between various points and take the average value (example when we have exactly four data points, as with the evolution of profits and revenues in a single year). There is NOTHING sacrosanct about the linear regression analysis, as mentioned by Legendre himself, in his famous 1805 paper when he introduced this technique in the statistics literature. Of all methods that can be used to determine the slope h and the intercept c of the best-fit line through a number of points that lie approximately on a straight line, the method of least squares (or linear regression
Page 32 of 40
analysis) is the most elegant and the fastest technique. I have just paraphrased a bit but this is almost exactly what Legendre said in his paper; see link below. ****************************************************************** Legendres exact words are: Of all the principles which can be proposed for that purpose, I think there is none more general, more exact, and more easy of application, that of which we made use in the preceding researches, and which consists of rendering the sum of squares of the errors a minimum. (Some points will lie above the best-fit line, something below. The sum of the deviations from the line will be zero but the sum of the squares of the deviations will never be zero. The method of least squares, or linear regression, is so-called since it minimizes the sum of the squares of the deviations from the best-fit line. Those who get carried away with statistics should remember these remarks of Legendre.)
Slope h = (x xm)2 / (x xm)(y ym) this is the rigorous formula without any approximations for computational simplicity.
http://www.stat.ucla.edu/history/legendre.pdf English translation of the original paper. This is a really short paper, with a worked example and became the standard method in statistics within the decade (see Stigler, Stephen M. (1986). The History of Statistics: The Measurement of Uncertainty Before 1900. Cambridge, MA: Belknap Press of Harvard University Press. ISBN 0-674-40340-1.) http://www-history.mcs.st-and.ac.uk/Biographies/Legendre.html http://en.wikipedia.org/wiki/Least_squares http://www-history.mcs.st-and.ac.uk/Biographies/Legendre.html The method was actually introduced by Legendre, without reference to the theory of probability. ****************************************************************** The rising costs that we see here with Air Tran, between 1995 and 2010, is similar to increasing values of the work function W in the photoelectricity experiment. W is a fundamental property of a metal. A companys organizational structure also leads to a fundamental property called its cost structure. This actually appears as the fixed cost a and unit variable cost b in the breakeven model. Air Tran appears to be behaving like a metal whose work function is increasing.
Page 33 of 40
Or, it was behaving as if it was changing into metals with different work functions as the years progressed. In other words, the organizational structure and the many operational decisions made as revenues grew dramatically between 1995 and 2010 (as noted already, they had almost tripled) led to the increasing costs, the decreasing profits, the Type III behavior between 2007 and 20l0 and eventually its inevitable merger. Thus, within quantum physics, we also find a new and elegant explanation for the working of the business world, the world of finance and economics as a whole. A few points to bear in mind, as we attempt this extension of the ideas from quantum physics to economics, business, finance (and, perhaps, even beyond), are: 1. Linear regression analysis, or the best-fit line, is not necessarily the only way to determine the slope h and constant c in the linear law y = hx +c. 2. Taking the cue from Millikan, we can simply determine the slopes between various points in the data set. Five points means 10 slopes and six points mean 15 slopes. With 10 points, it goes up to 45 slopes, with 16 points to 120 slopes. Now we appreciate what Legendre was trying to tell us. The general formula is nCr = n!/r!(n r)! = n!/2(n 2)! = n(n 1)/2, the combination of n things taken r at a time, with r = 2 in our case since we will always choose two points from the n points to determine the slope. (I am by NO means an expert in statistics, so if I have made an error here, please let me know. I worked out all cases for n = 6 and n = 5 to test this formula.) By the way, Millikan does not determine all the possible slopes exhaustively from his data. He calculates only a few slopes. His average value for the Planck constant h, therefore, seems to be based on what he believes to be his best measurements. This is not uncharacteristic of Millikan and historians have noted that he has indeed ignored measurements (recorded in his lab notebooks), even in the oil drop experiments, based on what may be called scientific judgment or intuition. 3. The least squares regression line always passes through the average point of the data set. Let (xm, ym) denote the average or the mean value of all the x and y values, respectively, as in our tables of profits and revenues. Thus, ym = hxm+ c. In this method, traditionally, we first determine the slope h using the formula given by Legendre. The intercept c is then determined using the above property, c = (ym - hxm). Sometimes, this may be the best
Page 34 of 40
or the most conservative approach. However, and without any offense, this is seeking the average or the search for mediocrity. In our search for excellence, however, we should seek the highest slope (or sometimes, even the lowest, if appropriate, as already done in some calculations here). 4. Thus, taking the cue from Einstein, we should really be seeking the highest slope (like seeking electrons with the maximum K) to determine the potential for converting revenues into profits and also to determine the costs of a financial enterprise. This is the real meaning of the work function beyond physics. As noted, it is conceivable that, in some cases, it might be appropriate to seek the lowest slope. Certainly, there would also be situations where Legendres recommendation is to be followed.
http://www.airtran.com/common/pdf/SpreadingLowFares_FactSheet.pdf http://www.getfilings.com/o0000931763-98-000779.html
Cheers! Can I say all this without that your x-y graphs?
If anyone is reading this, please go back now and enjoy the story told by each of these graphs! It is really the story of what we all do each day, as employees, to make the company we work for profitable, to enrich our own lives, and to enrich our communities. Lurking behind each of our actions is that demon called the costs. And before we know it h > 0 turns into h < 0 And the day of reckoning arrives! It happened between 1993 and 2011!
Page 35 of 40
Illustration of DC-9 ValuJet, Flight 592. The plane was observed crashing.
It crashed on a lovely Saturday afternoon, the day before Mothers day. The improper placement and loading of canisters with chemicals (that are used to produce Oxygen for the Emergency System), in the cargo compartment below the passenger cabin, seems to have contributed to the spark that led to the fire and the crash. http://en.wikipedia.org/wiki/ValuJet_Flight_592 Sadly, this is, perhaps, the clearest example of incompetent and/or ignorant employees, working without proper training or supervision, doing what they think is best! They just did not know how stupid it was to do what they did! The loss of the space shuttle Challenger, on January 28 1986, seconds after launch, is another example of a similar tragedy that could have been avoided. http://psiresearcher.files.wordpress.com/2011/09/flighteverglades-plane-crash2_05320299.jpg?w=640 http://www.theatlantic.com/magazine/archive/1998/03/the-lessons-of-valujet592/6534/ Time to get over that fateful 1996 crash!
Page 36 of 40
http://www.getfilings.com/o0000931763-99-000958.html 1994-1998 http://www.getfilings.com/o0000931763-98-000779.html Data from 1993-1997 http://www.getfilings.com/comp/k0000948846.html 1996 to 2005 http://www.airtranairways.com/common/PDF/AR/AR2008.pdf 2008 report; has data from 2004 to 2008
Page 37 of 40
12. Bibliography
Related Internet articles posted at this website Since the Facebook IPO on May 18, 2012
1. http://www.scribd.com/doc/95906902/Simple-Mathematical-Laws-GovernCorporate-Financial-Behavior-A-Brief-Compilation-of-Profits-RevenuesData Current article with all others above cited for completeness, Published June 4, 2012 with several revisions incorporating more examples. 2. http://www.scribd.com/doc/94647467/Three-Types-of-Companies-FromQuantum-Physics-to-Economics Basic discussion of three types of companies, Published May 24, 2012. Examples of Google, Facebook, ExxonMobil, Best Buy, Ford, Universal Insurance Holdings 3. http://www.scribd.com/doc/96228131/The-Perfect-Apple-How-it-can-bedestroyed Detailed discussion of Apple Inc. data. Published June 7, 2012. 4. http://www.scribd.com/doc/95140101/Ford-Motor-Company-Data-RevealsMount-Profit Ford Motor Company graph illustrating pronounced maximum point, Published May 29, 2012. 5. http://www.scribd.com/doc/95329905/Planck-s-Blackbody-Radiation-LawRederived-for-more-General-Case Generalization of Plancks law, Published May 30, 2012. 6. http://www.scribd.com/doc/94325593/The-Future-of-Facebook-I Facebook and Google data are compared here. Published May 21, 2012. 7. http://www.scribd.com/doc/94103265/The-FaceBook-Future Published May 19, 2012 (the day after IPO launch on Friday May 18, 2012). 8. http://www.scribd.com/doc/95728457/What-is-Entropy Discussion of the meaning of entropy (using example given by Boltzmann in 1877, later also used by Planck to develop quantum physics in 1900). The example here shows the concepts of entropy S and energy U (and the derivative T = dU/dS) can be extended beyond physics with energy = money, or any property of interest. Published June 3, 2012. 9. The Future of Southwest Airlines, Completed June 14, 2012 (to be published).
Page 38 of 40
have many applications far beyond blackbody radiation studies where it was first conceived. Einsteins photoelectric law is a simple linear law, as we see here, and was deduced from Plancks non-linear law for describing blackbody radiation. It appears that financial and economic systems can be modeled using a similar approach. Finance, business, economics and management sciences now essentially seem to operate like astronomy and physics before the advent of Kepler and Newton.
Acknowledgements
With sincere thanks to the many Internet sources that have been used to compile this document as evident by all the corporate logos and various photographs used here to make the presentation more interesting. All of them have cited and are liberally and profusely acknowledged.
Page 40 of 40