# Tag: John Horn

On June 13, the Federal Reserve released updated inflation figures showing that the Consumer Price Index grew at a 4% annual rate in May. The difference in consumer prices from April to May, however, was just 0.1%. These two numbers paint very different pictures of the current state of inflation and the American economy.

The confusion comes from the way in which we calculate inflation, according to John Horn, a professor of practice in economics at the Olin Business School at Washington University in St. Louis. Horn earlier explained how the “math” of inflation works.

“As a refresher, inflation is an annual measure—the increase in prices over 12 months,” Horn said. “The Bureau of Labor Statistics creates a representative basket that an average person would buy, then calculates the price for that basket. The formula for inflation is:

“That’s just the definition of a percentage change: the change over time divided by the initial value. Using this formula means inflation can increase really fast but has a hard time coming back down. That has nothing to do with economics; it has everything to do with math.”

Take a very simple example. Say the monthly price for the basket of goods is \$100 every month and has been for a couple of years. That means inflation is 0%, since (100-100)/100 equals 0%. If the price suddenly increased to \$110 in January, then inflation would be 10% because (110-100)/100 equals 10%.

But here’s how annual inflation numbers can distort the economic reality: If prices stayed flat in February, then the price of the basket would still be \$110, and inflation would be: \$110 (current February’s price)-100 (last February’s price)/100 (last February’s price). That’s 10% again. And in March, if prices stayed flat at \$110? Then current March equals \$110, last March equals \$100, so inflation is (110-100)/100, which equals … 10%.

In this simple scenario, there was a one-time fast increase in prices and then prices stayed stagnant for a full year, but the lag in inflation calculation would lead to 10% inflation for a full year.

“This is troublesome because the news reports and headlines would scream, ‘Inflation stays stubbornly high at 10%,’” Horn said. “That’s true, but in terms of buying power, there was only a one-time increase in prices. For the rest of the year, prices stayed flat—admittedly, at an elevated rate. And that’s assuming prices remain stagnant after January. Even in a healthy economy, we expect prices to rise modestly — typically around 2% annually.”

“When prices continue to rise modestly after a one-time spike in prices — as they did in 2022 — it can make the situation seem much worse than it really is,” Horn added.

## Perception versus reality

The latest Bureau of Labor Statistics figure shows inflation for May 2023 was 4%—good, but still above the Fed’s target level of 2%. What should inflation have been if prices had started rising at 2% starting in August 2022?

“Under this scenario, the annual inflation rate in May would have been 3%,” Horn said. “Is that below the 4% we’re actually at? Sure, but not that far off to think we’re wildly stuck in an inflationary economy. In fact, since December 2022, we’ve been off this 2% trendline by about 0.5 to 1% each month — pretty steadily, in fact. We are running only slightly ahead of where we should be.”

“Overall, inflation is not running away—as you can see in the chart—it’s gliding back to the path we’d like to see of around 2%,” Horn said.

When thinking about the economy, and inflation in particular, Horn said it’s important to not fall into “base rate fallacy” thinking by focusing too much on specific details — like the prices of commercial real estate, used cars or eggs — and ignore the larger-picture trends. For example, there are some worrying trends in rental rates, since those prices are rather sticky for longer periods of time, baking in those changes into inflation for longer. But those changes are often offset by changes in other products’ prices in the overall basket.

While rental prices are currently keeping inflation up, unemployment — which is often mentioned as a driver of higher inflation — has stabilized at the rates we saw right before the COVID-19 pandemic, when inflation was right around the Fed’s target of 2%, Horn said.

Looking back to last summer, Horn pointed out that many feared the Fed would either overcorrect by raising interest rates too high, which would throw the economy into a recession, or it was going to undercorrect and raise interest rates too little and create endemic inflation that would never come down.

“No one had great confidence that the Fed could achieve the soft landing, whereby the economy didn’t enter a recession while inflation slowly came back down to the 2% target,” he said. “We clearly didn’t have a recession, and while we’re still about a percentage point too far above the tarmac, the plane appears to be on an approach glide path.

“At least, if we take a longer view and remember the math behind inflation,” Horn said.

When John Horn started helping companies run war games—simulations to determine the best strategies to take regarding competitors—he was struck by how clients characterized their competitors.

Often, they’d say they couldn’t role-play specific competitors in a workshop because those competitors were “irrational.”

“They truly believed this. They couldn’t wrap their minds around why competitors behaved the way they did,” said Horn, professor of practice in economics at Olin Business School. “It always struck me as odd.”

In his career, he has worked “with really large companies whose competitors were really large companies. And you don’t get to be a really large company by acting irrational.”

To help businesses think like their competitors, Horn wrote the book Inside the Competitor’s Mindset: How to Predict Their Next Move and Position Yourself for Success (The MIT Press, \$34.95).

## Culmination of decades of work

“This book was the culmination of about almost 20 years of work on competitive insight,” said Horn, who was a senior expert in the strategy practice of McKinsey & Company, based out of the Washington, DC, office, before joining Olin in 2013. He spent most of his nine years at McKinsey working with clients on competitive strategy, war gaming workshops and corporate and business unit strategy across many industries and geographies.

By using some relatively simple techniques, companies can gain insight into what their competitors are likely to do and be better prepared when it’s time to act, according to the 272-page book to be released April 11, 2023.

“The point of competitive insight is not to explain why a specific action occurred in the past but to get a better understanding of what might happen in the future,” Horn said. “Strategic thinking is inherently a forward-looking effort.”

Readers will learn where to look for competitive insights; learn to anticipate how competitors will react to their company’s moves; and even apply lessons from archaeologists, paleontologists, neonatal intensive care unit nurses and a homicide detective when they can’t ask direct questions.

The retired homicide detective, for instance, shared that all cases are different, so go where the evidence and witness statements lead. The detective saw the job as always asking questions and playing devil’s advocate to test the conclusions of the case officers. What else is missing? What else can you do?

Horn interviewed more than two dozen professionals from the above fields and synthesized their insights into guidance for business strategists. One strong takeaway: “You have to have a diverse team, or you’ll miss something.”

“We’re not going to retroactively solve for the historical ‘why’ but focus on the forward-looking ‘how can we make sense without talking with them?’” Horn says in the book.

“In the real world, you have to rely on second- or thirdhand reporting and piece it together without the inside story.”

It has been nearly three years since the COVID-19 pandemic upended businesses worldwide. From supply chain disruptions to shipping delays, worker shortages and, now, the looming threat of a recession, it has been anything but business as usual ever since.

With so much uncertainty, how can businesses gain a competitive edge going into the new year and beyond? How can they better anticipate threats created by competitors, the economy, suppliers, politicians and more, and identify new opportunities?

One way is through the process of “war gaming,” according to John Horn, professor of practice in economics at Washington University’s Olin Business School and author of the forthcoming book “Inside the competitor’s mindset: How to predict their next move and position yourself for success.” In simple terms, war gaming is a simulation that allows risk-free analysis of how to act strategically in the actual marketplace, Horn said.

“War gaming gives businesses the opportunity to practice a series of situations in a risk-free environment so that when they confront that situation in the real world, they have better insight into the best way to respond.”

For centuries, militaries have conducted war gaming exercises to better anticipate how their enemies will act in battle. Likewise, war gaming in a business setting always involves other “players,” such as competitors, supply chain partners and regulators. War gaming is not used to test strategy against some abstract market model or in cases where decisions made—like the Federal Reserve raising interest rates—are outside the company’s influence, Horn explained.

Instead, the practice is used to test strategy based on how competitors, regulators and other influencers will react to choices you make, and how their choices could affect you. During the simulation, team members are given background information on the role they are assigned to play. Then, they develop their strategy and the facilitators determine the market outcome resulting from all the teams’ collective decisions. The workshop helps the organization gain insight into what works, and why.

## Walk a mile in competitors’ shoes

Prior to joining the Olin Business School faculty, Horn worked as a senior expert in the strategy practice of McKinsey & Company. Over the course of nine years, he worked with more than 100 clients on competitive strategy, war gaming workshops and corporate and business unit strategy across a variety of industries and geographies.

“I began doing war gaming exercises because I wanted companies to experience what it was like to make those decisions, and to feel those decisions, both for themselves and for their competitors,” Horn said. “What I realized is that a lot of companies ignore their competitors because they think they are irrational. But it’s not that competitors are irrational. Companies have never taken the time to understand their competitor’s perspective and why they do what they do.

“Through role playing, you gain a better understanding of why your competitors make the choices they make, even if you do not agree with them.”

John Horn

“Through role playing, you gain a better understanding of why your competitors make the choices they make, even if you do not agree with them. Like, why are they lowering prices? Why are the focused in a particular region? Why are they topping my products? From there, leaders are better positioned to anticipate their future moves and how best to respond.”

## Practical applications

There are many practical applications for war gaming, Horn said. It can be used when there’s something strategic you’re wanting to accomplish, like growing sales or introducing new products. War gaming also can be used to test how you and others in the industry will respond to things happening outside of your company, like a recession or a regulatory change.

Additionally, war gaming can be useful to understand how new technology or trends — like increased awareness about global warming or consumer demands — will impact your industry. And it can be employed in response to new competitors entering the market. These are just a few of the potential scenarios in which war gaming can help business leaders analyze the situation, Horn said.

With the threat of a recession looming, business leaders should be thinking about how an economic downturn could shake up their strategic plans and affect their bottom line, Horn said. War gaming might help.

Let’s say you owned a sporting goods company that struggled during the past two recessions. During the last recession, your chief competitor fared better. Through war gaming, you can analyze the possible decisions your competitors will make this time around and how your company might respond.

“War gaming helps companies avoid being caught off guard, better anticipate decisions their competition might make and determine how to respond to them,” Horn said.

## War gaming ‘lite’

One downside to running a war game exercise is that it can require several weeks of designing and building the material needed to conduct the workshop. However, there is a way of getting the benefits of war gaming without the resource-intensive costs of a traditional effort, which Horn calls “war gaming lite.” This format can be incorporated anytime the organization meets to discuss future industry trends.

Based on his observations, Horn said one of two things typically happen when business leaders discuss strategy and future plans. Most often, leaders focus on what they’re going to do and why it’s going to be good for them. Occasionally, the conversation takes a much more negative tone — we’re going to get crushed, there’s no way we can win, Horn said.

“It’s only natural for business leaders to have a more biased view about how situations will play out to their advantage,” Horn said. “War gaming forces them to take a more realistic view of the situation. Yes, I want it to work this way, but my competitors want it to play out a different way, and they’re going to make choices that may not be good for us. The benefit of ‘lite’ war games is that you realize these benefits without incurring the costs of a traditional war game.”

For example, imagine a hospital rolling out a new weight loss surgery program. In preparing to launch this new service, hospital leaders will likely have detailed conversations about how this program will increase patient volume and profitability, giving them an edge. Or, they may worry that the larger hospital in town will continue to stay one step ahead, dominating the market. As a result, they may limit expectations for the new program.

It would be more beneficial if the team took the time to incorporate a lite war game. Assuming the roles of the hospital’s competitors and referring physicians, the business development team could test ways to market the procedure with patients and physicians, referral processes, clinic practices and more before going public with the announcement. The role-play information would build off ongoing competitive insight efforts, and the conversation about how the industry would play out would incorporate each of those players’ perspectives based on what works best for them. The process can highlight risks and opportunities business leaders might otherwise miss, Horn said.

The best part is this process does not require a large investment of time or resources. While it’s true that larger simulations—the kind companies may do every few years as a part of their overall strategy process—often occur over days and may require external consultants, Horn said it doesn’t always need to be that detailed.

“Ideally, I would like to see companies getting in the habit of conducting their own lite war game activities any time they have a strategic question that involves outside players. Set aside 30 minutes to think about how these outside players may react and what you can do to get ahead,” Horn said.

By making this a regular habit built into the company’s strategic planning process, companies can maintain their competitive edge through recessions, market changes, supply chain disruptions and any other challenge they may face in 2023 and beyond.

The monthly news headlines are alarming: “US inflation hit 40-year high in June,” “US inflation eased slightly to 8.5% in July.” To the casual observer, it may seem like prices are going to continue to climb for the foreseeable future.

To be certain, inflation is a serious problem and has been for more than a year. “Prices are higher than they were pre-pandemic and that has put pressure on consumers’ pocketbooks and ability to afford the things they need to live a comfortable and productive life, especially since wage increases have not kept up at the same pace as inflation increases,” said John Horn, professor of practice in economics at Olin Business School.

However, focusing on the annual rate of change, rather than month-to-month inflation changes, distorts the economic reality, making an already bad situation look worse, Horn explained. And that’s a problem because we may convince ourselves that the price level will continue to increase.

“High inflation could become a self-fulfilling prophecy that would require a deep recession to shake off, which would definitely not be a good outcome for those struggling to make ends meet,” Horn said.

To better understand the math of inflation, Horn offered the following explanation.

## How is inflation calculated?

“The government statisticians select a bundle of goods that represent a ‘typical’ basket of goods consumers buy in a given month. This bundle is periodically updated but is kept constant from month to month. The analysts then determine the price for each of the items in the bundle and sum across all the items to determine a total expenditure for buying the entire basket. This is called the current price index. They then compare this current price index to the total expenditure for buying the bundle at a fixed point in time in the past (the base year index value) to determine how much prices have increased in the intervening period,” Horn said.

“The percentage change in inflation is calculated by taking the price index today, subtracting the price index in the previous time period of interest and then dividing by the previous price index. That’s the basic formula for a percentage change: (current value – prior value)/prior value.

“So far, pretty straightforward. Let’s look at the current CPI (consumer price index) numbers. In July 2022, the index was 296.276. In June 2022, the index was 296.311, and in July 2021, the index was 273.003. Let’s calculate the annual inflation rate. That’s today’s index (296.276) minus last July’s index (273.003) divided by last year’s index (273.003). The result is 8.5%, which is the number the Bureau of Labor Statistics released a couple of weeks ago.

“The monthly inflation rate — or change in prices from June 2022 to July 2022 — was 0.0 percent. We get this by taking July’s index (296.276) minus June 2022’s index (296.311) and dividing by June’s index (296.311). When rounded up to one decimal place, the answer is 0.0 percent. It’s actually very slightly negative, but this goes away with the rounding,” Horn said.

## So, we’re comparing apples and oranges?

“It is pretty bad that inflation was 8.5% over the last year, and it sounds like prices keep increasing by almost 10%. But what if the prices stayed constant? What if the economy ‘fixed’ itself and prices were flat — staying at 296.276 — for the next 12 months? Prices would be higher than they were 12 months ago, but they would stop increasing. If that happened, most consumers would still wish for the prices from three years ago, but at least they wouldn’t be increasing,” Horn said.

“Here’s where the math gets interesting. If prices stay flat for the next 12 months, then here is the annual inflation rate for every month:

“Inflation won’t go back to a ‘normal’ 2% until May of next year. Remember, that’s if prices stay flat for every month, so the month-on-month inflation rate is 0%.

“The reason this happens is that we’re comparing today’s index to a price from a year ago. For the past year, prices have been increasing really fast. The CPI index hit 250 in April 2018. It got to 260 in September 2020, two and a half years later. It reached 270 in June 2021, or nine months later. It ballooned to 280 in six months (January 2022) and four months later was at 290. That means prices have increased 5.4% since January.

“If prices stay flat, inflation next January will still reflect that 5.4% increase over the entire year. Again, that feels like really high inflation, when in fact prices will have been flat for six months — hypothetically.

“Annual inflation numbers can adjust quickly on the way up, but they will take time to come back down because of the lag in calculating inflation. It takes a long time for the 12-month lag in prices to catch up to today’s higher prices and get inflation back down to the 2% range we expect.

“The Personal Consumption Expenditures (PCE), which the Federal Reserve uses to measure inflation, is calculated a bit differently than the CPI, but it also shows the same ‘math’ persistence. If prices stay the same in the PCE metric, then we’ll be back at 2% inflation next March,” Horn said.

## What if prices fell, would that correct inflation faster?

“The easy answer might seem to have prices fall in the next three months to get the CPI index back to the 275 level we saw at the end of last year. That would move the annual CPI back toward the 2% range faster, but that would also risk kicking off deflation, which can be as bad or worse than high inflation.

“If prices fell by 7 or 8%, then many consumers would think, ‘That’s great, but prices are still well above what they were before the pandemic, and they’ve been dropping quickly, so I’m going to hold off buying until prices drop a bit more.’ That reduction in consumption will lower demand, which will in fact lower prices further. But that will encourage even more consumers to hold off on purchasing, which will decrease prices further. It becomes a self-reinforcing cycle that has the effect of pushing the economy into a recession — exactly what the Fed is trying to avoid,” Horn said.

## If prices can’t fall quickly, and we’re stuck with the ‘math,’ what should we do?

“One thing would be to focus more on the month-to-month trends, at least in the next few months,” Horn said. “If CPI holds flat or slightly negative through the fall, that’s a good indication that prices are stabilizing. They’ll still be well above their levels from two to three years ago, but we’ll avoid the deflationary spiral.

“Month-to-month inflation rates are typically noisy, so they are not a good metric for longer-term planning by the Fed during periods of stable inflation. But in times of crisis, they can provide a better measure of the current movement in the economy.

“The other benefit of focusing on the month-to-month is the messaging it provides to consumers and producers in the economy. Continuing to focus on the annual numbers will result in another six months of ‘historically high’ inflation. The messaging that the annual rate is decreasing will get lost in the headline attention-grabbing ‘Inflation still at near record levels.’ This increases the risk that consumers and producers develop an entrenched mindset that high inflation is here to stay.”

Last month, Russia and China declared that their friendship had “no limits.” But since Russia launched its attack on Ukraine, that friendship has been strained. As the war has gone on, China has sought to distance itself from Russia to avoid the same financial sanctions and economic isolation that has rocked Russia in recent weeks.

Following President Joe Biden’s meeting with Chinese President Xi Jinping March 18, international business experts John Horn and Patrick Moreton at Olin Business School offered their perspectives on the developing situation, the challenges facing China and what impact its actions could have on the Chinese and global economies.

## China is watching closely

All along, China’s stance in the conflict has been more anti-American than pro-Russian, said Moreton, professor of practice in strategy and management and academic director of the Olin’s MBA Global Immersion program.

“China’s official narrative on Ukraine reflects their dissatisfaction with the position the U.S. has taken on issues that they consider core interests, including Taiwan, Xinjiang and Hong Kong—to name just three—and a general chafing at what they consider the American outsized role in the global political and economic system,” Moreton said.

“I would expect that these are some of the issues that will come up when the U.S. and China sit down to discuss Russia and Ukraine.”

Horn, professor of practice in economics, agrees.

“My sense is that China is looking at this not as a communism versus the rest of the world construct, but rather as China versus the rest of world construct—what’s best for China,” Horn said.

Like many countries, China likely thought Russia’s invasion of Ukraine was going to be a very short-term effort. If this had transpired, and Russia did not face strong pushback from other countries, Horn said China could have interpreted that as an opportune time to militarily take control of Taiwan.

But much to Russia’s chagrin, the situation has not played out as expected, putting China in a tricky position.

## What’s at stake for China?

“From China’s perspective, Russia’s attack on Ukraine, if successful, could have provided an increased opportunity for China to partner with western Europe as a trade alternative to the United States, if the latter had been seen as unable to use its leadership position to prevent the Russian aggression,” Horn said.

Moreton added, “There is also the possibility that China sees considerable opportunity in the current crisis and may very well be asking the U.S. and the European Union for concessions on issues it considers important in exchange for a particular response to Russia’s request for help.”

It’s a delicate balance for China, though. The Chinese government and businesses are acutely aware of how Russia’s actions have decimated its international business and trade and want to avoid the same fate. While China is Russia’s No. 1 trading partner, China relies more heavily on trade with the European Union and the U.S.

Beyond financial and economic implications, there are also serious reputational issues at stake both outside of and inside of China, Moreton said.

“The fact that the Chinese people aren’t being allowed to see what is happening in Ukraine seems to me to be a clear indication that the Chinese leadership sees a legitimacy problem at home if it supports Putin and it becomes widely known just how wrong his invasion and conduct of the war has been,” Moreton said.  “The Chinese people are not indifferent to the suffering of others, and they, like most Americans, expect their government to conduct itself in a moral manner.”

From a global perspective, Horn said, “The Chinese government appears to be playing this situation in a way that at the end, China is stronger than where they were a month ago relative to the United States, relative to Western Europe.

“And while a successful Russian invasion could have drawn into question the U.S. role as a global leader, the fact that the majority of countries have followed the U.S.’ lead with economic and trade sanctions, and that there hasn’t been a backlash toward the U.S. more broadly, makes that potential goal harder to achieve,” he added.

## What is the best approach to working with China?

Moreton said it’s important for Americans to recognize that each country has many different types of interests, some of which are familiar and others that are quite different based on culture, stage of development, regional and global security, etc.

“In that regard, I think it’s important for Americans to recognize that what we think is right or wrong may not appear so to China and vice-versa,” Moreton said. “This doesn’t mean we acquiesce to these interests. Rather, it simply means that countries trying to work with China have to try to understand their interests and offer a set of carrots and sticks that resonate productively with China’s interests and are consistent with the country’s values.”

But imposing economic sanctions on China is likely not on the table, in part because it would be too politically risky for the Biden administration Moreton said.

“The fractured nature of the American body politic makes harsh sanctions on China like what we have imposed on Russia very hard to pull off politically,” he said. “There are plenty of political and media opportunists who will jump on an opportunity to beat the Biden administration about the head for the inevitable disruptions that this move will have. To pull it off right now would require a level of political leadership beyond what I’m seeing in our political system.

“That’s not to say that more selective sanctions like we currently have aren’t possible, though.”

Photo: Russian President Vladimir Putin meets with Chinese President Xi Jinping. (Image: Shutterstock)