Yes, it was his hubris

In the Wall Street Journal, columnist Holman Jenkins writes about Ron Johnson’s term as JC Penney chief:

Every human effort is flawed. Failure is not proof of incompetence. So don’t buy the narrative that Mr. Johnson was done in by his hubris and cluelessness about retail. At Sears starting in 1989, a new leader introduced a new strategy of dramatically reduced promotions and manipulative “discounts.” Instead, Sears would feature “everyday low prices,” in-store boutiques and jazzier merchandise. Yes, the same formula. And Mike Bozic lasted the same 17 months that Mr. Johnson did.

I agree that failure is not proof of incompetence. But failure isn’t the reason Johnson has been charged with hubris. It’s not clear to me from Jenkins’ column why we shouldn’t buy the hubris narrative.

Johnson’s hubris was that he made network-wide changes to the business without evidence those changes would help. He never considered that he could be wrong. Some folks like it when someone swings for the fences, but shareholders should be leery when someone comes in with a shoot from the hip attitude. It’s the rare occasion that ends well.

If Johnson’s strategy would have worked across the entire network, it would have  worked on a smaller scale, first. He could have made the changes in a market, at much less cost and risk to business. Not testing his ideas first, when he has the ability to do that, is hubris…or stupidity, or a little of both.

Boards Beware

Today’s Wall Street Journal article, about the firing of Penney’s chief Ron Johnson, identifies clearly Johnson’s main problem:

The board’s decision ends a brief and turbulent career in the corner office for Mr. Johnson. He arrived at Penney to great fanfare in November 2011, but lost the confidence of directors and investors after he rolled out an ambitious plan to reinvent Penney’s stores without following the usual retail practice of testing the changes first.

Mr. Johnson was unapologetic about his decision not to test his strategy. Asked earlier this year if he would do things differently given a chance to start over, he replied, “No, of course not.”

That’s dumb. Boards of Directors should not hire these pompous jack-asses. Tests allow companies to discover what consumers want and prefer and evolve the business to serve their preferences.

This should be a standard question asked in an interview for a CEO, what do you think of testing? If the candidate doesn’t believe in tests, boards should stay away from these candidates.

Why?

Because what consumers want is not always obvious — even to consumers. Very few business ideas pan out, because they fail to deliver value to consumers — even if they sound really good. Tests are hedges against being wrong. They allow a company to discover if a new thing does what it is supposed to — provide what customers are willing to pay for.

What customers want isn’t often obvious. Even customers can rarely truly tell you what they want. They think they can, but what they say very often doesn’t match how they really behave. Economists call this the difference between stated and revealed preferences.

This is the reason why it’s rare that CEOs can divine what their customers want. Trial and error is how customers find out what they want and trial and error is typically how businesses figure out what customers value. Cut out the trial, and you set yourself up for a gigantic error. Small errors are better. Johnson has what economist F.A. Hayek called the Fatal Conceit. 

At least, in this case, from the Journal article we find out that one activist shareholder was the main reason Penneys went with Johnson and, thankfully, that shareholder took a bath for his foolhardiness. Perhaps he will learn a valuable lesson that discovering what customers want, rather than having a conceited fool like Johnson tell them, is a more effective approach running a business.

Longer than I thought

It appears that Ron Johnson’s days at the helm of JC Penney may be over. I predicted this last July. Granted, I wasn’t going too far

out on a limb.

Ron Johnson was thought of as a retailing guru at Apple for leading Apple Stores. I think it has become clear that it was the Apple products that were the bigger factor in that success.

By the way, I own several Apple products. Not one did I purchase in an Apple store. In fact, now that I think about, I’ve spent as much time in Apple stores as I did in JC Penney after Johnson took over.

Who’s on the hook?

According to this article, student loan defaults are surging (HT: Instapundit)

Perhaps schools should also be on the hook when their former students aren’t able to repay their student loans.

More Signals vs. Causes: Business Edition

In the Wall Street Journal, Rachel Emma Silverman reports on efforts by large company managers to learn from startups.

A couple of the observations made me think of the signals vs. causes thread.

Mr. Osifchin also took note of startup-company quirks, such as the large bell that staffers rang to gather colleagues and magnums of Champagne feathered with Post-it Notes encouraging workers to meet deadlines so that the bottles could be opened.

More likely, the large bells and Champagne celebrations reflect milestone celebrations for folks that are heavily invested and stand to benefit a great deal from the company’s true success.

That success probably represents something larger than the standard large company 10 – 20% bonus that is predicated on factors other than your team’s success — like if the rest of the company delivers, or someone limits your payout to get more for their buddies.

In other words, they don’t work better because of the bells and champagne. They work better because of the incentives. The bells and champagne just help them blow off the steam that comes with that kind of effort.

Here’s another one:

After comparing notes, the executives found that senior managers at the startups spent a significant amount of time in product meetings, says Brad Smith, Intuit’s CEO. That observation led the company to decide its executives should spend more time in the product-development trenches, says spokeswoman Cassie Divine.

More likely, senior managers at startups are the original founders of the product and they have a good idea of what they want it to become.

Senior managers at large companies achieved their status with bully bureaucrat skills, not delivering what the customer wants. Put these guys in the trenches and they’ll feel the need to dominate the discussion and show all the underlings why they’re the big-shots.

What is your company focused on? Startups fail. Big businesses fail. Big businesses were once startups that got a hold of a valuable enough value proposition to sustain itself.

But, if you want to learn something from successful startups, learn this. They respond and evolve to what customers want, not what a steering committee full of empty suits who are far removed from their customer base wants. They have to survive.

The senior leaders of startups are closer to their customers. They probably started off solving a problem they were experiencing and discovered others experienced the same problem and were willing to pay for a fix.

Leaders of steering committees will say they are focused on what customers want. They don’t recognize what they really mean is they are focused on the stylized, segmented, homogenized interpretation of what the steering committee members want the customer to want.

Want to replicate a startup? Remove as many obstacles to getting a true read on the customers’ response as possible.

Then, get the startup people out of corporate and give them some rope. If they succeed, the rewards should be rich. If they fail, they shouldn’t get a paycheck. They should lose something.

From the story, I’ll give credit to GE for doing more than mistaking signals for causes:

General Electric Co.’s ”GE Garages,” created in partnership with four tech startups, are roaming workshops that allow GE’s own workers and visitors to tinker and noodle together on new products. GE also began a companywide venture-capital initiative earlier this year, making the firm an investor and partner in some 60 startups.

“Losses Encourage Prudence”

I wonder if Russ Roberts saw the opinion piece, How to Shrink the “Too-Big-to-Fail” Banks, in Monday’s Wall Street Journal from Richard Fisher and Harvey Rosenblum, who are, respectively, the CEO and Director of Research, at the Federal Reserve Bank of Dallas.

I wonder if Russ Roberts has seen it, because it appears to agree with his hypothesis that a history of government bailout of banks contributed to the financial crisis, because bankers took on more risk than they otherwise would.

Here are Fisher and Rosenblum’s first three paragraphs:

A dozen megabanks today control almost 70% of the assets in the U.S. banking industry. The concentration of assets has been in progress for years, but it intensified during the 2008–09 financial crisis, when several failing giants were absorbed by larger, presumably healthier ones. The result is a lopsided financial system.

Meanwhile, the mere 0.2% of banks deemed “too big to fail” are treated differently from the other 99.8%, and differently from other businesses. Implicit government policy has made these institutions exempt from the normal processes of bankruptcy and creative destruction. Without fear of failure, these banks and their counterparties can take excessive risks.

It also emboldens a sense of immunity from the law. As Attorney General Eric Holder admitted to the Senate on March 6, when banks are considered too big to fail it is “difficult to prosecute them . . . if we do bring a criminal charge, it will have a negative impact on the national economy.”

That last paragraph paints an image for me of the TBTF bankers holding the economy hostage for the taxpayer ransom. I wish I could draw.

Here they sum up the problem rather well:

…market discipline is still lacking for the largest dozen or so institutions, as it was during the last financial crisis. Why should a prospective purchaser of bank debt practice due diligence if in the end, regardless of new layers of regulation and oversight, the issuing institution won’t be allowed to fail?

The return of marketplace discipline and effective due diligence of banking behemoths is long overdue.

In case you are wondering, prospective purchasers of bank debt practicing due diligence is an example of market discipline, just like you practicing due diligence on your car purchase.

Credit Fisher and Rosenblum for going on to offer a solution, which involves rolling back the Federal government safety net and restructuring TBTF banks into entities that can go through speedy bankruptcies so they will be “too small to save”.

I like it. Read the whole thing.

Driving blind

Here’s another good Seth Godin blog post (in its entirety):

Confusing loyalty with silence

Some organizations demand total fealty, and often that means never questioning those in authority.

Those organizations are ultimately doomed.

Respectfully challenging the status quo, combined with relentlessly iterating new ideas is the hallmark of the vibrant tribe.

I’ve worked with leaders who claim they wanted you to challenge them, but beware. While I believe many of them meant it when they said it, when they were actually challenged it was a different story and typically a career-limiting move for the challenger.

I would also add that my experience lines up with Seth’s observation. Those who demanded fealty were doomed.

This is not surprising. As I’ve mentioned before, all problems can be traced to a problem in feedback. Leaders who are not genuinely open to challenge are not open to feedback. It’s like they are driving a bus without the feedback of the seeing the road. Of course, they will eventually drive into the ditch.

Overnight Failure

According to this article, JC Penney CEO Ron Johnson once told a packed house about JC Penney:

All it takes is courage. We can change a brand overnight.

The article, goes on to say that Johnson fell short of that. But, Johnson did change JCP overnight, just not for the better.

Johnson changed the value proposition such that whatever it was that appealed to the old JCP customers, only appeals to about 70% of them now.  In politics, that’d still be huge win. In business, that causes big losses.

Profits and Ballot Boxes

In the comments of this post, commenter Wally and I discuss the business feedback of profit and government feedback of votes.

W. E. Heasley, of The Last Embassy blog, recently posted an excellent short video from Learn Liberty that helps explain why voting isn’t a very effective feedback mechanism:

 

Most of us make purchasing and voting decisions. Sometimes they are a little of both, like when you vote with your family on what’s for dinner.

The following are links to and excerpts from previous posts I’ve made quoting economists Thomas Sowell and Walter Williams, who do an excellent job of explaining why purchase decisions are a more effective feedback mechanism than voting.

1. From this post in 2010, I quoted from Thomas Sowell’s book, Intellectuals and Society.  He explains the difference in these feedbacks well:

The fundamental difference between decision-makers in the market and decision-makers in government is that the former are subject to continuous and consequential feedback which can force them to adjust to what others prefer and are willing to pay for, while those who make decisions in the political arena face no such inescapable feedback to force them to adjust to the reality of other people’s desires and preferences.

A business with red ink on the bottom line knows that this cannot continue indefinitely, and that they have no choice but to change whatever they are doing that produces that red ink, for which there is little tolerance even in the short run, and which will be fatal to the whole enterprise in the long run.  In short, financial losses are not merely informational feedback but consequential feedback which cannot be ignored, dismissed or spun rhetorically through verbal virtuosity.

In the political arena, however, only the most immediate and most attention-getting disasters — so obvious and unmistakable to the voting public that there is no problem of “connecting the dots” — are comparably consequential for the political decision-makers.  But laws and policies whose consequences take time to unfold are by no means as consequential for those who created those laws and policies, especially if the consequences emerge after the next election.  Moreover, there are few things in politics as unmistakable in its implications as red ink on the bottom line is in business.  In politics, no matter how disastrous a policy may turn out to be, if the causes of the disaster are not understood by the voting public, those officials responsible for the disaster may escape accountability, and of course, they have every incentive to deny having made mistakes, since admitting mistakes can jeopardize a whole career.

2. In three paragraphs that I quoted from Thomas Sowell’s book, Applied Economics, he explains the differences in our buying and voting decisions. Here are those three paragraphs:

Politics and the markets are both ways of getting people to respond to other people’s desires.  Consumers deciding which goods to spend their money on have often been analogized to voters deciding which candidates to elect to public office.  However the two processes are profoundly different.  Not only do individuals invest very different amounts of time and thought in making economic vs. political decisions, those are inherently different in themselves.  Voters decide whether to vote for one candidate or another but they decide how much of what kinds of food, clothing, shelter, etc. to purchase.  In short, political decisions tend to be categorical, while economic decisions tend to be incremental.

Incremental decisions can be more fine-tuned than deciding which candidate’s whole package of principles and practices comes closest to meeting your own desires.  Incremental decision-making also means that not every increment of even very desirable things is likewise necessarily desirable, given that there are other things that the money could be spent on after having acquired a given amount of a particular good or service. For example, although it might be worthwhile spending considerable money to live in a nice home, buying a second home in the country may or may not be worth spending money that could be used for sending a child to college or for recreational travel overseas.  One consequence of incremental decision-making is that increments of many desirable things remain unpurchased because they are almost–but not quite–worth the sacrifices required to get them.

From a political standpoint, this means that there are always numerous desirable things that government officials can offer to provide to voters who want them–either free of charge or at reduced, government-subsidized prices–even when the voters do not want these increments enough to sacrifice their own money to pay for them.  The real winners in this process are politicians whose apparent generosity and compassion gain them political support.

3. In his classic column, Conflict or Cooperation, which I linked to in this post, Walter Williams explains how to pit beer drinkers against wine drinkers. Here’s a taste:

Different Americans have different and often intense preferences for all kinds of goods and services. Some of us have strong preferences for beer and distaste for wine while others have the opposite preference — strong preferences for wine and distaste for beer. Some of us hate three-piece suits and love blue jeans while others love three-piece suits and hate blue jeans. When’s the last time you heard of beer drinkers in conflict with wine drinkers, or three-piece suit lovers in conflict with lovers of blue jeans? It seldom if ever happens because beer and blue jean lovers get what they want. Wine and three-piece suit lovers get what they want and they all can live in peace with one another.

It would be easy to create conflict among these people. Instead of free choice and private decision-making, clothing and beverage decisions could be made in the political arena. In other words, have a democratic majority-rule process to decide what drinks and clothing that would be allowed. Then we would see wine lovers organized against beer lovers, and blue jean lovers organized against three-piece suit lovers. Conflict would emerge solely because the decision was made in the political arena. Why? The prime feature of political decision-making is that it’s a zero-sum game. One person’s gain is of necessity another person’s loss. That is if wine lovers won, beer lovers lose.

The differences in political and private decisions has spawned a branch of economics study called public choice economics. Here’s more.

 

Source of evil

My blog received a big boost in traffic this week because, according to commenter Stephen (with minor corrections):

Founder of Crossfit had a talk in which he used rent-seeking as a reference and why that was bad for crossfit and against his business model which he likened to “Striving to excellence instead of striving to make money is a better way to run a business”

He then posted a link to a blog post I wrote in 2011 to distinguish rent-seeking (or as one of the excellent regular commenters here, Mike M, put it, “privilege seeking”) from capitalism. So, I’d like to thank the Founder of CrossFit, thank all who visited Our Dinner Table and thank to all who left a comment to advance the discussion — even those who disagreed with me.

I’m guessing he posted a link for rent-seeking because, as I point out in that blog post, so few people understand what rent-seeking is and the term itself is not intuitive.

Privilege seeking is a more intuitive term. Seeking privileges at the expense of others is about as spot on description as I’ve heard, so far.

Rent-seeking is using government to reduce consumer choices for the benefit of a special interest.

In my 2011 post, I used the sugar tariff as an example of rent-seeking. It works like this: Government adds a tariff to sugar imports, which results in a higher price paid for sugar products in the U.S. by consumers. The higher price benefits domestic sugar farmers who get to charge more since their foreign competitors’ sugar prices includes the tariff.

The objective of my previous post was to highlight that to the extent the tariff allows domestic sugar farmers to charge more, those profits are not earned through capitalism. But, too often folks see that as capitalism. In their eyes, profit and capitalism are almost interchangeable.

I’d like to commend the founder of CrossFit for shunning rent-seeking (it’d be great if he could hook me up with a set of pipe/monkey bars and maybe a small climbing wall for my basement ). That means his strategy is to attract and retain customers by making their lives better, rather than using government to restrict their alternatives.

As it turns out, I happened to also listen to a Harvard Business Review podcast this week with guest John Mackey, Founder and CEO of Whole Foods Market. He has a new book titled, Conscious Capitalism.

capitalism is actually beautiful (Photo credit: wallstalking.org)

In the podcast, Mackey describes his journey from spouting progressive to appreciative capitalist — and it sounds a lot like mine, except I haven’t founded any big companies, yet.

He discovered that how he viewed businesses when he was young — as greedy, singularly focused money-makers — wasn’t all true. He learned that businesses (usually) succeeded by providing something customers value, which is a tremendous overlooked (or perhaps taken for granted) benefit for society. It may be fun to hate on capitalism, but by gosh, don’t take away my iPhone, sort of thing.

But, I think Mackey misses something BIG. While I applaud Mackey and the Founder of CrossFit for eschewing rent-seeking and favoring customer value creation, i.e. for being capitalists, not all businessmen are capitalists.

One thing almost all business people have in common with the rest of us is that they are human. And one thing nearly all economists know about humans is they respond to incentives (though they differ in their beliefs by how much).

So, it follows that business people respond to incentives. They make more money when their companies do well. One way to guide their companies to success is through good-ol’ capitalism — providing the customer with products they value enough to buy.

But, another way for business people to make money is through rent-seeking. Whether it’s a sugar tariff that allows you to charge more or a state giving special tax breaks for auto plants to ‘attract jobs’, as government at all levels have gained more power, the value of rent-seeking has increased along with it. As Harry Browne put it:

Government is good at one thing: It knows how to break your legs, hand you a crutch, and say, “See, if it weren’t for the government, you wouldn’t be able to walk.”

You can blame greedy business people who are unlike John Mackey and the CrossFit founder for seeking profits without creating customer value, but you’d be blaming the wrong people. The right people to blame would be us, for letting government out of its cage to sell the power we give it to the highest bidder to do things like transfer $40/year of our money to rich, rent-seeking sugar farmers so they can continue to buy that power…with our money.

Think about that for a second, $40 isn’t much (which is why we’re not picketing in the streets about it). But, wouldn’t you rather use that $40 to buy something you value rather than give it to the sugar farmer so he can use it to keep getting it from you?

That’s a double-whammy. Whammy one: You lose your chance to buy something with that $40 that makes your life better. That value never materializes in society. Whammy two: Some of that money goes to do nothing more than to convince politicians to continue getting it. If you understand that, it shouldn’t be hard to see that shrinking government can help the economy.