A couple thoughts from Thomas Sowell

From Thomas Sowell’s latest Random Thoughts:

Everybody is talking about how we are going to pay for the huge national debt, but nobody seems to be talking about the runaway spending which created that record-breaking debt. In other words, the big spenders get political benefits from handing out goodies, while those who resist giving them more money to spend will be blamed for sending the country off the “fiscal cliff.”

I, too, am amazed at how spending gets a pass, even from folks like Warren Buffett who should know better.

Would Mr. Buffett give such a pass to a manager of one of his businesses who habitually spent 20% to 30% more than he took in and planned to do so as long as possible? In this case, would Mr. Buffett be so eager in volunteering his own income to continue to support such a manager so that manager could carry out his indefinite plan of spending beyond his means?

Here’s another good Thomas Sowell thought:

The more I study the history of intellectuals, the more they seem like a wrecking crew, dismantling civilization bit by bit — replacing what works with what sounds good.

I’ve seen the same with managers of successful businesses. New managers often ignore the actual success of the business they’ve been entrusted to run — what works — and change that business with their own ideas — what sounds good.

The typical outcome of that can be seen with JC Penney of the past year, where the new manager of JC Penney has made major changes to the business that sounded good, but have reduced the stock price by more than 50% against the S&P 500.

Intellectuals often have the same effect on society. For example, they may wish to ‘wage war on poverty’, but they ignore the best anti-poverty mechanism ever — innovationism (what works) — and instead seek to replace it with systems that sound good, but actually encourage poverty.

Restaurant Impossible

In this post, I wrote about the Food Network show Restaurant Impossible.

Its viewers are interested in whether the show transforms the failing restaurants into successful operations in two days, as my blog gets a fair amount of traffic looking for “Restaurant Impossible success rate“.

As a fan of the show, I too would like to know. The updates at the end of show and on the Food Network’s website are not detailed. I’d like to know if the restaurants became profitable and how profits trended after six months, 1-year and 2-years.

My hunch is that a 2-day intervention doesn’t stick with the owners, cook and wait staff.

These restaurants are in trouble because the owners do not know how to operate a restaurant and don’t seem that interested in learning. They do not know what good customer service is or how to lead, train and coach people. They know little about food preparation, menu design or safe food handling. One cook didn’t think that seasoning chicken made a difference in taste.

Something to consider when evaluating business opportunities

From Blake Masters’ notes of Peter Thiel’s (founder of PayPal) class on startups (emphasis added).

Suppose you want to start a restaurant in Palo Alto that will serve only British food. It will be the only such restaurant in Palo Alto. “No one else is doing it,” you might say. “We’re in a class of our own.” But is that true? What is the relevant market? Is it the market for British food? Or the restaurant market in general? Should you consider only the Palo Alto market? Or do people sometimes travel to or from Menlo Park or Mountain View to eat?

These questions are hard, but the bigger problem is that your incentive is not to ask them at all. Rather, your incentive is to rhetorically shrink the market. If a bearish investor reminds you that 90% of restaurants fail within 2 years, you’ll come up with a story about how you’re different. You’ll spend time trying to convince people you’re the only game in town instead of seriously considering whether that’s true.

You should wonder whether there are people who eat only British food in Palo Alto. In this example, those are the only people you have pricing power over. And it’s very possible that those people don’t exist.

Many bad business decisions are based on bad market analysis. There may be a reason why you’d be the only British food restaurant around — nobody wants it.

I see this mistake made often in the business world. Business leaders see something like ‘no British food restaurants around’ and mistake that opportunity for an opportunity like ‘the world really needs an iPod.”

Granted. It is hard to tell those two types of opportunities apart. But, so often is the case that the person making the decision doesn’t consider that they might be wrong, or see if it has already been tried and, if so, consider why it didn’t work the other times it was tried.

They should also deeply consider who will value their product and why, which gets to Thiel’s comment about pricing power. These are the only people who want it.

I can do without potato chips. They don’t do much for me. I never buy them for myself. I sometimes eat them if they come with a meal that was provided for me or if I just feel too lazy to ask for a substitution.

Potato chip companies have no pricing power over me. They can raise and lower their prices all they want, that won’t make me buy any less or any more potato chips. Fortunately, for them, there are plenty of people who do value potato chips and are willing to buy them.

(HT: Marginal Revolution)

“I’m not your best friend, I’m your only friend”

Mitt Romney should adapt this speech from Larry the Liquidator, from the movie Other Peoples Money, for his campaign.

I especially like Larry’s 10-year analysis. Here’s Larry’s version (to shareholders):

For the last ten years, this company has bled your money. Did this community ever say, ‘we know times are tough, we’ll lower taxes, reduce water & sewer.’ Check it out. You’re paying twice what you did 10 years ago.

And our devoted employees, who have taken no increases for the past 3 years, are still making twice what they made 10 years ago.

And our stock? 1/6th what is was 10 years ago.

Here’s a version for Romney:

For the last 10 years, our government has bled our money. Did they ever come to you and say, ‘we know times are tough, we’ll share your pain, we’ll lower government spending so you can invest more and grow the economy, that way we’ll all do better?”

No. They increased spending in the good times and increased it more in the bad. They don’t care about you. They care about growing their power and telling you its for your own good.

Check it out. They’re spending twice as much as ten years ago.

Our debt? It’s tripled in the last 10 years. It was about $16 thousand for every man, woman and child back then. That was plenty. Did you just have a baby? Congratulations! She was born owing $50 thousand.

Other parts of Larry’s speech that I really liked:

  • It doesn’t pay to grow market share in shrinking market. The last buggy whip maker was probably the best, but you wouldn’t have invested in it.
  • Take the buyout, then go invest your money in growing businesses. You’ll help the economy, you’ll create jobs and “God forbid, you’ll make a couple bucks!”

That last one is another good one for Romney.  “God forbid that I pursued the American dream and SUCCEEDED. You can too!”

Spoiler alert: Other Peoples Money had a happy ending. Larry the Liquidator gained control of the company off the strength of his speech (hint, hint Romney), but discovered that the company could produce something useful.  I believe it was kevlar or gore-tex fabric, or something like that. So everyone got to keep their jobs and the company became a success again, without being liquidated.

Short lesson in value proposition

I find that many folks don’t quite understand what I mean when I talk about value proposition. Value proposition is the complex web of reasons that you may choose one product over another or may not choose any product at all.

I don’t care for potato chips. I would eat no more potato chips if potato chip companies gave them to me for free. For me potato chips have no value proposition.

I thought of another example to illustrate value proposition with something I use often: iPod/iPhone ear buds. I have three sets.

The first set came with the iPhone. They sound nice and I use them when I listen to podcasts while working around the house where there isn’t a lot of background noise.

The second set I bought because I quickly discovered that the standard ear buds fall out of my ears when I exercise. This set has hooks that go over my ears to hold the ear buds in place.

The third set I bought because I quickly discovered that my other two sets were not good for situations with lots of background noise, like flying in an airplane or mowing the lawn. This set insulates the background noise with cushy buds that I stuff into my ears.

All do well for their specific niche, but not so well for other niches. I purchased two additional sets of ear buds. The makers of the exercise ear buds could not have persuaded me to buy my third set from them if all they did was lower the price of their exercise ear buds.  I already have a set of exercise ear buds, I don’t need another.

The best way for that manufacturer to persuade me to buy their brand is to make what I want for my third set — a set of noise insulating ear buds.

Good thoughts on business strategy

I agree with what Chris Zook, head of Bain Capital’s strategy practice, had to say about business strategy on a recent Harvard Ideacast.

His advice (in my own words):

  1. Know why customers choose your product.
  2. Make sure everyone in your organization knows why customers choose your product.
  3. Make sure your organization can learn and respond to what your customers want.

I’ve dealt with a number of business managers who think they know why customers choose their products, but are dead wrong and they make disastrous business decisions and often lose their jobs because of it. Then they go to the next organization and repeat.

Such organizations tend to be bureaucratic and set up to follow the leaders’ commands and satisfy the leaders’ egos instead of learning what satisfies customers. These organizations are the vast majority of companies.

In an organization that does well on the three principles above, you’ll tend to see decentralized management and an environment that encourages lots of little experiments with the customers. Customer response drives which of these rise and expand. McDonald’s and Starbucks are a couple of good examples.

Zook used Enterprise Rent-a-Car as an example. Each Enterprise location is rated and ranked each week against each other on one simple metric: what percentage of customers would recommend Enterprise. This is the “Ultimate Question” that Fred Reichheld developed. It’s simple and telling. Customers won’t recommend your business unless you satisfy them.

The branches review their scores and rankings and try to learn from their better ranked locations what they can do to improve their scores. This is a good example of decentralized management.

In bureaucratic organizations, you’ll see more centralized control with the “troops” executing the new-fangled and untested strategy designed by the bureaucrats and their consultants. Little experiments will languish and innovation resources will be directed at the whim of the bureaucrats to satisfy whatever they think sounds good — until they’re fired.

Discovering why customers choose your product can be tricky. We tend to over simplify and over complicate these reasons. More on that in a future post.

Library ebooks hit snag

My local library reports that one reason their ebook selection is low is because four out of the “Big Six” publishers do not allow libraries to purchase their ebooks and the other two either have restrictive purchase policies are charge libraries more for ebooks.

In other words, these publishers are acting like Blockbuster in the early days of Netflix.

Change is a bear.  I understand wanting to cling on to profits from your traditional business model as long as possible.  But, just as Blockbuster learned, it works out better to be the change agent than the stick-in-the-mud.