Accidents are the mother of invention

Here’s a nice piece on the invention of the Slurpee (via Marginal Revolution). An excerpt:

Knedlik’s [Dairy Queen] franchise didn’t have a soda fountain, so he began placing shipments of bottled soda in his freezer to keep them cool. On one occasion, he left the sodas in a little too long, and had to apologetically serve them to his customers half-frozen; they were immensely popular.

When people began to show up demanding the beverages, Knedlik realized he had to find a way to scale, and formulated plans to build a machine that could help him do so.

You never know what customers are going to like. Here’s a secret, kids,– they do not teach you how to figure that out in business school. There’s not a formula or process to follow to do it, other than trial-and-error.

I think executives who are trying to find ways to grow their company should consider using more low-cost, trial-and-error discovery .

Examples of how one company deals with the mountain of policy disincentives

Speaking of the mountain of disincentives we face from policy-makers past and present, this weekend’s Wall Street Journal features an interview with Carl’s Jr/Hardee’s CEO Andy Puzder.

Policy-makers act as if business managers will not respond to their disincentives and end up hurting the very people they are trying to help. Puzder illustrates one such action:

Mr. Puzder also expects fast-food restaurants to deal with ObamaCare by replacing workers with kiosks. “You’re going to go into a fast-food restaurant and order on an iPad or tablet instead of talking to a person because we don’t have to pay benefits for any of those things.”

While Mr. Puzder supports technological progress and the efficiency of tools like the iPad, he laments that “there’s a personal element that you don’t get from machines, and I think you’re going to lose that.” It’s also unfortunate, he says, because fast food is a “great level of job for people to enter the labor force.

The sci-fi geek in me wonders when they’ll come out with RoboCashiers. I’ve seen RoboBlackjack Dealers in Vegas. They are 3D animated ladies on big screen TVs that sense your movement and interact with you. Max Headroom, SIRI and Watson, for $500, can you run a cash register and make small talk? You could probably even program it so that the 3D image that appears would be one that the customer prefers.

I enjoyed Mr. Puzder’s comment on price strategy:

Mr. Puzder’s Journal visit comes while he’s in New York scoping out sites for new restaurants in the city. I ask him how he plans to deal with New York’s sky-high rents, a recent minimum-wage hike and labyrinth of regulations. “I went into a McDonald’s yesterday and a Big Mac combo cost $7.19 for a Big Mac, fries and a drink,” he says. “That’s how you deal with it.”

Here’s Puzder on why he doesn’t prefer building in California:

These days, California is one of the few states where the company isn’t looking to expand. “Like many businesses, we love California and would love to build more restaurants,” he says. But “California is not interested in having businesses grow,”

Consider how long it takes for one of his restaurants to get a building permit after signing a lease. It takes 60 days in Texas, 63 in Shanghai, and 125 in Novosibirsk, Russia. In Los Angeles, it’s 285. “I can open up a restaurant faster on Karl Marx Prospect in Siberia than on Carl Karcher Boulevard in California,” he says.

Mr. Puzder’s favorite California-bites-business story is a law that requires employers to pay general managers overtime if they spend 50% of their time on non-managerial tasks like working the register if they’re short-staffed, “which is what we pay and bonus them to do in just about every other state.” Since managers were filing class-action lawsuits against the company for not being paid overtime, “every retailer in the state basically has now taken their general managers and made them hourly employees.”

The managers hated the change “because they worked all their careers to get off the base to become managers…

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.

Ahead of my time :)

My business school professor: What is the number one goal of a firm?

I raise my hand.

My business school professor: Seth?

Me: To please the customer.

My business school professor: Wrong! To maximize shareholder value. You could please customers by giving your product away for free, but that wouldn’t please your shareholders.

Me: With all due respect, it wouldn’t please your customers for very long if you go out of business by giving away your product for free — especially if they value your product, now would it? 

My business school professor: [This-discussion-is-over glare] [Proceed to explain why maximizing shareholder value is the key goal of a firm].

I never bought the ‘maximize shareholder value’ credo, or at least the moronic behavior it led to. I do believe it is the manager’s job to maximize shareholder value, but I never believed that was the goal. Rather, it is a result of pleasing customers.

I’ve seen too many short-sighted decisions come from the ‘maximize shareholder value’ mantra because the customer was left out of the equation.

 

I was pleased to see this article from Steve Denning on Forbes.com, The Dumbest Idea in the World: Maximizing Shareholder Value. Here’s a key snippet from the article:

Although Jack Welch was seen during his tenure as CEO of GE as the heroic exemplar of maximizing shareholder value, he came to be one of its strongest critics. On March 12, 2009, he gave an interview with Francesco Guerrera of the Financial Times and said, “On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy… your main constituencies are your employees, your customers and your products. Managers and investors should not set share price increases as their overarching goal. … Short-term profits should be allied with an increase in the long-term value of a company.”

I remember one example of this short-sighted focus on shareholder value when I as an engineer for a utility company.  One of our big industrial customers — infected by the shareholder value mantra — approached us seeking to buy the electrical facilities at their plant. We delivered power to them at the low voltage they needed to run their equipment. We also had special switchgear at their site — that we owned — to provide the volume and reliability they needed. We charged them extra for this enhanced service.

They computed the simple math of the cash outlay to buy the equipment from us, the fees that would save them and the cost they thought it would take to maintain the equipment. I saw their analysis. On paper it looked like a good investment, one that would add to their shareholder value by reducing costs and increasing profits.

But, their experience was different. They quickly learned that the higher fees they use to pay us included something they didn’t have — expertise and opportunity cost. They realized that trying to figure out how to maintain electrical switchgear took time away producing the products they made for their customers.

They first hired us back to maintain the equipment and then eventually sold the equipment back to us and ‘got out of the business of maintaining electrical switchgear’ so they could again focus on delivering value for their customers.

In their initial analysis, they forgot to include their customers.

 

The Business Cycle

Stage 1: Entrepreneurs experiment and take risks to make things to satisfy customers.

Stage 2: When they discover something the consumer values — aka value proposition– the experiment turns into a going-concern, or a business, and the business becomes self-funding.

Stage 3: If that value proposition is strong enough, the going-concern grows and comes to generate a safe and steady income stream.

Stage 4: Eventually, the safe and steady income stream attracts bureaucrats who use it to satisfy their own desires to boss people around and self-importance.

The focus of the going concern shifts from satisfying consumers to satisfying bureaucrats.

Stage 5: And not just the bureaucrats that take residence in the corporate offices. Outside bureaucrats will come seeking to hook up their bureaucratic organizations to the safe and steady business streams generated by those successful customer value propositions.  These bureaucrats will come from government at all levels, non-profits, foundations, consulting groups, lobbying groups, industry associations, employer organizations, unions, education, self-governing bodies, franchise owners and regulatory agencies.

Stage 6: Fortunately, competition is there to continue to find ways to satisfy customers. And when they do so, they have an advantage to the organizations that are satisfying bureaucracies. Remember, a start-up need only satisfy customers. Big, successful businesses must satisfy its bureaucracies, often which is a higher priority to satisfying the customer, no matter what the bureaucrats in-charge pay lip service to the customer.

Stage 4: But, if competition is successful, it too will attract bureaucrats.

A company that has suffered deterioration in its attention to value proposition, sometimes is able to attract turnaround entrepreneurs and refocus on the customer. However, many of the outside bureaucracies will stay interested and impede progress as long as the business has the resources to help them, which usually causes further deterioration and continues to give advantage to start-ups.

“Experiments” Update

As noted in the sidebar, the photo at the top of this screen is titled “Experiments” and is from a 2010 post of mine with the same title.

I liked it because it represents what goes on around us everyday. Almost everything we do is a trial-and-error experiment. We find something that works and stick with it until we find something that works better.

If you tried a new bathroom cleaner, you are evaluating whether it does a better job than your regular cleaner and whether it’s worth the price.

Every new business and product is a trial-and-error experiment and I thought this photo was a good representation of it. Not only does it show drink makers experimenting with different varieties of drinks to find out what satisfies consumer preferences, but it shows the store management experimenting with how to use its space to offer the most value for its customers and drive the most sales.

Below is a picture of the same space, nearly two years later.

This refrigerated end-cap in a high traffic area of the grocery store use to carry health and sports beverages (see top of screen). It was recently converted to a “You Pick Six” craft beer cabinet.

Store management may have had several reasons to make the change. This end cap is close to the liquor section, so it may have made sense from a product placement.

They might also have six packs with broken bottle or two, and this might be a good way to get rid of the extra inventory.

The sports beverages may not have sold well here. They have been moved to another area of the store and the selection has been reduced to the best sellers.

From a consumer standpoint, this might represent a trend. It seems the latest trend in partying is to offer a variety of craft beers to choose from. This type of cabinet may allow smaller group of people to do just that without having to buy full six packs.

A happy, former Walmart employee

You don’t often hear this side of the Walmart story (H/T Carpe Diem). Here are a few of the things this former Walmart employee had to say:

I worked hard and came back during a break from college to be promoted to work in the photo lab (more responsibility, higher rate of pay). I also saw many full-time employees that I worked with move up to become department managers, assistant store managers, and even move on to the corporate office.

Every evening I would go to a meeting with the store manager, who would tell us the stock price, how much we had sold that day, and if there were other expectations before we left for the night.

I also saw the opposite end of the spectrum. Some fellow associates seemed content to do the bare minimum and didn’t go anywhere in the company because of it. In fact, they are still at the same level.

In my opinion, these are also the employees that you hear speaking negatively of Walmart’s employment practices. They want something for nothing from the company and they aren’t getting it.

Walmart emerged from a willingness to try new things and learn

Thanks to Mark Perry at Carpe Diem for the link to this video illustrating Walmart and Sam’s Club growth.

We see the success stories after they’ve become successful and don’t often think how they got to that point.

I recommend reading Sam Walton’s book Made in America. It paints a good picture of how Walmart emerged from Walton’s constant experimentation and trial-and-error learning, in the store, store location and in the supply chain. It took him years to evolve the retailing model into something that would fund its own expansion by simply pleasing its customers.

It’s been awhile since I’ve read it (~15 years), but a few stories are stuck in mind.

Walton started his first store in a town on the eastern side of Arkansas. He grew it into a success and when it came time to renew his lease, the landlord kicked him out to take Walton’s store for himself. There Walton learned to build renewal options into his leases.

When Walton opened his store right across from a competitor in Bentonville, most people thought he was crazy, but Walton relished the competition and would try things to get people to try his store and keep them coming back, which was great for the customer. Walmart still gets a lot of resistance to this strategy — generally from people who care less about the customer.

He wasn’t too proud to borrow ideas from competitors. When he read an article about a store with a self-serve model in Minnesota or Wisconsin, he hopped on a bus (or train) and visited to see how it worked and then adopted the model in his stores and changed the retailing industry forever.

As he opened more locations, he tinkered with various ownership structures and incentives to drive the right behavior. He discovered joint ownership was the best incentive structure, which carried through all the way to employees of the eventual Walmart earning shares of stock. Early stores were partnerships between him and the store’s general manager.

Even after Walmart was getting larger, they tried new things. They took on a massive project in the warehouse in the 1980s to improve product distribution efficiency. It took years and a few costly mistakes, but it eventually paid off. I often think about that when I see companies ditch a project after the first failure. I wonder if it could be successful with some more learnings applied.

Businesses emerge from the interactions of customers and business owners. They aren’t designed by consultants in board rooms.

The “cheaper to keep a client than get a new one” myth

I’ve heard this repeated dozens of times to focus an organization on client retention.   The trouble is, it isn’t always true and if an organization focuses too much on client retention when it isn’t true, it can hurt.

Most organizations would love to have 100% client retention, except maybe non-profits whose goal is providing temporary help.

In the real world, no organizations have 100% client retention.  Even the best lose clients. Sometimes clients die, move or change what they value or just discover they want something different.

Good organizations will have client retention in the 70% – 85% range.  Organizations with less than 65% to 70% retention might have the opportunity improve retention, depending on the nature of the business.

But, at some point above 70% retention (and this varies depending on the type of organization and service, etc.) you reach a retention rate where you run into the law of diminishing returns.  To increase the retention by another 1%-point, for example, is costlier than bringing in new clients who value what you offer.

Let me illustrate with an example.

I use to use a small plumber for my home plumbing needs.  He was good and reasonable and good enough, in fact, that sometimes I had to wait a few days for him to come out. Once this proved to be a problem, because I had a leak that couldn’t wait a few days to fix.

I called another company and found they also did good work and I didn’t have to wait a few days.  They could have someone out within two hours.  That convenience advantage, along with their good work and reasonable prices, was enough to get me to switch.

However, my previous plumber still has plenty of work.  Losing me didn’t cost him much business.

For him to change his business to satisfy folks like me would cost him a lot.  He’d need to hire enough plumbers to cover the demand 24/7 and invest in more trucks and equipment. He’d need to hire schedulers and manage a larger workforce.

But, he’s happy with the business and profits he earns from his set of loyal clients, who don’t place as much value on how quickly the plumber arrives.  Perhaps his customers are builders and commercial accounts who can schedule work in advance, or simply people who can get by for a few days with a leak.

Even in a market that appears as homogeneous to outside observers as plumbing, there are some key things that differentiate the value proposition of what different plumbing companies offer and it is difficult for any one company to satisfy all these value differences.

For my previous plumber, it is cheaper to let me go to the competitor that offers what I value while spending his resources on finding another client who values what he offers.

That holds true until you reach a point where fewer and fewer customer value what you have to offer.  At that point, the market (i.e. customers) is sending you a signal that you need to change what you offer, or go out of business.

Admittedly, there’s a fine line and art between knowing when you need to just focus on finding clients that value what you offer and when you need to change.

Based on these thoughts I have a few recommendations for businesses.

First, don’t always assume that increasing retention is cheaper than finding new clients. It’s actually not very difficult to estimate the costs of each for any business.  Try it and see if you can compare the acquisition and incremental retention cost per client.

Second, if your retention is stable within a few percentage points, plus or minus, then that’s likely a sign that it’s just as effective to keep focus on both finding new clients and retention.  You should not favor one over the other.  You need both.

Third, be prepared for when retention does start to plummet.  Consumer preferences do change in unpredictable ways.  One way to prepare your organization for such changes is to run small experiments with various business model approaches and see which ones resonate. Also, keep and eye on what your competitors are doing differently and understand why that may or may not work for you.

I’ve seen too many organizations who only focus on their bread-and-butter value proposition and get caught by surprise when consumer preferences change.  That puts them in a dangerous position of throwing hail mary’s when preferences change rapidly. The chances of hail mary’s succeeding are less than the chances of small, unforced experiments.

I’ve also seen organizations who move too rapidly to change their business model even when it’s doing fine.  In the process, they often fundamentally lower the value proposition for existing clients.  New Coke is a good example.

Starbucks irked some of its faithful recently be introducing a light roast.  But, they didn’t repeat the mistake of New Coke, by replacing dark roast with light roast, they just added the new light roast to the existing product line.  Starbucks’ faithful will get over it, because they can still get the products they love and now more of their friends (the 40% of coffee drinkers who prefer lighter roasts) will come with them.

Fourth, develop a deep understanding of the value proposition your organization offers. Why do customers use your product or service?  Ask them and ask them again.  Don’t take their first answer as the real answer. There is probably four to ten reasons why they use you. Also, don’t just look for the answers you think are right. Some of the worst business strategy blunders come from folks who impose their own incorrect view of the value proposition on the organization.

Would Buffett want to give politicians more of his money to spend if they ran his company?

President Barack Obama and Warren Buffett in t...

Would Buffett hire this guy to run Berkshire-Hathaway?

Warren Buffett makes another plea for government to take more from him and his net worth peers.

First, I’ll point Buffett to my advice for those who would like to raise taxes.  Thankfully, many others are calling for Buffett to lead by example and voluntarily cut a check as well.  Maybe Buffett will hear that message and respond.

I’ve also addressed Buffett’s analytical hypocrisy on this matter before.  That didn’t seem to work.

I’ll try another approach.

Carefully read Buffett’s words from this paragraph of his editorial:

They’ve [Twelve members of Congress] been instructed to devise a plan that reduces the 10-year deficit by at least $1.5 trillion. It’s vital, however, that they achieve far more than that. Americans are rapidly losing faith in the ability of Congress to deal with our country’s fiscal problems. Only action that is immediate, real and very substantial will prevent that doubt from morphing into hopelessness.

He never mentions spending — only deficit.  Buffett seems unwilling to hold our elected representatives accountable for spending way beyond our means.

I believe that’s partly due to an incentive effect.  If it were Buffett’s own pocketbook that representatives spent from he might think otherwise.

Buffett’s business, Berkshire Hathaway, is a holding company that owns lots of other companies.  He grew wealthy by buying good businesses run by good managers, keeping those managers and letting them do what they do best, run their businesses.

What do you think Warren would do if a business manager began spending much more than he was bringing in with no hope of closing that gap?

Do you think he would beg that manager to take even more of Buffett’s money so the manager could continue his spending spree?

I don’t think so either. I think he would fire him swiftly and find a replacement.

In my opinion, Buffett and his net worth peers, do much better for the economy by continuing to invest their wealth in productive ventures that make products and services that we value as consumers and provide jobs for millions of people, than by handing it over to politicians to help sustain the bureaucratic, rent-seeking behemoth we know as government.

I also think Buffett and his net worth peers could do much better by explaining this to folks and encouraging us to support and vote for politicians who would like to reduce the bureaucratic drain on society and double down on productivity.