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.

From the airwaves

Last night, during a segment about health care and the Obamacare individual mandate, a caller to a local radio station talk show asked:

Let’s say the Supreme Court strikes down the mandate as unconstitutional. Don’t we still have the cost of all those uninsured who get health care? What are we going to do about that?

Here’s how I wish the radio hosts would have responded:

Do you think we would have as many uninsured if we stopped paying for their health care? I don’t. I think most would figure something out really quick.

Is that harsher than a $2,000 fine for not buying insurance?

At the very least, if you think we need some form of government health care assistance for folks who can’t afford insurance, why not use a model like food stamps?

Congress didn’t pass a law fining folks who don’t buy food. I imagine most folks would laugh if they tried. Rather, we provide resources for qualified individuals to buy food from the private food market. Pretty simple.

Singapore uses a similar model for health care and it seems to work.

The forgotten viewpoint

Mark Perry, at Carpe Diem, reminds us of some good advice from French economist, Frederic Bastiat:

Treat all economic questions from the viewpoint of the consumer, for the interests of the consumer are the interests of the human race.

Let’s apply this advice to some common situations.

Minimum wage.  Here’s a good story about how consumers pay for higher minimum wages (HT: Don Boudreaux, Cafe Hayek). The costs to the consumer includes higher prices and fewer options. Some of the cost is also born by low-skilled workers who will have fewer employment opportunities.

Credit card regulations: Don Boudreaux does a nice job in his Pittsburgh Tribune column, Help That Hurts, of looking at the credit card regulations from the viewpoint of consumers.  Here’s an excerpt:

Congress, the White House and most of the news media describe CARD [Credit Card Accountability, Responsibility and Disclosure Act of 2009] as “pro-consumer.” At first glance this description seems accurate. After all, don’t consumers benefit when the fees and interest rates they must pay are reduced?

Although the answer to this question is “yes,” this isn’t the correct question.

The correct question is, “Don’t consumers prefer to have the option of paying higher fees and interest rates if the alternative is having no access to credit at all?”

Not everyone is financially careful or responsible. Traditionally, credit-card issuers dealt with this fact not by refusing to lend to consumers with poor credit scores but, instead, by using an ingenious approach that helps both those consumers with poor credit scores as well as the banks that lend to them. That approach is to charge delinquent customers significant fees for late payments and to raise interest rates on delinquent balances.

Here are a couple more things where the consumer viewpoint is usually ignored:

• Foreign trade – Who would be hurt by restricting access to foreign goods? Consumers.
• Labor unions – Who funds the generous wages and benefit packages of unions? Consumers.

I’ve added a new category to my blog, Consumer Viewpoint, to remind me to continue to apply Bastiat’s advice as I encounter various situations.

My Individual Mandate

It’s simpler and more effective than the Obamacare individual mandate. And, it is Constitutional.

Rather than forcing people to buy insurance or pay a penalty to the government, here’s my mandate:

If you choose not to purchase insurance and you need medical care, we will expect you to pay for your medical care.

Some will say, “But what about the people who can’t afford insurance?”

I have three responses to those people.

First, check out the insurance rates in Missouri. A $5,000 deductible plan for a family of four runs around $300 a month. That’s not dirt cheap, but it’s affordable for many people. It’s about like a car payment.  If insurance is more expensive where you live, I suggest that you give serious thought as to why (psst…It’s because of your state insurance mandates — maybe you should elect a legislature that will enact affordable mandates).

If someone has new cars, premium channels and a smart phone data package, don’t expect me to feel sorry for them if they say they couldn’t afford insurance.

Second, if we got government out of medical care and insurance, we’d have even cheaper solutions that would make it even more affordable. Government involvement distorts the incentives (e.g. emergency room care mandate) that makes it more expensive.  Without government involvement and restrictions, we’d see more solutions along the lines of $4 Walmart prescriptions.

Third, after that, if you still have some people who can’t afford insurance I’d offer two solutions:

1. Donate money to a charity that provides affordable insurance those folks.

2. If we still must do a government solution, target low-income folks with a medical care credit that they will use to buy health insurance and pay deductibles. Why break the system for everyone else? Just fix it for them.

Update: As I was writing this, it came to my attention that the administration is trying to rebrand its mandate as an “individual responsibility” clause.  I think my mandate better fits that description.

Update 2: I like MikeM’s response in the comments to those who ask, “What about the people who can’t afford insurance?”

If they were expected to pay for their medical care, then they “could not afford not to have insurance.”  They would figure something out.

I’m skeptical of the chocolate study

While my own biases really, really want this one to be true, I am just as skeptical of the study that says: “Eating Lots of Chocolate Helps People Stay Thin,” as I am about the red meat study.

I have many of the same concerns. The main one is that the folks who eat a lot of chocolate may simply lead healthier lives.

Other concerns I have about the study include:

• Just like in the red meat study, is that the amount of chocolate eaten is determined by self-reporting, which is not reliable. For example, unhealthy people may simply have under reported their chocolate intake.
• Small sample size. The study contained 1,000 people. That’s small.
• The average age was 57 and we don’t know how long these folks have had their chocolate habit. In 57 years, there could be many more things that influence health than chocolate consumption.

So, it’s possible that this research shows that healthier people in this group of 1,000 said they eat more chocolate than the less healthy people, which really doesn’t mean much.

I will, however, give the researcher credit. She wasn’t nearly as pompous about her findings as the red meat researcher.  When asked if we should all eat more chocolate she responded:

Our findings – that more frequent chocolate intake is linked to lower BMI – are intriguing, however it is not a siren call to go out and eat 20 pounds of chocolate a day.

Though, I’ll point out that while linked is a better word than causes, I think the statistically-challenged will not appreciate that fine point and will likely treat the two words as synonyms.

Commerce Clause for Dum-Dums

The Supreme Court hearing this week is about this one sentence from our Constitution:

From Article I, Section 8: The Powers of Congress:

To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes

Most people know this as “the Commerce clause.”  We usually hear the Commerce Clause as “Congress has the power to regulate Commerce”.  I wonder how many people know there’s more to it?

In my view, the debate breaks down as follows.

On one side we have people who incorrectly believe this statement empowers our Congress to force citizens of foreign nations and Indian tribes to buy something.

On the other side are people who correctly understand that this statement empowers our Congress to settle trade disputes between states and with foreign nations and Indian Tribes, on behalf of the U.S.

Some folks may claim to believe that this statement empowers Congress to force only U.S. citizens to buy things.

Such people would need to believe two things that I find far-fetched coming from a group of authors who were concerned about limiting the power of government to protect liberty from government:

1. There is a significant difference between the meanings of the words “with” and “among” as used here.
2. “States” or “among the several States” actually means “citizens of the United States”.

I find it far more likely that a group trying to preserve individual liberty from government after the learning the lessons of central and arbitrary power firsthand (granted, I admit, not all founding fathers was pure in this regard), actually meant this to be a rather dry power of Congress to settle trade disputes that arose due to laws passed by state legislatures.

For example, this power would be used to settle a dispute if two state legislatures disagreed on how they were to share a common waterway.

No matter the Supreme Court outcome, I’m not convinced that the authors of the Constitution meant this to be an absolute grant of power for Congress to do anything that sounds good that can remotely be tied to a trade between parties.

If that were the case, there wouldn’t be much need for the rest of the Constitution — including Article III, which vests the judicial power of the U.S. in the Supreme Court.

We’re all utilitarians now

Alternate title for this post: “That sounds like a good idea” government

When discussing what government should and shouldn’t do, it’s rare for anyone of any political persuasion to ask, “Does the government have the power to do that?”

That’s utilitarianism — justifying policies and actions on what we believe it will do for overall welfare or happiness.

Our thinking usually goes like this: “Send more people to college? That sounds good. Of course I’m okay with that.” “Help the poor? That sounds good. Of course I’m okay with that.”

Often, even the stuff that sounds good, isn’t good in practice. The “sound-good/feel-good” utilitarian policies often produce unintended consequences that cause more of the problem that they’re intended to help. But that’s a subject for another blog post.

This post is about how it doesn’t even occur to most of us to ask whether the government has the power to do whatever sounds good, or what would have to happen to give government that power.

Those should be the first questions we ask.

We treat it as a given that the country’s founders designed a government for that time and we live in different times.

We don’t consider why they tried to design a government to limit the power of government.

I had a couple recent conversations that I found interesting. They started as a discussion about my homeowners’ association and the following is a mash-up of those conversations plus a little staircase wit:

Me: My neighbors are fighting over fence placement. Officers of my neighborhood homeowners association have threatened to file suit, on behalf of the homeowners association, over the placement of a fence that a neighbor recently built.

I doubt the HOA’s claim will stand in court. The fence placement covenant was added to the covenants by the officers, but our covenants requires any covenant change to be approved by 60% of homeowners.

The fence-building neighbor pointed out the officers did not get that approval from homeowners to amend the covenants. I agree.

The officers contended that too few people show up at the annual meeting to get 60% approval for a change.

The fence builder contends that doesn’t matter. The covenant amendment process does not specify the approval take place at the annual meeting. They should have gone door-to-door to collect signatures to enact the change. I agree with my fence building neighbor again.

The other people:  I do too. It seems like a cut and dry case to me. That’s why I don’t live in neighborhoods with homeowner associations. You get those people who run those things for their own benefit. It’s okay for them to add something to their house, but not for you to do it. It just becomes about politics.

Me: Exactly. When they say it’s okay for their home addition, but not yours, that’s an arbitrary exercise of power. That’s picking winners and losers.

And you do live in a homeowners association — our big one: the Federal government.  The Constitution is like our homeowner association covenants. It defines what the homeowners association has the power to do and it also defines what needs to be done to change it.

In the Constitution, that’s Article V. My homeowners association covenant requires 60% of homeowners to approve a covenant amendment.  The Constitution requires  75% of state legislatures to approve an amendment to the Constitution.

The officers of my neighborhood home owners association took it upon themselves to amend our homeowners association covenants, much like how Congress and Presidents have taken it upon themselves to effectively amend the Constitution without Article V approval.

[This is a part I wish I would have said] They generally do this by misinterpreting two words in the Article I, Section 8 Powers of Congress: Welfare and Commerce. These words were intended to give Congress the power to keep the U.S. safe and settle trade disputes between states.

But, those two words have been misinterpreted over the past hundred years to give government power to do whatever sounds good.

And, so the Article V of the Constitution is short-circuited for the following test: Will this improve welfare? Sure. That sounds good.  Does this have anything to do with commerce? Sure. Okay.

The other people:  [They really did say this] Well, I’m not so sure about that.

Me: [I did say this] Well, then can you explain why we have Article V of the Constitution if Congress can do whatever sounds good? Don’t you think it makes sense to have a formal and somewhat democratic process, in a government for the people and by the people, to amend the governing documents? How’s that different from expecting my HOA officers to follow the covenants and get 60% homeowner approval before amending our HOA covenants?

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.

Innovators v Bureaucrats

If I could draw, I’d draw one picture titled “Current Politics”

It would have an innovator blowing up a balloon with the word “Economy” on it.

Then I’d have another person, labeled “Bureaucrat” holding three straws that are inserted into the side of the balloon.

The first straw is tiny. The bureaucrat directs air from the balloon back onto to the innovator and says: “See how much I’m helping you? I’m making sure we’ll be competitive for the future. Vote for me!”

The second straw is larger than the first. The bureaucrat directs it to a group of people labeled “cronies”. The bureaucrat says to them, “See how much I’m helping you? Vote for me! Also, I’ll be looking for a job in a few years.“

The third straw is larger yet. The bureaucrat directs it to a group of people with their hands out.  They’re labeled “Special Interests”.  The bureaucrat says to this group, “See how much I’m helping you? I’m solving your problems. Vote for me.”

The second picture would be titled, “How it should work”

Innovator is blowing up the balloon. The politician stands behind him facing all the people – special interests, cronies and voters. The politician says, “Get off his back and we will all be just fine. If you have a problem you want solved, do what he’s doing — solve it.  Vote for me.“

Call it like it is

A few recommended edits for a Wall Street Journal article:

Health Law Slow to Win Favor Opposed by Majority of Americans

The day after the president signed the bill into law, which happened exactly two years ago, an average of major polls collated by the website Real Clear Politics showed 50.4% of Americans opposed. This week, that had changed only by a tenth of a percentage point, ticking up to 50.5%., which means the health law has not gained any support.