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.

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