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)

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.

Market Share Myth

Company managers love to chase market share.  They like it because it’s a competitive head-to-head score, like a score to a baseball game. If you “take” market share from your competitors, then you’re beating them up and that’s good. If they take it from you, that’s bad.

I don’t think we should worry much about market share.  I have several reasons.

First, it isn’t necessarily a good read on the measure of business health.

Consider a simple ad absurdum: Would you be better off by doubling market share by cutting price in half?

No. You may be worse off. What if you cut your salary in half and got two jobs?

Sure with more clients, you’re less dependent on any one client. But, it will cost twice as much to serve those clients. So, you’ve doubled your costs while keeping revenue flat. And, you may have attracted a less loyal client that is more likely to leave you.

Several years ago, a company I worked with exited a line of business that had given it some market share and consistent financial losses for six years. It showed no signs of producing profits. There’s another name for such a line of business: unnecessary cost.

The managers kicked themselves on the earnings conference call for losing that market share. Rather than kicking myself, I would’ve celebrated giving up that line because it would mean getting rid of an unnecessary cost and more money for shareholders.

Getting rid of unprofitable market share, as in the example above, can be good. Acquiring unprofitable market share can be bad.

Earnings is a better measure of health.

Second, focusing on market share keeps managers too focused on their existing product lines. The best makers of buggy whips probably acquired significant share of the buggy whip market as the automobile was replacing the buggy.

Third, the “market” is to easy to get wrong. Is McDonald’s market share its share of hamburgers sold, its share of fast food hamburger restaurant sales, its share of fast food restaurant sales, its share of all restaurant sales or its share of all food and beverages sold?

Why pick one definition over the other? Should McDonald’s be bothered that you chose to buy a Coke at the vending machine in your office building instead of one its restaurants? Should they get into the office vending business in order to “capture” that market share?

I don’t think so.

Fourth, the market share paradigm turns the business world into a caricature of a “battle for control of the market”.  Company managers even try to act like that’s how it works as they bludgeon their troops to deliver results.

I think that’s an inaccurate and damaging representation of the business world.

Companies that gain profitable market share are those that provide products that clients value enough to buy at a price that more than covers the company’s costs.

Rather than a heartless battle for market share, the business world is really a trial-and-error lab that looks for ways to delight customers. Rather than Glengarry Glen Ross, it’s more like Starbucks.

Rather than gaining market share, businesses should be focused on pleasing customers and growing profits.

Growing profits is less like war and more like convincing a girl to go on a date. The secret to doing that is to give a girl what she wants. Figuring out what that is a trial-and-error process and can change at any time.

A kid learns a little bit about market evolution

My young son asked me two great questions this past week.

First, while I was driving him around he asked why the grocery store built a new building and moved across the street?

Second, while standing in our garage next to the trash and recycling bins that our trash company provided he asked why they gave those to everybody?

In case you’re interested on how I answered, on the first question I said its because with more than one grocery store in town, people can choose which one they want to go to.  Since people seem to like modern, newer, cleaner buildings, the managers of the grocery store built a new store to keep it attractive and keep people choosing them over their competitors.  He seemed to get it.  He responded, oh so what people like changes?

On the second question, I said it’s to be more efficient.  When I was a kid, the trash truck had three people — one driving and two walking behind the truck throwing the bags into the back as the truck rolled down the street.

Now our trash truck has one person, the driver, and a robot arm that grabs these special bins and dumps the trash in the back.  The bins fit the robot claw and the trash company only pays one person instead of three. The trash company must have figured out that providing everyone with these bins, using the robot claw and one driver was less expensive for them than paying two or three people.

Oprah Winfrey Business Leader

Watching the Behind-the-Scenes making of the final season premiere of the Oprah Winfrey Show on Oprah’s new television network gave me a good glimpse into Oprah Winfrey’s leadership skills.  I was impressed and surprised.

I shouldn’t have been.  Oprah’s highly valued media empire is evidence that she’s doing a lot of things right.  But, I think it’s disarming in that we all know Oprah as the high energy TV personality and don’t often think about what it takes to produce a show every day of the work week.

I’m amazed that there hasn’t been more attention paid to Oprah’s leadership skills over the years.  I believe anybody in a leadership position can learn a lot from her.

Here are some of the things I noticed.

In addition to having a flair for hosting, interviewing, having good visions about what people want to watch, she’s one helluva people leader.

She appears to have made some very wise hiring decisions.

She doesn’t appear to micromanage.  She gets good people and let’s them have some rope.

She gives general directions and ideas about what she’s looking for and her people come back with specific ideas and then they follow through with making them happen.

Oprah heaped praise on her team as being top notch.  And everyone appeared to be energetic, creative, detail oriented and engaged.  Everybody from the teams of producers, to her director, to the team that brings in the audience and gets them ready for the show and the stage hands received praise from Oprah and it appeared well deserved.

I was even impressed with the state of the studios and the offices.  All the details seem attended to.  Nothing was out of place, every place seemed warm and inviting.  Reminds me of the old adage that you can tell how well an employer takes care of its associates by the state of the break room.

When one of the production teams pitched a crazy idea for the season premiere (to have some road tripping ladies unknowingly drive right up on stage during the taping of the show) Oprah was blunt.  “That’s a crazy ass idea.”  The producers pushed forward.  Other producers praised them.  “It take some guts to go with an idea that Oprah thinks is ‘crazy-ass’.”

The producers in question did seem to have some fear for their jobs, “this could be our swan song.”  But, they still pushed ahead.  They must have felt comfortable enough to take risks.  And, back to the hiring decisions, they seemed to hold themselves accountable, “nobody will be more disappointed in me than me if this doesn’t work out!”

The production team pulled it off (though they did sweat bullets) and it worked beautifully.  Oprah came into the production booth and gave them high praise and said, “You were right, I was wrong!”.  I have not heard many leaders say that.

I’d love to see how Oprah handles it when something doesn’t work out well.  That is one of the truest tests of a good leader. In my experience, that’s where I’ve seen big separations between the mediocre and the superstars.  Bad leaders do nothing.  Mediocre leaders either tend to get mad, huff and puff, flex their muscles and show their teeth or simply lose confidence in the talent, write them off and second guess them until they eventually part ways.

Superstars tend to understand that not everything goes perfectly all the time and they give clear, timely and actionable feedback that will help the person improve, rather than feel like a heel.  Good talent will blossom into superstars working for such leaders.

I’d like to interview Oprah about how she came about her leadership skills.  Some of the questions I would ask:

1.  Is hiring good people something you always knew to do or did you learn that through experience?

2.  What a-ha moments led you to realize the importance of a good team?

3.  What about micromanagement?  Did you ever have a tendency do it?  How did you overcome that and were there any a-ha moments that made you realize that micro management could limit you?

4.  Have you made any bad hiring decisions?  How did you handle those?

5.  Surely, things don’t always go as expected.  How do you handle it when that happens?

6.  Were there moments early in your career where you didn’t think it was going to work out?

7.  Were there any lucky breaks that you had, that when you look back you think, “wow, if that didn’t happen, I may not be doing this.”?

8.  Was there anyone particularly that inspired your leadership style?

9.  What advice would you give other leaders?

Experiment, Fail, Retool

At the local Target I noticed they replaced their store brand, whole bean coffee-by-the-pound end cap and with a traditional shelf end-cap that can hold any product.  They had it stocked with single cup coffee brewing machines and accessories.

Experimentation, failure and retooling and success are in constant motion around us.  That motion is the market responding to the signals we send it with our behavior.

Five years ago we liked whole bean coffee-by-the pound.  Now, we favor convenience and consistency with the single cup brewers. Our tastes change as we experiment and discover new value propositions.  When we find something we like or find useful, we tell our friends and they too discover the value proposition.

It’s fun to watch.

Ebook Wars

The Wall Street Journal reported today that Google is set to launch an e-book venture.  That could put some wrinkles in my Print vs. Kindle value proposition analysis.

Advice for Google:  Figure out how to put ebooks on devices that do not have to be shut off and stowed during take off and landing in airplanes.

Advice for Kindle: You have a really cool device.  Open it up to Google.

Advice for whomever wishes to make some moneyApply Netflix’s subscription model to ebooks.

Megan Liked My Comment

Last week I posted a comment to this post about Starbucks putting quality over quality on Megan McArdle’s blog on The Atlantic’s website.

Megan then posted my comment in her next blog post, writing that

A reader offers this perspicacious take on Starbucks.

I had to look up perspicacious.  It means:

Having keen mental perception and understanding; discerning: to exhibit perspicacious judgment.

I always find it an honor when someone likes something I wrote.  Especially so when that someone writes professionally on similar topics.

Thanks to Megan for posting my comment, the compliment and expanding my vocabulary.

My comment that she posted was:

I suggest the title: “Starbucks is firmly in the tinkering stage”.

All retailers see their sale growth shrink to single digits once they saturate the market geographically. They then enter the tinkering stage where they try things like this that usually have roughly net neutral trade-offs.

Focus on quality (or consistency) and you attract clients that value that and lose some that value convenience. Focus on convenience and you lose those looking for quality.

But, it never hurts to experiment. After all, nearly all successful products and business are the result of a successful experiment.

To this post I modified the thought, adding that experiments can hurt.  But, for a business to move forward it needs to experiment.

Value Proposition: Netflix vs. Blockbuster

Megan McArdle’s post Netflix Nation reminded me of this post about my extremely late adoption of the online DVD rental service.

Megan’s post explores why Netflix may have achieved such an advantage over a company like Blockbuster, when other innovators have failed.  She offers Netscape, TiVo and cat scans as big innovations that changed the market, but were ultimately copied and outdone by established players.

I think it’s a great question.

A fellow I met through work earlier this year had previously managed some Blockbuster locations.  He shared with me his view.  He said that Blockbuster execs couldn’t understand the Netflix value proposition.  They thought of movie or game rentals as impulse purchases and that the bricks and mortar model was better than having to sign up and wait to get something through the mail.  I thought that myself until earlier this summer.  I couldn’t imagine why I would want to do that. I moved late.  I could afford to. Blockbuster execs moved much too late.  They couldn’t afford it.

Repeated conversations with a co-worker and facing a summer of bad television got me to pull the trigger.  I chose Blockbuster Online.  Continue reading

Questions for Managers

This is another post in my continuing series of good questions to ask managers you may be hiring to run a business.  These come in handy whether you are sitting on a Board of Directors for a business and need to interview executive candidates, running a piece of business or a small shop.

The Question:

We’re strangers sitting next to each other on an airplane.  How would you convince me to give this business a try?

This question gets to the heart of whether this candidate can effectively sell your business.

In the business world, I’ve witnessed many problems that stem from having managers in place that cannot sell the business.  They don’t understand the business’s value proposition, don’t know or seem to care why clients voluntarily part with their money to buy the products or services.

Having such a manager is bad news.  It will very likely destroy value.

What’s even worse is when the manager would not choose to use the product or service if they were not employed by it.  The tendency of such a manager is to remake the business to suit their own preference as customer, while ignoring or changing what it is about the business that makes it valuable to its existing customers.   This also destroys value.