Wednesday, July 15, 2015

Review of Billion Dollar Lessons: What You Can Learn from the Most Inexcusable Business Failures of the Last 25 Years by Paul B. Carroll and Chunka Mui

Well, I read Billion Dollar Lessons without noticing that valueprax already read it and did not seem completely swept away by its value. I would say that Why Most Things Fail is a better theoretical study of failure, but this did have some worthwhile case studies of breathtaking failures like the Conseco acquisition of Green Tree Financial, which was a dumb subprime housing investment before dumb subprime housing investments were cool.

They say that "no one looks at failures and lays out methods for how not to emulate them". Certainly, there are far too many selection bias success books like Outsiders, Good to Great, and - by definition - any business biography.

Their classification system for business failure is based on management strategy: synergy, aggressive accounting, rollups, inertia, acquisitions of "adjacent" businesses (that aren't), wrong technology, and problems with consolidation.

They give some great examples of business failures where even ex ante it seems that the strategy was not going to work. One is a company (Oglebay Norton) that had shipped iron ore on the Great Lakes and decided to move into what it thought was an adjacent business, limestone:

"Oglebay assumed that it would be able to integrate its acquisitions and improve its efficiency, but it had never accomplished such a task before... Oglebay also overestimated the pricing power that its limestone business would have. Being the fifth largest producer of limestone just didn't carry much weight. In addition, Lauer's hopes about the power of being an integrated producer and shipper of limestone didn't pan out. With the decline of the steelmakers, there was lots of extra capacity available to ship limestone around the Great Lakes."
Another seemingly obvious ex ante business failure was Iridum, the Motorola satellite phone company.
"None of these limitations should have been a surprise, as they had been well documented characteristics for years. But they had been overshadowed by the poetic descriptions about Iridium's anywhere-to-anywhere phone capabilities."
The problem is that many business failures, or successes in the case of The Outsiders, aren't so clear ex ante. It is rare that what sinks a business is "well documented" in advance. As I mentioned in the review of Ling, when we say someone followed a "flawed" strategy, it sounds like he is dumb or a bad guy, but it often just means that the strategy hits an environment that it is not adapted for.

Again from Why Most Things Fail,
"given the complexity of the world, there are limits to how much corporations can control their fate or governments can control the success of their policies. Governments, firms and households lack complete information. They do not have the cognitive power to process the available information to determine the optimal choice. As a result, when you look at their success, the outcomes look more like the result of chance than of rational strategic decisions."
The only thing I can think of as an investor is that cash as the default position seems to be an essential rule. Then it is an epistemological question of what sorts of situations can one have better knowledge than the market?

Speaking of business failure, I can't understand someone who opens a bar, restaurant, or brewery in 2015. Extremely competitive, consumer discretionary spending is at another stupid (unsustainable) cyclical high, and retail rents are priced accordingly. You're on the hook for five or ten years of rent payments, so you've combined a real estate speculation with a business that has strong barriers to exit (food away from home, or bust).



CP said...

Here's an example of a business question that right now, ex ante, is imponderable:

"With regard to Amazon, I think the bullish thesis - they are unprofitable because of growth investments - is probably right. The problem is, there's a way for that thesis to be right and for bulls to still lose. What happens if the future of discretionary purchasing - and that's all Amazon is for - isn't that bright? What if American consumers find a lower level of confidence that better fits their reduced future circumstances, and they tighten their belts?

Then the flywheel would essentially run backwards; the huge fixed costs of the capex investments working against you."

If Amazon craters, or becomes a trillion dollar company, will someone write a book proclaiming that it was inevitable?

Because right here in 2015 it does not seem inevitable.

CP said...

Another imponderable question is the winner of a winner take all contest:

That's the thing about these winner take all business competitions. They select for jerks who don't spend time with their families, who sell vaporware which hurts honest competitors, who trick investors with bad accounting to get a lower cost of capital.

CP said...

Another example of almost random-seeming success, versus lesser success:

I can't imagine that Lauren could sit on a stage and chat about clothing retail the way Drexler does. And I don't think that Drexler hates his customers - you'll notice he is really interested to talk to potential customers in the audience. I suspect that if you spent a day with Drexler and a day with Lauren, you would think that Drexler is the much more successful merchant, when the opposite has turned out to be the case.

innerscorecard said...

Your aside about cash being the default position is an interesting one. Cash (in this environment, 0% - the rate of inflation) isn't used as the benchmark usually. The S&P 500 (or perhaps long-term treasury bonds) is. And that makes index funds seem like the default position to be in if one has no epidemiological insights.

And that default starting position has huge ramifications for the way people think about risk and opportunity cost.

As for the bars and restaurants, I suppose social prestige and other non-monetary explanations (having a place that feels like you are in charge, etc.) is the real explanation.