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Last February I got to hear John Mackey give a speech about a better way of doing business. He’s a founder and co-CEO of Whole Foods, and he stopped in at a Raleigh Chamber of Commerce event to promote his book, Conscious Capitalism: Liberating the Heroic Spirit of Business.

John Mackey, Whole Foods CEO Photo Source: Joe M500, Flickr (Creative Commons License)

John Mackey, Whole Foods CEO
Photo Source: Joe M500, Flickr (Creative Commons License)

The book’s premise flies in the face of Milton Friedman’s argument that the business of business is business. While Friedman makes the case that the only purpose of a business is to increase value for shareholders (i.e., maximize profits), John Mackey says its obligations are better understood as a balance among five groups of stakeholders:  stockholders, employees, customers, suppliers and the environment.

Mackey actually takes it one step further. He says companies that serve the interests of all the stakeholders have a competitive advantage. They create more value and are rewarded by the stock market.

After his speech I had the opportunity to ask Mackey a question. “If conscious capitalism is such a good thing,” I asked, “why aren’t more companies doing it?”

He responded by saying, in essence, that it just needed a vocabulary, someone to give it a voice, a demonstration to the world that it is a better way of doing business. “I’m giving all of you a secret formula for building a successful business,” he continued. “It will be copied as others see you succeed with it.”

Whole Foods is meant to be the living example of this better model.

Fast forward to this morning. I’m enjoying coffee with a friend at my local Whole Foods. It seems a good time to reflect on Mackey’s secret formula. Since last year the Whole Foods Market stock price has been cut almost in half, dropping from $65 per share to around $37. It’s been a rough ride. Continue Reading…

(Or, Why I Put My Money In Self-Help Credit Union, Part II)

 1.

When Michelle Holland started her little bus company in 2009, she would rouse her son at four each morning. He was ten and his single mom had no option but to grab his pillow and plop him in a rear seat of her refurbished yellow school bus while running routes through Charlotte’s neighborhoods. He would grab his last winks of sleep while she collected students from their homes for delivery to a local charter school. For the privilege of avoiding the hassles of car pools, the parents would pay Michelle a small fee each month. She would drop them off before extending her trip a few extra miles to get her own son to his school.

Such was start-up life for Michelle and her Eagle Bus Service. It was tough, but it supplemented the income from her bookkeeping practice. And after several years spent juggling the demands of an all-consuming corporate life with the demands of being a young, single mother, it let her be near her son more often.

Now word was spreading to other charter schools that Michelle could solve their transportation woes. The state gave them funding to educate kids in their own unique ways, but it didn’t give access to the county-run fleets of buses. Principals saw what Michelle was doing for her first client, and they wanted her to expand; to help them, too. They were offering guaranteed payments and year-long contracts if only Michelle could scale-up her service. If only she could get more buses and more drivers.

Michelle's Bus Fleet (Credit: Michelle Holland)

Michelle’s Bus Fleet (Credit: Michelle Holland)

This is the story I’m getting first hand from Michelle in a phone conversation one afternoon last fall. We had been trying to connect for weeks, but Michelle isn’t exactly swimming in spare time. Her morning schedule remains largely the same as it was in 2009 – up well before dawn, preparing to get students safely to school – and her days are spent balancing the desk work of Eagle Bus with the needs of her few remaining bookkeeping clients. In the meantime she was searching desperately for another bus to add to her growing fleet. She usually bought them in North Carolina, but someone was grabbing all the state surplus vehicles before she could get to them. Michelle had just driven to rural Virginia to find one that met her standards. We were speaking because I was interested in how she got the money for that purchase. Continue Reading…

My September books brought so many amazing learning experiences, not to mention the discussions they generated with family, friends, colleagues and even one of the authors.

Financing Our Foodshed by Carol Peppe Hewitt

Let’s start with the winner of the prestigious Most Dog-Eared Book of the Month Award. Thank you Carol Peppe Hewitt for writing Financing Our Foodshed: Growing Local Food with Slow Money, a collection of 22 stories on North Carolina food entrepreneurs (farmers, bakers, restaurateurs and the like) to whom Slow Money NC has introduced local financiers eager to fund sustainable local eating ventures.

IMG_20130929_124805Mainstream investing has become overwhelmed by the opportunity cost heuristic, guided by the simplistic question, where can I make the most money as quickly as possible with the least risk? 

This is not entirely bad, and I’m not quick to cast moralistic aspersions on using capitalism in pursuit of profits. There’s a place for that, and there always will be. But it brings to mind the notion of hypertrophy, this glitch in evolution’s system by which nature allows (for example) a male ibix to grow horns so large, its neck cannot support the weight. Yet those large horns have become a proxy for virility, and the females are programmed to mate with him whose horns spread widest. And so this glitch propagates through the generations with the genes of big-horned ibix begetting even bigger-horned ibix until an entire species is handicapped with antlers with all appeal but no function. I can imagine the big cat mountain predator eager for this easy prey. Given enough generations of reproducing those big horns, the hypertrophy glitch will bring doom to that gene pool.

It’s not that big horns are bad, but there is such a thing as too big.

So it is with capitalism and opportunity cost. It’s not that it’s bad, but there can be too much.

In chasing the biggest-dollar, fastest-bang, lowest-risk return, we put all our resources into high-scale enterprise that promises crazy riches while we starve our local entrepreneurs of the capital they need to get off the ground or grow. Herein lies a hypertrophy risk in our investing system. We chase the promise of the next Facebook (that big-horned ibix) while ignoring the small-scale businesses that create happier, healthier, more sustainable local economies.

The weight of that imbalance threatens to topple us. Continue Reading…

Apparently my fascination with all things Zingerman’s knows no bounds as I explore this Enough Project. I’ve trolled a brilliant little video (by Daniel Seguin) featuring Zingerman’s co-founder, Paul Saginaw, that promotes a concept called “Localism.”

“There’s this idea of having enough” Paul narrates over beautiful pictures of the Zingerman’s businesses. “So when you believe that, when you’re not wanting more and more all the time, what’s driving you is wanting to create something of excellence. It’s liberating.

“What is this? Is it capitalism? Is it socialism? What do we have here? I don’t know if it’s capitalism. I know it’s not socialism. I don’t know what it is and it isn’t. But anybody can do it. It’s just a lot of work. But I would say try it. It’s also fun.”

(The video is here.)

(h/t to Ron Maurer for this link via Twitter)

Business Gone Good

July 10, 2013 — 2 Comments

A musing on my recent mental captivity to conscious capitalism.

The Conscious Capitalism Pebble

Somehow, someway I was introduced to John Mackey’s 2007 manifesto, “Conscious Capitalism: Creating a New Paradigm for Business.” (1) That essay led to a book promoting the the notion that business can be done better and an organization to convene the like-minded around those ideals. (2)

And I can’t get enough of it.

I read Mackey’s essay nearly a year ago. It’s been like a pebble in my shoe since. Its slight, nagging presence won’t let me forget it; won’t let me ignore it. Its themes have dominated my recent essays, hijacked my reading stack, and overwhelmed my thinking.

So, why? Why this fixation on doing business in a better, more conscious way? Continue Reading…

An essay in which I consider Whole Foods CEO John Mackey’s response to my question, “if Conscious Capitalism is such a good thing, why aren’t more companies doing it?”

John Mackey, Whole Foods CEO Photo Source: Joe M500, Flickr (Creative Commons License)

John Mackey, Whole Foods CEO
Photo Source: Joe M500, Flickr (Creative Commons License)

John Mackey Speech in Raleigh // Conscious Capitalism // Asking Why?

John Mackey stares at the running faucets in the men’s room just moments before his talk. He shakes his head incredulously, muttering to no one in particular, “That’s an awful lot of wasted water.”

The co-CEO of Whole Foods is a man of medium height and possesses a slight build. A tight haircut has tamed the unruly locks of curled hair I’ve seen in so many of his media headshots.  He’s in Raleigh this chilly February morning for a breakfast talk sponsored by our chamber of commerce. Mackey is promoting his new book Conscious Capitalism: Liberating the Heroic Spirit of Business.(1)

He looks around for an air dryer for his wet hands and finding none seems to ponder briefly whether to just slide them across his tan slacks. He opts for a single paper towel instead. Those who want to greet him this morning with a handshake will just have to endure his damp fingers.

Moments later Mackey is giving his spiel before an attentive crowd, a set of remarks unburdened by notes, spilling freely from a mind that has spent much time mulling over the subject. Then he opens the floor for questions. I sneak one in just at the end. It went something like this:

If Conscious Capitalism is such a good thing, why aren’t more companies doing it? Continue Reading…

Bill SpruillPhoto Credit: Bill Spruill

Bill Spruill
Photo Credit: Bill Spruill

When an investor believes he has an edge, he’s supposed to stay quiet. He’s supposed to focus his energy on exploiting his advantage, not on trying to teach others the methods behind his approach. That’s conventional wisdom anyway.

And yet here I find Bill Spruill, an angel investor who backs software startups (and a stranger to me just a few months ago) explaining his investing strategy in painstaking detail. It’s the day before Thanksgiving, and we’re sipping warm beverages at the Whole Foods café near my home in Raleigh. We’ve rendezvoused at local coffee houses since September, and at each meeting – despite knowing I’m both an investor looking for ideas and a writer likely to tell my readers all that I learn – he reveals a little more about what we’ve come to call the Spruill Theorem for Reasonable Angel Returns.

In a calm and thoughtful manner befitting a college professor, Bill presents case after case for me to consider. This morning he pushes a folded copy of the day’s Wall Street Journal across the table and points to an article about a high-flying social media venture attempting to raise a fresh round of funding. Its prospects are a bit dimmer than the last time it went looking for cash. “What’s going to happen to the early investors,” Bill asks me in his Socratic style of teaching-by-interrogation, “if this effort fails? What’s going to happen to other promising startups looking to get off the launch pad?”

Those two questions signal the reasons Bill wants to tell me and other prospective angel investors about his insights. What we think we know about the risks of these investments may be misguided. And sticking to conventional wisdom carries with it consequences not only for individuals but for the larger dynamic between investors with cash and entrepreneurs with their creative visions.

It’s bigger than Bill’s portfolio.  It’s bigger than any one startup. It’s an ecosystem issue. And Bill believes that debating the ideas of the Spruill Theorem will make for better informed angel investors and ultimately a healthier ecosystem of software startups in our Triangle community.

“Angel investors are heeding the wrong models,” he tells me. “We’re trying to copy the huge successes, thinking we’ll get the same outcomes. But these stories can be dangerous. These models rarely work for angels.”

He pauses for a moment before adding, “We need new models to follow.”

Continue Reading…

lucyThe Case for Conscious Capitalism

Next week Austin will play host to a group of executives that label themselves “conscious capitalists.” [See consciouscapitalism.org.] John Mackey, founder and CEO of Whole Foods, will provide the keynote address and suitably so. In 2007 he loaned his influential voice to this movement by penning the missive “Conscious Capitalism: Creating a New Paradigm for Business.”

It’s worth the read, and you can download it here. [pdf] The gist is this:

There is a longstanding prejudice that businesses exist for the enrichment of shareholders. While this is technically true, the notion has been interpreted to mean that corporate managers have the fiduciary responsibility to grab profits whenever they are available for the taking, all other constituencies be damned. It is the investor dominated viewpoint, often ignores the other stakeholders in a business, and it can be obscenely myopic. (See my related article, Whom Does Management Serve?)

It also creates, Mackey argues, a zero-sum game that pits investors against managers, employees, customers, vendors and all other stakeholders. By spending more on employee pay and benefits than absolutely necessary, for example, you’re taking earnings off the table that are the rightful property of investors. If employees win, investors lose.

The Conscious Capitalist movement argues for a different framework for understanding the game of business. Rather than a zero-sum dynamic, it suggests viewing it as a system of interconnected parts. By investing more in employee benefits, Mackey says, you get happier employees who better serve the customer…who then buys more products…which leads to higher profits…which can be shared with investors. Treat all stakeholders in a fair manner and the whole system is hoisted ever higher in a virtuous cycle. The sum of the parts, working in unison, become much more valuable than the individual components.

Continue Reading…

Tom Pirelli ESI Baby

I caught Tom Pirelli on his mobile phone one morning last week. He was near his house in Jupiter, Florida preparing his thoughts for an afternoon meeting about his latest venture, (something to do with using therapeutic lasers to manage chronic pain). He immediately strikes me as a man overflowing with energy, though he is not so young anymore.

I learn that he made a noble attempt at a leisurely retirement after selling his software company, Enterprise Systems, 15 years ago. But it would seem retirement did not fit his constitution. He has since started an ambitious foundation to provide better affordable housing options to impoverished communities in Mexico and Haiti. He has worked with USA Rugby, and took great pride in seeing his favorite sport included on the roster for the 2016 Olympics in Rio. And, of course, he has involved himself deeply in this new laser therapy business.

Tom is a success through and through with the sort of bona fides that might just turn a less humble man into a braggart. Yet despite his litany of accomplishments, this is the picture for which Tom is best remembered:

We’ll return to that later…

Continue Reading…

Exceptional Business Pic

I’m testing a theory here, the driving question of which is What are the cardinal traits of exceptional software and technology businesses?

The term “exceptional” is as qualitative as it gets. Perhaps we’ll give it more definition as we proceed, but for the time let’s be comfortable with former U.S. Supreme Court Justice Potter Stewart’s threshold test for obscenity: I know it when I see it.

I’m suggesting four criteria and using them as a framework for evaluating various businesses in different stages of development, as early as start-ups and as late as technology that has been retired from companies that have long since moved on. The application for what we learn will resonate most, I think, with young businesses either in their fledgling stages or otherwise still able to mold their cultures and their values.

My early thesis is that the exceptional software and technology companies share some combination of the following traits summarized below in very rough form:

Continue Reading…

I didn’t intend this to be a series, but it has quickly turned into one. The original idea, from this post, is that holding up company managers as “shareholder friendly” (in that they do a fine job representing shareholder interests) can be like a backhanded compliment. Which shareholders, exactly, are they representing? Because it’s a certainty that few of the company owners share the exact same interests or desires for the business.

The most stark contrast might be between investors with an interest in the business showing short-term gains to impress the market, increase the stock price, and provide an opportunity to exit with a profit. They will want managers to work over their accruals as best as possible to show higher earnings. Or to just stop making investments in the business and let the lowered expenses generate a bigger bottom line.

Their objectives are not going to mesh with the investors hoping to stick around for the long haul. This group will not be excited by elaborate accounting to increase GAAP earnings. Nor will they want executives to neglect important expenses (like marketing, talent acquisition, research and development, etc.) in order to show a fatter profit next quarter. These expenses are investments in spurring growth and/or maintaining strong barriers to entry, both important in maintaining long-term profitability.

And even reasonable, level-headed investors can disagree with each other and therefore have diverging interests.

 

Case in point: Joel Greenblatt versus Michael Burry, a disagreement Michael Lewis brought to light in his book, The Big Short.

Joel Greenblatt, of value investing fame for his various books and tremendous track record with Gotham Capital, seeded Michael Burry’s hedge fund and benefited from multi-year period of impressive returns. Then Burry made his big bet against sub-prime lending, a complex and hard to understand investment, but one with a high likelihood of success (in Burry’s estimation at least).

Burry’s fund was down 18 percent in 2006. It was making his investors very edgy, and most of them – while being perfectly happy with his extraordinary returns in the years leading up to this – pushed him hard to ditch the strategy. As they threatened to pull their capital from him, he locked it up.

From the book:

In January 2006 Gotham’s creator, Joel Greenblatt, had gone on television to promote a book and, when asked to name is favorite “value investors,” had extolled the virtues of a rare talent named Mike Burry. Ten months later he traveled three thousand miles with his partner, John Petry, to tell Mike Burry he was a liar and to pressure him into abandoning the bet Burry viewed as the single shrewdest of his career.

Listen…there is a certain fog of war to these things. This stuff is not black and white. What seemed such a low-risk, high-return investment to Burry appeared quite different to Greenblatt. Perhaps Burry did a poor job communicating his ideas to the Gotham Partners. Perhaps the partners did a poor job listening. Regardless of the reasons, here we have two very intelligent investors and reasonable people disagreeing over how the money should be invested.

What is the shareholder friendly move in this dilemma? Should Burry try to liquidate his bets to give Greenblatt his money back? Not only would that go against a thesis Burry held with deep conviction, but it would ensure a loss as the strategy had not yet matured.

Or was the the shareholder friendly move the very action that Burry took? In other words, protecting Greenblatt against himself by locking up the money (no redemptions) and handcuffing him to the trade.

History tells us Burry was right. Greenblatt made off like a bandit by getting stuck with his former mentee. But this is just one example. I have no doubt there is no shortage of counterpoint examples in which hedge fund money is locked up, promptly lost (Philip Falcone anyone?), and investors are left holding the pittance that remains.

If reasonable, intelligent people (even value investors) can have diverging opinions and interests in a hedge fund example like this, surely the conflict only broadens when you have a wide base of investors in a public company.

So, what exactly does it mean to be shareholder friendly? Does it mean paying out a fat dividend to keep pension funds happy even when you have an expansion opportunity to plow that cash into growth? Does it mean cutting your marketing staff during a down turn because you know your margins will be pressured and you don’t want to disappoint Wall Street with a down earnings period? Does it mean cutting off a research initiative after two years of losses when you have high conviction that it will pay off in a big way if you just suffer another two years of losses to get it going?

*****

I’m a big fan of Joel Greenblatt. His books have helped my thinking tremendously, and he is serving an important role as he spends time educating people about his investing methods. And while I use the story of Michael Burry to illustrate my point, I want to make sure Greenblatt has the chance to make his case.

He did so in an October 2011 presentation to the Value Investing Congress (courtesy of Market Folly here).

In a Q&A Greenblatt was asked about Lewis’ account of events. His response was witty (and I suspect true), but more importantly he provided some balance to the whole affair…

Michael Lewis has never let the facts get in a way of a good story. What they got wrong in the book is Burry wanted to side pocket both mortgage and corporate CDS… we did not want him to side pocket the liquid corporate CDSs … only reason we took money from him was we were getting redemptions.

Greenblatt was not the unreasonable ogre Lewis made him out to be. He had his own pressures. This doesn’t contradict my point. In fact, I think it strengthens it. Sometimes a manager must be able to ignore the panic of his investors. He just might be protecting them in the long-run by sticking to his strategy despite their immediate needs. We know this happens in publicly traded companies, too. Large investors (hedge funds, pension funds, mutual funds) get calls for redemptions that force them to sell their holdings to generate cash to pay out departing investors. They must sell irrespective of the investment prospects.

The CEO of a publicly traded company can’t, of course, stop investors from selling. But in understanding that investors will often have interests that diverge from those of the business itself, one can see that it does make sense – sometimes – to vest enough authority in managers to let them ignore their shareholders and keep plugging away for the long-term benefit of the franchise.

All eyes are on Facebook and CEO Mark Zuckerberg as the stock is scheduled to debut on the NYSE this Friday. They have lips flapping as pundits and gurus are shouting over each other to get their opinions noted on whether this business is worth your investment dollars. Allow me to add to the din by expanding on my previous post, Whom Does Management Serve?

Zuckerberg has garnered plenty of criticism for pocketing the majority of voting rights, ensuring that he will have total and complete control over every aspect of the business, not the least of which is strategic direction. And he’s not shy about saying has his own plans for the company which is likely to be at odds frequently with investors looking for financial results.

Facebook’s Registration Statement (filed in February with the SEC) contains a letter from Zuckerberg outlining his priorities. Some excerpts…

 

Facebook was not originally founded to be a company. We’ve always cared primarily about our social mission, the services we’re building and the people who use them. This is a different approach for a public company to take, so I want to explain why I think it works…

Simply put: we don’t build services to make money; we make money to build better services. And we think this is a good way to build something…

These days I think more and more people want to use services from companies that believe in something beyond simply maximizing profits.

By focusing on our mission and building great services, we believe we will create the most value for our shareholders and partners over the long term — and this in turn will enable us to keep attracting the best people and building more great services.

We don’t wake up in the morning with the primary goal of making money, but we understand that the best way to achieve our mission is to build a strong and valuable company. This is how we think about our IPO as well.

Here we have a CEO telling the world, in no uncertain terms, that maximizing profits is not his priority. He has a bigger and different vision for the world. As investors we should be aghast, right?

Before addressing that, let me admit that I have no idea what Facebook is worth as a business. It’s probably a fair amount, but my prevailing model used to understand social media companies is MySpace.  It was the pre-Facebook darling, beneficiary of young eyeballs and the power of the network effect. As such, it was scooped up by News Corp for a fat price. And shortly thereafter all the eyeballs left. Quickly and unceremoniously. That fickle bunch decided Facebook was the place to do all the stuff they had previously done on MySpace. And now MySpace is a shadow of its former self.

We’re assured that Facebook is superior, having solved all the problems that plagued MySpace and left subscribers willing to entertain an alternative. That would never happen to Facebook, we’re assured. Maybe. But I’m not comfortable with the possibility, and so it’s a clear pass for me.

That being said, I’ll confess the utmost admiration for the move Zuckerberg pulled to consolidate control. And if Facebook is going to live up to its potential, it will come at the hands of the founder. He has a vision for it that extends beyond share price. I think that’s essential for a business. They lose their soul when they get too eager to please shareholders.

If I could get pass the MySpace hang up, I would assess the following in determining if Facebook was a good investment…

First, is it participating in a large and/or growing market for the services it offers? I believe it probably is. It has a lot of room to add new users and expand the ways members utilize it today.

Second, does it have a profitable economic model? (i.e., Do its revenues exceeds its costs and expenses and can it produce earnings in excess of its costs of reinvested capital?) Most likely, yes. It’s profitable now, though throwing tons of cash back into growth. That user base must have some economic value, and the management minds at Facebook will likely discover the right method for tapping into it.

Third, does it have competitive advantages in place that protect its market share and margins from encroachment? That’s the part that I just don’t know, and I don’t think I could wrap my head around that issue even if I decided to spend a lot of time researching it.

If the answers to these questions were yes, and I believed Mark Zuckerberg had the ability to drive its success by focusing on the long-term value of Facebook as it serves as social connector for the world…but that in continuing to build it in that model, he was likely to face the ire of investors that would prefer profits now rather than wait…

Then I would celebrate Zuckerberg cornering control the way that he did. As a long-term investor, I would celebrate a CEO that openly denigrates profit decisions in favor of investing in the long-term competitive advantages of the business. And I would relish the fact that profit-takers would have no voice in the decisions guiding the business.

I would appreciate that the characteristics that make Facebook a franchise will be stronger five or ten years hence, and that I would therefore own a piece of a much more valuable pie.

But there are a lot of “ifs” to be satisfied first.

The Witch’s Dilemma

The witch gave the man two options. One, he could have a woman that, to him, would appear stunning. But the world would see her as ghastly. Or two, he could have a woman that, to him, appeared hideous. But to the world she would look beautiful.

So goes the dilemma from some fairy tale I recall from childhood, the source of which eludes my most diligent Wikipedia searches.  (If anyone remembers the title, please pass it along.)

Imagine yourself in a revealing moment of brutal honesty. Which option would you choose if the witch forced this decision on you? Switch the genders around if needs be, but be truthful.

I suspect most people would claim option one, confident in their ability to filter out the judgment of people around them. But I think they would be overestimating their capacity to be misunderstood. Disapproval and criticism from our family, friends, and colleagues has a withering affect on our psyches. Even if we put on confident airs, we shiver at the thought of others ridiculing our choices behind our backs. We want to be understood. We want our people to confirm our choices with their support. We want inclusion in the most desperate way.

And so I believe, despite our protests, the vast majority of us would select option two.

Yet there are those with the steely resolve to pull off option one. They are outliers. They have a tremendous capacity to be misunderstood.

Corporate CEO’s, the Capacity To Be Misunderstood, and Decision Making

I’d like to hire a social psychologist to visit the CEO’s of all publicly traded companies, administers the Witch’s Dilemma test in conjunction with a heavy dose of truth serum. I would ask her to use the responses to rate the individual executives’ capacity to be misunderstood. (Perhaps there are alternative questions we could devise that get to the heart of the matter. These CEO’s are emotionally intelligent folks. They didn’t get where they are without developing the ability to read into people’s intentions…the questions behind their questions.)  And I would compare that rating to the CEO’s track record of making bold (albeit sensible) long-term investments in the well-being of their businesses versus managing earnings to keep various constituencies content.

My suspicion is that those CEO’s that could be lumped in with option one (ugly wife) would correlate more closely with making better long-term decisions on behalf of their businesses. The other group would have a more difficult time departing from the expectations of their shareholders, employees, customers, family members, etc. Understandably so. It’s tough to do.

Getting to my point, when I see a business that combines some set of competitive advantages with the potential to grow and compound earnings, I want the leaders of that business to invest in that growth. This should go without saying, but very often it’s a difficult thing to do. Not so much because the operational expansion is daunting (though there is that part, too), but because the company must often take a winding path to secure that growth. It’s confusing. It changes things. It’s easy to misunderstand.

Let’s think a little about how a company grows. First, it must identify an opportunity to a.) expand its current offerings; b.) add new offerings; and/or c.) move offerings into new markets. In most cases, each option requires teams to make a judgment call. On the most fundamental level it is, can we execute that growth in a profitable way? In other words, will the added costs of increasing headcount, ramping up production, expanding infrastructure, investing in R&D, buying equipment, or marketing more aggressively…are these costs likely to succeed AND produce revenue in excess of costs and invested capital?

While executives can learn to mitigate risk (just as we do with investing), there is no crystal ball providing play-by-play of how the future will look. They must use their judgment. And investors hope they bring a certain amount of analytical rigor, management skill, experience-based intuition, and wisdom to the ways they spend the company money. In an ideal scenario, they possess a deep understanding of the strengths of their business – its advantages over the competition, barriers to entry, and moats – and know how to invest behind these strengths. (The better the strength, the easier the planning process!)

But there are no guarantees. Expansion is and always will be an exercise in predicting the future. It is about, after all, believing that additional supply you produce will be consumed by increased demand. A management team will try and fail. They MUST try and fail (at least occasionally) to test the limits of the business potential.

The most bold attempts to grow and compound earnings on behalf of investors – those investments with the greatest possibility for outsized rewards – do not happen in short time frames. They require big investments over long horizons with the real possibility of depressed earnings over the ramp-up period.

This enervates holders of the company’s stock – investors, employees, the CEO, his/her family. While all of them will say they want the earning to grow, each group tends to be averse to the risk and time required to make that happen. If you were to provide them with a slight bump in their dividend payout versus putting the same amount of cash into investments that have a high likelihood of paying out a nice return in, say, five years (but impair earnings growth in the meantime), far too many will forego a better payday for the feel-good immediate gratification.

Worst yet, if the investments are made in growth, they depress earnings for multiple periods, and the market has trouble understanding how and/or when the investments will pay off, the stock price will feel that misunderstanding.

And this is where the CEO’s decision making becomes hard. He must choose between investing in the long-term prospects of the business, a move that will impact earnings next quarter and bring the ire of Wall Street.   Or he can punt. Making timid investment choices; managing the earnings by looking first at whether the next statement will satisfy analyst expectations for the company’s performance. And then deciding how much more to allocate to investment in the company’s future.

If he invests for the future and is misunderstood, the move will generate a share price drop. And a lot of people are affected by the stock dropping. People that are important to the CEO. People he must see everyday. People who influence his life; that invested in no small part because they believed in him.

Back To the Witch’s Dilemma 

So here the CEO is playing out the Witch’s Dilemma. If he goes with option one – investing in the future of the business that impacts short-term results…the woman that looks pretty to him, but ugly to the world – the share price will be hammered. He will be misunderstood. People who have invested with him will be disappointed. They will feel less wealthy as a consequence of his decisions.

And all CEO’s know that if they get labeled with the dreaded letter “U” (Underperformance), many of the constituents they disappointed, along with a new slate of activist investors, will turn up the heat. They will make noise and start demanding change. The pressure will be enormous.

The CEO asks himself…will I even be around long enough to see these bold investments come to fruition? Or will my board bend to the discontented swarm and show me the door?

Being misunderstood is very hard on a person.

Allow me this aside about the concept of learned helplessness…

The psychic punishment of being misunderstood conjures memories of “learned helplessness” a concept belonging to psychology and the term being coined by Dr. Martin Seligman in the late-1960s.

Seligman ran a research lab at Cornell University and spent much of his time experimenting with lab rats. In one particular and somewhat cruel study, he placed a lab rat in a specially constructed box, repeatedly rang a bell, and followed the sound with a mild electric shock. The rat quickly learned to anticipate the shock when he heard the bell. As you can imagine, the rat would become frantic at the sound, running around his box in a futile attempt to avoid the discomfort.

It took very few rounds of this “bell-plus-shock” routine before the rat’s behavior changed. The bell still evoked agitation, but once he resigned himself that he had no control to stop the shock, the rat basically gave up and took it.

This observation led Dr. Seligman to his theory of learned helplessness, a phenomenon as easily applied to humans as rats. When faced with stressors most humans – including powerful CEO’s – that perceive they lack the control to resolve or avoid it end up sucking it up and going with the flow.

And so most CEO’s elect to avoid the discomfort of being misunderstood (if not fired) and choose the Witch’s option two. Even though they know the investments will pay off for long-term shareholders, that they will enhance the firm’s competitive advantages, that they will compound its earnings…the vast majority of CEO’s swallow hard and go with the woman that looks beautiful to the world but that they recognize as unattractive and unsavory.

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Anyone For Investing In a Car Periscope?

I’ll conclude with a light-hearted parallel…

Season eight of HBO’s Curb Your Enthusiasm highlights this dilemma in an episode called Car Periscope. By way of quick summary,  Larry David and his agent Jeff are weighing an investment with an inventor of a device you snake above your sunroof in traffic jams to see the source of the slowdown and review your options for getting out quickly.

It’s a terrible concept, clearly, and the two are ready to decline the investment opportunity. But they meet the inventor’s wife and are struck by the disconnect. She is somewhat homely while the inventor is a decent looking guy. Larry is unabashedly shallow. He always wants the younger more attractive woman. It’s foreign to him  that a man would ever choose anything less; that someone would subject himself to the ridicule of the guys. This inventor is an outlier. He sees something in his wife that others don’t, and he possesses the capacity to be misunderstood.  Surely this belies some deep-seeded virtue in this inventor. In Larry’s logic, if he has the qualities that permit him to be comfortable and confident with the less attractive girl, perhaps he possesses the tenacity required of an inventor and businessman.

Hijinks ensue. The investment falls through, but Larry believes he has found a new model for gauging the character of men. He meets with his investment manager and, upon seeing a photo of his gorgeous wife, fires him. He selects another adviser on the sole basis of his plain-looking spouse.

This week I’ve been a bit obsessed with the idea that the manager’s job is to represent the interests of shareholders. It brings to mind the Yogi Berra epithet:

In theory there is no difference between theory and practice. In practice there is.

In theory it makes sense. Companies are vehicles for invested capital to find returns. We entomb that concept in law and in corporate structure where the board of directors is explicitly charged with representing shareholders. Managers run the day-to-day and should have investors’ interests on their minds, remaining on constant look out for ways to increase shareholder value.

But we put the idea in play, how does a manager best represent investor interest? Indeed, which investor?

Investors are far from a like-minded group bound together by common interests in the business’ success and united in their opinions on how that success is best achieved. Oh no. To highlight just a few investor archetypes:

There are the hedge fund traders, moving in and out with positions measured in millions of shares and closed out within minutes or hours when the stock moves up or down by a penny or two.

There are the pension funds for (as an example) retired nuns. They hold shares for years but issue measure after measure for shareholder consideration on such social issues as whether you should offer health benefits to your lowest paid employees.

There are the corporate raiders that accumulate massive positions, gain board representation, and then force management to monetize assets and distribute the cash. This pushes the share price up for a time, during which the raiders sell out and move on to their next target.

All are investors in your public company. Each has very specific objectives. And those objectives are divergent and irreconcilable.

So, how does management effectively represent investors when their interests don’t align?

As a frequent visitor of Charleston, South Carolina, I’ve been required to read the works of native son Pat Conroy. My favorite book is his memoir My Losing Season in which he details his time playing basketball for the Citadel.

The Citadel, a military prep college in Charleston, is hard on its first year students (called “Knobs”), believing it must break each of them down and build them back up again in its own disciplined model. Conroy was not spared the hazing rituals. In a particularly poignant scene from the book he recalls being surrounded by several upperclassmen who begin demanding he do a variety of conflicting activities. As I recall, one would get in his face and scream that he do push-ups. Another would degrade him for doing push-ups, telling him he’s supposed to jump up and down. And yet another would scream at him for jumping; he should be reciting the school’s creed.

The demands came rapid fire. After several minutes of this Conroy was a wreck. He instinctively fell into fetal position on the floor, his mind unable to process another command. The older cadets walked away, satisfied that they had broken this cocky Knob.

The human mind cannot process conflicting orders without freezing up. It’s simply not how our wiring works. And so, while the idea that management works for investors sounds good in theory, in practice it’s unworkable. Many an executive has driven himself to exhaustion trying to appease these feckless masters.

What’s a manager to do?

Focus on the business itself.  Use the overall health of the business as a proxy for the long-term investor…that investor whose interests are aligned with the company investing in its advantages, foregoing immediate gratification en lieu of higher earnings further down the line.

These are the businesses I want to invest in. The opposite are those that pledge allegiance to blind total shareholder return, returning cash to investors that could be reinvested in the business to fortify its barriers to entry, improve its offerings, or make itself invaluable to its customers.