Tag Archives: Investing

Lessons on Competition from Mother Nature

An interesting short article by Joel Barker with some ideas to think about, Surviving the Fittest: New Lessons on Competition from Mother Nature:

As a result of this emerging body of research, we now must reexamine our competitive paradigm and factor in the new information. It is now clear that ‘the fittest’ not only don’t win all the time, but are only a piece of the more complex system. This information can lead to new strategies for small companies and new insights for the big companies that presently dominate their industries.

The idea that what is winning right now is best is flawed. What is successful now is dependent on the larger system and the conditions that impact that system. In the news the last few days British Airways had to shut down flights worldwide. This has happened numerous times for major airlines in the last few years.

view from a train in Rocky Mountain National Park with tree and snow covered mountains in the background

By John Hunter, see more of my trip to Rocky Mountain National Park.

The systems that they settled on may seem to be working well for years and then suffer catastrophic failures. Why did they accept systems that could fail so completely? Given the frequency it is happening numerous competitors are choosing solutions that are too fragile. And it isn’t just one organization doing it, numerous huge airlines (United, Delta, British Airways, Southwest) have found themselves caught in a situation where they fail to deliver what customers pay for due to so complete a failure of their IT system that they cannot fly any planes many hours in a row.

I suppose this could be evidence that designing an IT system for a huge airline is not something that can be done with the reliability we expect from most things (that the business doesn’t have a day every decade or two where they business just can’t operate that day). But I doubt it. It seems much more likely the existing system creates organizations that are more focused on other things than building a reliable, robust IT infrastructure.

A post I wrote on my Curious Cat Science and Engineering blog a few years ago, 500 Year Floods, looked at the problem of making judgements about unknown systems. The concept of 100 and 500 year floods is to help us make decisions about long term planning and risks. Looking at an area to build a building (or city) can be aided by history and seeing what the area has experienced in the past. But you can’t just assume the future will be the same as the past. Systems change over time. What worked in the past doesn’t necessarily work well in the future.

And as I mentioned in my article, our evidence and understanding also changes (hopefully by us gaining more knowledge and gaining a clearer understanding as we learn more). Thinking systemically takes into account the impact of interactions on results. Results are not independent of the circumstances.

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Some Thoughts on Investing from My Recent Interview

In the first few years of this blog I posted occasionally, but still much more than the last few years, on investing and economics. Now I mainly post on those topics on the Curious Cat Investing and Economics blog (see how the name and that practice are in sync with each other?).

I was recently interviewed about investing strategies and thoughts and decided to share that with the readers of this blog. Some excerpts from the interview:

I have maintained a portfolio that I call the sleep well portfolio for 10 years (started April 2005). I hardly have any turnover (under 2% annually I think) and hold stocks I would be comfortable locking in a vault for 10 years. The largest holding there is Apple, followed by Google; I also still really like Google as a long term investment. The stocks in the portfolio for the entire period are: Google, Amazon, Toyota, Intel, Pfizer…

We got out of the “Too Big to Fail” crisis, but have not addressed the core problems – and likely have made them much worse. We didn’t take the opportunity to address the financial system risks created by the actions of “Too Big to Fail” banks. And it seems to me we have left the central banks in a very vulnerable position. They have already played strategies that previously seemed impossible due to the position they were placed in, and if it happens again, what are they going to be able to do? I think the risk of massive economic failure is large enough to consider in an investment portfolio.

How would you suggest an investor guard against the potential for a massive economic disaster?

John Hunter: My main thoughts on that are to greatly value companies that are likely to weather economic calamity greater than any since the great depression. Having tons of cash obviously helps (Apple, Google…). Having a business model that puts a company in a position to make money (even if it is a lot less than they are making today) if the economy does extremely poorly, is also good (Apple, Google, AbbVie…).

It is possible for the economy to be hit so hard Apple, Google, etc. lose money. But if that happens, I believe huge numbers of other companies are going to be out of business, and the economy will be in shambles…

The sleep well portfolio has beaten the S&P 500 by about 220 basis points (on an annual rate of return basis) (see details on how marketocracy calculates returns – they reduce returns by 200 basis points to simulate investment adviser fees). The interview includes much more details as well as links to posts on my investing blog going into more detail.
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The Importance of Leadership by Those Working to Improve Management

This month Bill Troy, ASQ CEO, asked ASQ Influential Voices bloggers to explore the importance of leadership for every quality management professional.

Leadership is important but also something that often is difficult to understand what exactly is meant by the person using the term. In Bill’s case he provides some guidance with: “Leadership encompasses… business savvy, people skills, and decisive action all are required to get results in the world.”

The ability to find solutions and move forward efforts in organizations does benefit from people skills. Working with people effectively is an important part of having success in improving organizations. What that means to different people is very different. Some people see charisma as key, others believe decisiveness is very important, others see winning over the hearts of people as what it takes to make a difference.

For me the key is managing with an understanding of respect for people and how that concept fits with the rest of Deming’s management system.

There are different paths to success but you need to have others respect for your knowledge on the topic, your ability to make solutions work and your trustworthiness. Different leaders lean on different areas. Some people win over the hearts others may offer a low charisma aura but others are confident they have the ability to deliver based on their knowledge. As Dr. Deming said you have 3 ways to influence others, your authority stems from: your position, your knowledge and your personality.

I do think business savvy is something that doesn’t get enough attention of lean/Deming/six-sigma/quality professionals. There is a need to communicate with executives in a language they understand in order to make big changes. That requires an understanding of business and an appreciation for the importance of actually delivering value over talking about good plans.

I think six sigma efforts are less useful that Deming and lean efforts. But I do think six sigma has 2 things that are given more weight (by organizations using it well, far too few of them using it, sadly) that help six sigma efforts. First is a focus on training about design of experiments. To some extent this is then acted on by organizations pursuing six sigma – but too often it isn’t. However others neglect even talking much about design of experiments. My father did a great deal of work in this area and I am biased, but for me it is an extremely powerful tool that is used far too little.

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More Evidence of the Damage Done by Kleptocrat CEO Pay

I have been writing about the problems of overpaid executives that has lately become so bad that verbiage understand the nature of the problem. Today I see many CEO’s are acting as kleptocrats do – taking food out of others mouths to build their castles. The damage done to everyone else involved is of no concern. Both groups love bankers that flood them with cash for new and larger castles at the expense of the futures of their company (or country).

This paper does a very good job of providing more evidence of the damage done by these kleptocrat CEOs and their apologists.

Are Top Executives Paid Enough? An Evidence-Based Review by Philippe Jacquart and J. Scott Armstrong

Our review of the evidence found that the notion that higher pay leads to the selection of better executives is undermined by the prevalence of poor recruiting methods. Moreover, higher pay fails to promote better performance. Instead, it undermines the intrinsic motivation of executives, inhibits their learning, leads them to ignore other stakeholders, and discourages them from considering the long-term effects of their decisions on stakeholders. Relating incentive payments to executives’ actions in an effective manner is not possible. Incentives also encourage unethical behaviour. Organizations would benefit from using validated methods to hire top executives, reducing compensation, eliminating incentive plans, and strengthening stockholder governance related to the hiring and compensation of executives.

Many of the problems with the poor thinking around executive pay stem from the failure to grasp ideas Dr. Deming wrote about decades ago.

Executives are often evaluated on the basis of the success or failure of the business units for which they are responsible. In practice, many internal and external factors influence outcomes for firms, and assessing the role played by a given executive is not possible. For example, should a manager get credit for a firm’s success when the economy is booming or blame for the firm’s losses during a recession? When answering such questions, evaluators are biased toward ignoring contextual factors and overly attributing outcomes to leaders. This bias was illustrated in a laboratory experiment in which groups of participants had to solve a coordination task. In the experiment, group size varied, and participants could perceive that the task was harder when the group was larger. Despite this, participants credited group leaders for the success of small groups and blamed them for the failure of large groups (Weber et al. 2001).

The quote from their paper show a failure to understand variation (attributing variation to those near the variation at the time – good marks when the variation is good, bad marks when it is bad). And a failure to understand the organization as a system (the results of any subsystem are greatly influenced by the whole system and the conditions outside the system (the economy, the macro-economic conditions for the industry…). And a failure to understand the theory of knowledge: people should know our brains leap to causation explanations when the evidence doesn’t support it. Then confirmation bias and psychology lead us to accept the data that supports our biases.

Nonexperimental studies also find that increases in CEO compensation occur following increases in firm performance that result from factors beyond the CEO’s control—CEOs are paid for being lucky. For example, CEOs in the oil industry were compensated for increased profits resulting from fluctuations in the price of crude oil—a factor beyond their control (Bertrand and Mullainathan 2001).

You see this just looking at the money heaped onto executives (in addition to the already huge payments taken) in industries whenever those industries (not individual companies, the entire industry) have macro-economic windfalls.

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Kleptocrat CEOs and Their Apologists

I am disgusted by the lack of ethical and moral fiber of CEO’s (along with their cronies and apologists) in the USA. This lack comes out in many ways (see all the scandals at the too-big-to-fail banks etc.) but the problem I am upset about now is the increasingly commonplace kleptocrat behavior.

CEOs, and their cronies, were well paid decades ago. As their greed about their pay got to be unethical Peter Drucker started to speak out against their ethical failures. As those abuses became more extreme he increased his objections.

What Peter Drucker railed against was minor compared to the ethical meltdowns we allow in those serving in executive positions today.

Bloomberg study on What CEOs are Taking From Corporate Treasuries

Across the Standard & Poor’s 500 Index of companies, the average multiple of CEO compensation to that of rank-and-file workers is 204, up 20 percent since 2009

The average ratio for the S&P 500 companies is up from 170 in 2009, when the financial crisis reduced many compensation packages. Estimates by academics and trade-union groups put the number at 20-to-1 in the 1950s, rising to 42-to-1 in 1980 and 120-to-1 by 2000.

These CEOs act like kleptocrat dictators, taking what they can and challenging anyone to do anything about it. As with the kleptocrats they surround themselves with apologists and spread around the looting (from corporate treasuries for the CEO and the countries for the dictators) to those that support their kleptocrat ways.

Extremely Excessive Executive pay is so critical I classify it as a New Deadly Disease. I have discussed the problems created by allowing such morally and ethically bankrupt people in leadership positions: CEO’s Taking What They Don’t Deserve (2011)CEOs Plundering Corporate Coffers (2008)Tilting at Ludicrous CEO Pay (2007). In 2005 I spelled out some of the problems we face when we have kleptocrats running our companies:

The excesses are so great now they will either force companies to:

  1. take huge risks to justify such pay and then go bankrupt when such risks fail (and some will succeed making it appear, to some, that the pay was deserved rather than just the random chance of taking a large risk and getting lucky)
  2. make it impossible to compete with companies that don’t allow such excesses and slowly go out of business to those companies that don’t act so irresponsibly
  3. hope that competitors adopt your bad practice of excessive pay (this does have potential as most people are corrupted by power, even across cultural boundaries). However, my expectation is the competitive forces of capitalism going forward are going to make such a hope unrealistic. People will see the opportunity provided by such poor management and compete with them.

As long as the pay packages were merely large, and didn’t effect the ability of a company to prosper that could continue (slicing up the benefits between the stakeholders is not an exact science). The excesses recently have become so obscene as to become unsustainable.

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The Market Discounts Proven Company Leadership Far Too Quickly

Developing a strong executive leadership culture is not a short term effort. It isn’t based on one person. It almost never deteriorates quickly. Yet markets continually overact to minor blips on the long term success of companies. I think this is mainly due to a failure to appreciate systems and a failure to appreciate variation along with plenty of other contributing factors.

The market’s weakness does provide investment opportunities. Though taking advantages of them is much more difficult than spotting a general weakness. While excellent management almost never becomes pitiful overnight (regardless of how often talking heads would have you believe) business can change very quickly due to rapidly changing market conditions. Avoiding the purchases when the underlying business has sustained a significant blow that excellent management will deal with but which will reduce the value of the enterprise going forward is key to taking advantage of the market’s silly overreaction to bad news (or even calling things “bad news” that are not actually bad just not as awesome as some were hoping for).

My positive opinion of Toyota’s management has continued for a long time. A few years ago an amazing number of people were all excited about the “decline of Toyota” and wrote about how Toyota’s ways had to change. I wrote at the time was this is needless hysteria and if Toyota just focused a bit more on applying the Toyota’s management methods they would be in great shape. The problems were due to Toyota’s mistakes in practicing the Toyota Production System not in a weakness of those practices.

Looking at a chart of Toyota’s stock price from 2007 to today it peaks at about $137 in January 2007 and bottoms at $58 in early 2009 and now is at $96. Toyota’s stock price has been priced richly due to respect for management and consistently strong cash flow. As it fell below $75 there you no longer had to pay a premium for excellent management, but that management was still there. I like getting bargains when I buy stocks. One of the things I have learned I am too focused on bargains and I should be more willing to accept less of a bargain to get great management systems – so I have adjusted, and have improved my results. When I can get a great bargain and great management it is wonderful, though sadly a rare occurrence. Toyota’s price now seems reasonable, but not a huge bargain.

The market continually gets overly excited by either actual problems or perceived problems. I wrote about this happening with Netflix 2 years ago. Netflix made some mistakes and faced some tough business issues. The evidence of sound, sensible, effective management vastly outweighed the evidence for management failure – yet there were hundreds of articles about the pitiful failure of Netflix management.

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Long Term Thinking with Respect for People

Toyota nearly went bankrupt near 1950 and had to lay off a third of their employees. A huge focus of the Toyota Production System as envisioned by Taiichi Ohno was to secure the long term success of the company. The priority of doing so is easier to see when you respect people and are in danger of witnessing the destruction of their careers.

photo of John Hunter with a walking stick

I can’t find the quote (maybe Jon Miller, or someone else, can provide one), but I recall one along the lines of the first priority of management is providing long term viability of the company (my sense is this is first due to the respect of the workers and also for all the other stakeholders). The respect for people principle requires executive put the long term success of employees at the top of their thinking when making decisions for the company. I don’t believe it is a ranked list I believe there are several things right at the top that can’t be compromised (respect for people, safety of society, support for customers…).

This means innovating (Toyota Management System, Toyota Prius, Toyota Robots, Lexus brand, etc.) and seeking growth and profit with long term safety that does not risk the failure of the company. And it means planning for the worst case and making sure survivability (without layoffs etc.) is nearly assured. Only when that requirement is met are risks allowed. You do not leverage your company to put it at risk of failure in dire economic conditions even if that would allow you to be more profitable by various measures today. And you certainly don’t leverage just to take out big paychecks for a few short term thinkers.

The economic situation today is extremely uncertain. The whole eurozone financial situation is very questionable. The government debt burden in the USA and Japan is far too high (and of course Europe). China is still far from being a strong economy (they are huge, fast growing and powerful but it is still fairly fragile and risky).

The failures in the current financial system have not been addressed. Band-aids were applied to provide welfare to the largest 30 financial institutions in the form of hundreds of billions or trillions in aid. The system was left largely untouched. It is hard to imagine a more textbook example of failing to fix the causes and just treating the symptoms. This leaves a huge financial risk poised to cause havoc.

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Massively Unjust Executive Compensation Damages Companies and Investments

For years I have believed the massively unjust executive compensation packages have been doing great harm to American businesses. As an investor, one of the big risks that has to be evaluated is how much of the business profits executives will divert to their personal bank accounts. And investors also have to worry about the risks executives take to reach huge incentives which then greatly damage your investment.

In 2007, I added two of my own deadly diseases to Dr. Deming’s list. These deadly diseases have emerged since Dr. Deming created the list of 7 deadly diseases (which started out at 5 deadly diseases- he added 2 more later). Excessive executive compensation is one of those new deadly diseases. Our outdated and harmful laws, regulation and tolerated behavior relating to patents, copyright and “intellectual property” is the other.

The Incentive Bubble by Mihir Desai, Harvard Business Review

Mature corporations without large shareholders may become bloated with perquisites or preoccupied by empire building that satisfies managers rather than shareholders—the classic principal-agent problem.

In order for these pay mechanisms to be successful, managers and investors should be rewarded only for success beyond what would normally be generated. Said another way, there are returns that one can generate by doing little, and managers and investors shouldn’t be compensated for those returns.

A very important point to consider in calculating “excess” returns is an understanding of variation. This core component of Dr. Deming’s management system is not understood by most executives today and leads to mis-assigning credit and blame. In addition, an appreciation of systems thinking shows the fallacy of assigning individual causal credit or blame when in reality much of the result is systemic in nature (result of the system with little ability to sensibly assign individual cause – not that those wishing to have huge transfers of corporate wealth deposited in their bank account won’t pay lots of money to people that will create fancy formulas to try and justify such payments).

The rapid spread of stock options over the past two decades resulted in large windfalls for managers because no effort was made to subtract average performance during a period of remarkable returns in asset markets. Moreover, wide varieties of misbehavior have been traced to incentives created by the “cliffs” in most compensation packages: strike prices and vesting dates. Reaching for extra earnings by cutting small corners when such large amounts were at stake was inevitable. The corporate governance crises of the past 15 years had many roots; large stock option grants and the distorted incentives they provide loom large among them.

Absent regulators, irresponsible intermediaries, and oblivious homeowners were all important agents in creating the financial crisis, but the transformation of investment banks into risk-hungry institutions was central to it—and that transformation is connected to the growth of financial-markets-based compensation. At a basic level, the appetite for risk by managers of investment banks can be linked to the rise of compensation structures that provided them with highly asymmetrical incentives

Second, it is tempting to diminish the role of the skewed incentives identified above and reorient the debate toward ethics and morality: If only we hadn’t lost our sense of right and wrong. Such complaints may be well-grounded, but they obscure just how important these high-powered incentives are. More can be achieved by understanding incentive structures and the ideas that underpin them than by bemoaning a decline in character or promoting the virtues of professionalism. And moving away from shareholder-centered capitalism toward stakeholder capitalism risks overcorrecting the excesses of the past three decades. Indeed, capitalism appears to be serving managers and investment managers at the expense of shareholders.

Well said. From a Deming management perspective I see the huge problems created by the deadly disease of unjustly outsized executive compensation. And as an investor I see great risk in executives destroying investment returns as they try and extract hugely excessive amounts of the profits the organization makes to their personal treasuries.

Related: Taking What You Don’t Deserve, CEO StyleObscene CEO Pay, 2005 dataExecutives Again Treating Corporate Treasuries as Their Money“Too often, executive compensation in the U.S. is ridiculously out of line with performance” Warren BuffettLeverage, Complex Deals and ManiaThe soaring executive pay in the 1990’s turned Drucker into a leading critic of unjust pay (and those levels were tiny compared to what executives are taking from treasuries today) – No Excessive Senior Executive Pay at ToyotaBrooks Brother BureaucratsLosses Covered Up to Protect Bonuses

When Companies Can Treat You Like an ATM, Many Will Do So

The End of Refrigeration

One small custom chip, some relays, a transformer, a couple of heat sinks, and a bunch of passive parts. Maybe a build cost of $20-30 or so? But GE’s price to me was $250, plus $150 for the 20 minutes it took to pull out the old one and swap in the new one.

Paying $400 for a big piece of physical gear plus a couple hours of labor didn’t bother me. Paying $400 for a primitive circuit board and a few minutes to plug it in does.

Bottom line: $400 because a $2.02 Song Chuan 832 Series 30 A SPDT 12 VDC Through Hole General Purpose Heavy Duty Power Relay burned out.

This is a combination of companies 1) not being customer focused, 2) short term thinking, 3) very ologopolistic markets (very little competition). So when you are looking at this from the view of providing the best system, for in this case refrigeration, it is not a very difficult solution. You would want to minimize loss (have parts last) and in case they don’t minimize replacement cost. You would design the entire system so the parts that do burn out are easily replaceable and cheap and ideally notify you which part is broken (without the need for expensive contractor visits).

However, if your goal is to maximize company profit it is easy to see how you would develop a system that rips off the customer (very expensive part replacement, huge text messaging fees…) and attempts to capitalize on very little competition in the marketplace and customers that cannot reasonable analyze the system to see how they will be penalized by choosing your very expensive to maintain equipment. It is what they seem to teach in business school – take as much advantage of your customers as you can get away with. I prefer the Jeff Bezos school of thinking

There are two kinds of companies, those that work to try to charge more and those that work to charge less

It is a vastly different mentality to try to charge customers less as Amazon does (rather than say the practices of: Verizon, Bank of America, AT&T or Comcast). Your organization has to focused not on your quarterly profit (and if you are think kind of company, probably your personal bonus targets) but in serving your customers well, and in continually improve the value you provide to customers. And the company takes a share of the value just as all other stakeholders do (customer, employees [not just those in the c-suite)], suppliers, society…). Not only do I want to be a customer of this kind of company, I want to be a stockholder.

Related: Drug Prices in the USAWorse Hotel Service the More You PayCustomer Service is Important$8,000 per gallon printer inknew deadly diseases (often companies rely on bad “intellectual property” policies to restrict customer options)

6 New Kiva Loan to Manafacturing Entrepreneurs

I have been a big fan of Kiva for quite some time, and have written about it previously: Kiva – Giving Entrepreneurs an Opportunity to Succeed, Thanksgiving: Micro-financing Entrepreneurs. I made 6 new loans today to manufacturing entrepreneurs in the USA (and Mexico); Tajikistan; Nicaragua; Armenia; and 2 in El Salvador. The webcast above shows Armen Tsaghikyan in Armenia. It does seem like his process maybe could use a benefit from a bit of application of lean manufacturing ideas.

It is great to be able to help out people whether it is providing useful information (like I hope my web site and blog do) or a small loan of capital that allows some capital improvements. Many of the loans through Kiva amount to providing a loan to get additional supplies (often they have very limited capital). But my favorite loans are those that allow for purchases of new equipment that will make them more efficient.

It is easy to help out yourself; you can loan as a little as $25. The 10 members of the Curious Cat team have made 292 loans for a total of $12,000. Comment with the link to your Kiva page and I will add a link on Curious Cat Kivans.

Related: Kiva Fellows Blog: Nepalese Entrepreneur SuccessMore Kiva Entrepreneur Loans: Kenya, Honduras, Armenia…100th Entrepreneur Loan

Sometimes Micro-managing Works

Sometimes micro-managing works. That doesn’t mean it is a good strategy to replicate. If you benchmark Apple you might decide that you should have a tyrannical obsessive involved CEO who is directly involved in every detail of products and services. After all Apple is now the second most valuable company in the world with a market capitalization of $324 billion (Exxon Mobil is the top at $433 billion) and a huge part of that is Steve Jobs.

Nice quote from How to beat Apple

Apple products & services that Apple does well are the ones that Steve Jobs uses

An interesting point, and really it doesn’t matter if it is completely true it illustrates a point that Steve Jobs is the rare leader that helps by being completely involved in nearly every detail. And at the same time he provides strategic leadership rivaled by very few others. But if you try to benchmark this (simplistically – as most benchmarking is done) you will fail. This works with Steve Jobs and maybe a handful of other people alive today. But with most leaders and organizations it would fail completely.

On another point Jason Kottke makes, I would normally suggest the opposite approach:

Openness and secrecy. Competitors should take a page from Apple’s playbook here and be open about stuff that will give you a competitive advantage and shut the hell up about everything else. Open is not always better.

I think you may well be better off doing the opposite and countering Apple’s secrecy with openness. It would depend on your organization, but, I think you might be better off trying to exploit Apple’s weakness instead of trying to do what they do well. Now things are never this simple but on a cursory level I think that is where I would look.

Google now has a market cap of $171 billion, Apple is almost double that – just 3 years ago Apple first exceeded Google’s value.

Related: Leadership is the act of making others effective in achieving an aimThe CEO is Only One PersonJeff Bezos Spends a Week Working in Amazon’s Kentucky Distribution CenterRespect for PeopleDee Hock on Hiring

Warren Buffett’s 2010 Letter to Shareholders

Warren Buffett has published his always excellent annual shareholder letter. His letters, provide excellent investing insight and good management ideas.

Yearly figures, it should be noted, are neither to be ignored nor viewed as all-important. The pace of the earth’s movement around the sun is not synchronized with the time required for either investment ideas or operating decisions to bear fruit. At GEICO, for example, we enthusiastically spent $900 million last year on advertising to obtain policyholders who deliver us no immediate profits. If we could spend twice that amount productively, we would happily do so though short-term results would be further penalized. Many large investments at our railroad and utility operations are also made with an eye to payoffs well down the road.

At Berkshire, managers can focus on running their businesses: They are not subjected to meetings at headquarters nor financing worries nor Wall Street harassment. They simply get a letter from me every two years and call me when they wish. And their wishes do differ: There are managers to whom I have not talked in the last year, while there is one with whom I talk almost daily. Our trust is in people rather than process. A “hire well, manage little” code suits both them and me.

Cultures self-propagate. Winston Churchill once said, “You shape your houses and then they shape you.” That wisdom applies to businesses as well. Bureaucratic procedures beget more bureaucracy, and imperial corporate palaces induce imperious behavior. (As one wag put it, “You know you’re no longer CEO when you get in the back seat of your car and it doesn’t move.”) At Berkshire’s “World Headquarters” our annual rent is $270,212. Moreover, the home-office investment in furniture, art, Coke dispenser, lunch room, high-tech equipment – you name it – totals $301,363. As long as Charlie and I treat your money as if it were our own, Berkshire’s managers are likely to be careful with it as well.

At bottom, a sound insurance operation requires four disciplines… (4) The willingness to walk away if the appropriate premium can’t be obtained. Many insurers pass the first three tests and flunk the fourth. The urgings of Wall Street, pressures from the agency force and brokers, or simply a refusal by a testosterone-driven CEO to accept shrinking volumes has led too many insurers to write business at inadequate prices. “The other guy is doing it so we must as well” spells trouble in any business, but none more so than insurance.

I don’t agree with everything he says. And what works at one company, obviously won’t work everywhere. Copying doesn’t work. Learning from others and understanding what makes it work and then determining how to incorporate some of the ideas into your organization can be valuable. I don’t believe in “Our trust is in people rather than process.” I do believe in “hire well, manage little.” Exactly what those phrases mean is not necessarily straight forward. I believe you need to focus on creating a Deming based management system and that will require educating and coaching managers about how to manage such a system. But that the management decisions about day to day operations should be left to those who are working on the processes in question (which will often be workers, that are not managers, sometimes will be supervisors and managers and sometimes will be senior executives).

Related: Too often, executive compensation in the U.S. is ridiculously out of line with performance.Management Advice from Warren BuffetGreat Advice from Warren Buffett to University of Texas – Austin business school students2004 Warren Buffet Report
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Six Sigma Interview with Jack Welch

The short video includes some interesting points by Jack Welch on six sigma. GE was a huge company and did plenty of things that could be criticized. But often those criticizing take it much to far and disregard the sensible things GE understood and was doing well.

Quotes by Jack Welch: “variation is evil” “Will six sigma companies get more valuation in the marketplace? Not unless they produce results. You can’t put up a slogan that says we are a six sigma company and think the pe is going to move.”

Related: 3M CEO on Six SigmaManagement Advice FailuresNew Rules for Management? No!Has Six Sigma been a failure?

Kiva – Giving Entrepreneurs an Opportunity to Succeed

photo of a Kiva entrepreneur

Tony, a Kiva entrepreneur in Pennsylvania, USA looking to manufacturing specialty cars.

I really like Kiva. Kiva lets you lend small amounts of money to entrepreneurs around the world. My latest loan is to a manufacturing entrepreneur in the USA.

When Tony’s 6’0 6″ body could not fit in the traditional supercars, he built his own in 1990. Tony says, “If one door closes I just look for another opening; I don’t give up.” With much patience and hard work he continues to expand his business and hopes to make it a full-time job. With his ACCION USA microloan he has hired two designers to work with him part-time and has purchased a laptop.

I must admit I wouldn’t take this as an investment. It seems a very risky and doesn’t seem that likely to pan out, to me. But I see my loans through Kiva as a way to give people a chance to pursue their dreams. This loans is probably the one I find less compelling from a business point of view (to me), but I like to provide some loans in the USA so I decided to give Tony a chance.

I do try to select loans that look promising and seem to provide the entrepreneur an opportunity that will help them. By which I mean I love finding loans where, for example, they will buy equipment that will improve their productivity or take on new business. Very often loans are to buy raw materials or supplies, which is also fine but the potential gains are often less than something that improves the efficiency (it seems to me). Often this allows the entrepreneur to buy more and grow their business.

I have made nearly 200 loans now. The top country has been Togo (at 12%). I don’t target Togo but I do pay attention to the loan costs to the entrepreneurs (part of my assessment of the good business case for the loan) and some of the micro finance organizations offer good terms to entrepreneurs. Some of the microfinance organizations are more charitable (they may use donations to fund significant parts of the operating expenses, instead of profits from interest on the loans). Read more details on how Kiva works. It also used to be a bit difficult to find loans I really thought were great. It is getting easier to find more options so my guess is that the top few countries now will see declines in their percentages.

So far I have lent to 37 countries. Cambodia is 2nd at 7.7% of my loans, Viet Nam 3rd at 6.7%, Tanzania 4th at 5.1%, Nicaragua 6th at 5.1% along with Kenya, and Ghana and Boliva are 8th at 4.6%. The United States now makes up 2.6% and Mexico 1.5%. The sectors the loans are categorized in are: Services 25%, Food 18%, Manufacturing 17%, Retail 14%, Agriculture 12% and various others. Though the sector categorizations are pretty weak in my opinion (they seem to be fairly inaccurate – so it gives you an idea but it isn’t exact).

The default rate on my loan portfolio is 2.1% (3 defaults). One was in Kenya where $71.50 out of $75 was paid back and then huge civil unrest took place and it defaulted. The other 2 are from the same microfinance bank in Ecuador that was closed down due to mismanagement. In that instance I lost $87.50 out of $100 lent. 94 loans have been fully paid back and 94 are being paid back now.

I would love it if more Curious Cat readers joined Kiva and helped other entrepreneurs. If you do let me know your Kiva page and I will add you to the Curious Cat Kivans page. Also join the Curious Cats Kiva Lending Team.

Related: 100th Entrepreneur LoanThanksgiving: Micro-financing EntrepreneursUsing Capitalism to Make the World BetterKiva Opens to USA Entrepreneur LoansMicroFinance Currency Risk

Short Term Investing Focus

Buffett’s New CEO Shows Analysts, Hedge-Fund Managers to Door

Buffett’s Berkshire Hathaway Inc. completed the buyout yesterday after winning the approval of Burlington Northern investors. The deal, valued at $100 a share, allows Rose to hand out returns of nearly 300 percent, plus dividends, to investors who bought stock the day he was named CEO in 2000. The problem, he said, is that shareholders with that length of commitment are dwindling in number and influence.

“When I started as CEO 10 years ago, the typical investor had a time frame of three to five to seven years,” Rose said in an interview. “Year-by-year, that’s gotten shorter.”

The increased focus on short-term results, fueled by real- time media and quarterly analyst calls, can be a distraction for a railroad executive who needs to buy locomotives that run for 20 years and put down tracks that last for 40, Rose said. Burlington Northern said last month it would commit $2.4 billion this year to capital projects, including track, signal systems and locomotives, about $240 million less than in 2009.

“The money I spend this year really won’t pay off for three, four, five or seven years down the road,” said Rose, 50. “There’s the advent of the hedge fund which has changed the time horizon of what satisfies the institutional investor.”

“The speed of the news today I think has harmed, quite frankly, investors looking at long-term assets,” Rose told reporters in a news conference this week. A long-term perspective is “one thing that our country has kind of lost sight of, not just for the railroad equity investor but for a lot of investors.”

Decades ago Dr. Deming said short term focus was one of the seven deadly diseases of western management. Unfortunately we have made very little progress on the deadly diseases. The failed, health care system with it’s focus on a few special interests fighting to keep the broken system that does great harm to society but benefits the special interests is another a disease that has definitely gotten much worse.

Related: Think Long Term Act Dailyposts related to Warren BuffettGoodbye Quarterly TargetsA Great Day for Georgia-Pacific

The CEO is Only One Person

The CEO is important but they are only one person. Rarely do they determine the success of a company. The instances where they seem to are so rare as to almost seem like just random luck. I think they can make a difference, but that they make a significant difference rarely. Steve Jobs seems to have made a huge difference to Apple, for example (and Jeffery Bezos at Amazon – note both of these examples are also founders of the company). Jason Zweig has a good article on Why a New CEO Isn’t Always a Panacea

Management is important, which is why Warren Buffett puts such stock in the character of the people who run the companies he invests in. But management isn’t nearly as important as many investors think, which is why Benjamin Graham, Mr. Buffett’s mentor, paid so little attention to it. In fact, Mr. Graham seldom bothered to meet the managers of the companies he invested in, partly because he felt they would tell him only what they wished him to hear and partly because he didn’t want his judgments of business value to be influenced by impressions of personal character.

If you took the CEOs with the best track records and brought them in to run the businesses with the worst performance, how often would those companies become more profitable? According to economist Antoinette Schoar of Massachusetts Institute of Technology’s Sloan School of Management, who has studied the effects of hundreds of management changes, the answer is roughly 60%. That isn’t much better than the flip of a coin.

“Some people,” Prof. Schoar says, “may have this almost blind belief that the manager at the top changes everything. Our results show that managers do matter, but they don’t change everything.”

Since the 1970s, several other studies have measured what happens when companies bring in new bosses. Most of the findings have been consistent: Changes in leadership account for roughly 10% of the variance in corporate profitability on average.

a company will be much more inclined to replace the CEO after a run of bad losses—and to bring him in from a firm that has been on a hot streak. That leads to an illusion: “You change the CEO,” Dr. Kahneman says, “then performance reverts to the mean, and you attribute the improvement to the new guy.”

Furthermore, the hot profits at the new CEO’s former company are likely to cool off—by regression to the mean alone. When investors see that, they will mistakenly conclude that he is such a good boss that his old firm can’t thrive without him.

The management system is far more important than one person. Jim Press, Toyota N. American President, Moves to Chrysler (don’t expect much – Sept 2007). We are often fooled by randomness (understanding psychology lets you know this truth and factor it into your thinking): Illusions – Optical and Other, Attributing Random Results to a Special Cause, Seeing Patterns Where None Exists.

CEOs like to think they are royalty and take huge amounts of money from the company’s treasury, as a way, they hope, of providing evidence of this false belief. Don’t be fooled.

Jason Zwieg is the editor of the last few issues of the Intelligent Investor where he adds commentary on Benjamin Graham’s classic.

Related: Narcissistic Cadre of Senior ExecutivesCEO’s Given Lottery Sized PayoutsDiversification not Dazzling in InvestingTilting at Ludicrous CEO Pay 2007 Edition

Eric Schmidt on Google in 2010 and the Economy

CEO Eric Schmidt Reveals ‘Centerpiece’ Of Google’s 2010 Strategy, speaking at the White House jobs summit.

Google is definitely hiring. “We’re hiring a couple thousand people over the next year,” he said.

And looking at the White House summit he said, “The basic message today is that with small business – which is the primary source of jobs – we need to figure out the loan problem. The banks aren’t really lending to them and anything that the government can do to accelerate that, needs to happen right now.”

“Cloud computing is the centerpiece of our strategy. It’s a new model. You basically put all your information on servers and you have fast networks and lots of different kinds of personal computers and mobile phones that can use the applications… it’s a powerful model and it’s where the industry is going. It is the centerpiece of our 2010 strategy.”

Piper Jaffray analyst Gene Munster today said in a note, that by 2016, 78% of Google’s revenue will still be from search. Schmidt agreed.

“My guess is that advertising and search ads will be the lion’s share of our business for quite a long time,” he said. “The reason is, it’s such a large part of our business and it continues to grow quite well.”

I continue to own Google and have it in my 12 stocks for 10 years portfolio.

Related: Google Exceeded Planned Spending on PersonnelEric Schmidt on Management at GoogleMeeting Like GoogleGoogle Should Stay True to Their Management Practices

Zappos and Amazon Sitting in a Tree…

Amazon is acquiring the unique company – Zappos: we have written about Zappos previously: Paying New Employees to Quit. Jeff Bezos uses the webcast above to talk to the employees of Zappos. Excellent job. The letter from Tony Hsieh, the Zappo’s CEO, to employees is fantastic. This is a CEO that respects employees. These are leaders I would follow and invest in (and in fact I am glad I do own Amazon stock).

First, I want to apologize for the suddenness of this announcement. As you know, one of our core values is to Build Open and Honest Relationships With Communication, and if I could have it my way, I would have shared much earlier that we were in discussions with Amazon so that all employees could be involved in the decision process that we went through along the way. Unfortunately, because Amazon is a public company, there are securities laws that prevented us from talking about this to most of our employees until today.

Several months ago, they reached out to us and said they wanted to join forces with us so that we could accelerate the growth of our business, our brand, and our culture. When they said they wanted us to continue to build the Zappos brand (as opposed to folding us into Amazon), we decided it was worth exploring what a partnership would look like.

We learned that they truly wanted us to continue to build the Zappos brand and continue to build the Zappos culture in our own unique way. I think “unique” was their way of saying “fun and a little weird.” 🙂

Over the past several months, as we got to know each other better, both sides became more and more excited about the possibilities for leveraging each other’s strengths. We realized that we are both very customer-focused companies — we just focus on different ways of making our customers happy.

Amazon focuses on low prices, vast selection and convenience to make their customers happy, while Zappos does it through developing relationships, creating personal emotional connections, and delivering high touch (“WOW”) customer service.

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Pixar Movie Management Magic

image of Walle - PixarImage of Wall-e, from the Pixar film of the same name.

Pixar’s secrets on display in ‘Up’

“I think it comes down to two basic things: one is that we’re run by artists. … John Lasseter is a film director, as opposed to being from a business school or whatever. He has that side of him as well, but he’s always approaching these things as the same way we are.

“Second, we have some pretty great people that they’ve managed to collect here. This is our 10th film, and every film has just gotten better and better, whether that be in animation or special effects or lighting. And it just all comes together to make for some really fantastic stuff.”

“One of the things that I really love about [Pixar] is that no matter what you do, if you’re a production assistant or a producer or a marketing executive or running the kitchen, everyone here thinks like filmmakers,”

Like, I didn’t work on ‘WALL-E,’ but I feel like it’s mine, you know? And I want that to look great and be great. And then I want that bar to be higher and for us to be challenged.”

Pixar has done a great job of creating the right climate for the business they are in. They make movies and have been very consistently successful. Many of those strategies are useful concepts for everyone. Create a climate that promotes pride in work. Create a climate where everyone sees how they contribute to the end product. Hire people you trust and let them do their jobs. Seek continual improvement. Respect people. Customer Focus. Innovation (for example: Pixar Is Inventing New Math).

By the way, Steve Jobs, Apple co-founder, paid $5 million for Pixar and sold his share for $3,700 million of Disney stock (he is the largest shareholder of Disney – approximately 7%). Pixar Movies include: Toy Story, Monsters Inc. and The Incredibles.

Related: Tilting at Ludicrous CEO Pay 2008 Better and DifferentInnovation Examples

Warren Buffett Answers Shareholder’s Questions – 2009

Each year Warren Buffett and Charlie Munger answer questions in front of crowds of tens of thousands of Berkshire Hathaway shareholders in Omaha, Nebraska. The question and answer sessions provide great wisdom on economics, investing and management. Here are some of the highlights I have found from the meeting (see more on the Curious Cat Investing and Economic Blog review of the answers)

Buffett, Munger praise Google’s moat

“Google has a huge new moat,” Munger said. “In fact I’ve probably never seen such a wide moat.” Google’s main business of charging companies when people click on their ads after running an Internet search is “incredible,” the Berkshire chairman said. “I don’t know how to take it away from them,” he added. “Their moat is filled with sharks,” Munger said.

Google hopes the anti-trust regulators don’t see it the same way. And I believe Google sees their moat as easy to loose (and I think they are right). At the same time Buffett and Munger are right. The moat is huge but if Google looses focus they can drain the moat in no time.

Warren Buffett’s Q&A With Shareholders (Afternoon Session)

2:58 pm: Buffett says his hope for Berkshire Hathaway 20 years from now is that its culture will be maintained, that it will be seen as a place where good managers want to work for the rest of their lives. That and to have the world’s “oldest living managers.” The audience rises for a standing ovation. That concludes the Q&A session.

3:10 pm: After taking a break, Buffett is now conducting the formal business session of the annual meeting. It is totally routine.

3:15: Buffett, Munger and the other directors have been re-elected to the Board and the meeting has been adjourned.

Related: Warren Buffett’s Letter to Shareholders 2009Management Advice from Warren BuffetWarren Buffett Webcast on the Credit CrisisSleep Well Fund Investing Results