Advice for Managers

I must begin by first addressing the elephant in the room. My position is by no means one that provides solid ground for the title to stand. Little experience have I had as manager, or something close to it. As time goes by, my own management philosophy will be developed, but, for the time being, I’ll be focusing on pure theory, based on books, conferences and seminars. Authors like Clayton Christensen, Peter Thiel and Nicollo Machiavelli will conform the structure of the write-up.

This article will be longer than usual as I want it to cover multiple concepts. Being a manager is, as far as I can tell, not an easy task. Giving advice on this matter should, therefore, not be reduced to 1 or two ideas. Even though there’s a case to be made for such a write-up, I think the lack of coverage would make it ultimately useless, not something one would recurrently turn to, as there’s limited applicability to its reading.

Problems that limit growth

Peter Thiel had a very peculiar way of leading PayPal, one which I don’t know where I read of, but that makes superb sense from a philosophical perspective. He believes problems can be categorized depending on their difficulty:

• A: The most difficult problems, which are the ones that move the needle in the long-term.

• B: Those that require effort, address urgent concerns, but not ultimately determinant.

• C: Low effort, perceived as productive, but their relevance is close to zero.

• D: These ones require no effort and are a waste of time.

If you give a person problems A, B, C and D at the same time, you'll find trouble. You will notice that they will solve problems by going up the ladder of difficulty. The person will most likely start with problem D, then do C and B. The reason behind this is that people want to do productive things, but class-A problems are truly complex, so they have to think, and we are biologically designed to go for the lowest-effort activity.

Time goes by in this simulation and, as the person is solving problems D, C and perhaps working on B, D and C get refilled. The loop begins once again and they never get to solve problems of type A, which are the ones that matter and move the needle.

Peter 'solved' this by assigning people only one task and making them responsible for it. If you give a person only one problem, even if it is of type A, they will smash their head into the wall until they solve it. If you give them options, our human design will never allow the company to move forward.

“Give a man a problem and he’ll solve it. Give a man two problems and he’ll solve none”

It’s not the product, it’s the job

Clayton uncovered a fascinating concept. Businesses are first created to solve one of society’s problems, something they cannot efficiently solve by themselves. However, as time goes by, the product absorbs the company’s identity and the latter forgets its purpose: solving the problem. Because of this, managers begin to think how can they improve the product, which is the wrong framework. What managers must remember is what Christensen labeled as “the job that’s needed to be done”. Every time he went over this topic, he shed further light with an anecdote:

At a McDonalds, managers were trying to increase milkshake sales. They hired surveyors to ask some questions to people that bought milkshakes, who were asked, in a very general manner, how could McDonalds improve the milkshake they were buying so that they would buy more or lead other customers to do so. Surveyors gathered the feedback and told managers what was needed to be done. Curiously (or not), time went by and milkshake sales did not increase a single bit. That’s when McDonalds’ managers hired Clayton’s team to solve the puzzle.

The team started by observing and taking notes. After a couple of days, they noticed that 70-80% of people that bought milkshakes did so at 7:30-8 in the morning. That piece of data made them think why could this be the case. They then went to McDonalds early in the morning and stopped people that bought milkshakes to ask them:

What job are you trying to get done?

Why did you hire a milkshake to do this job?

Think of the last time you hired a milkshake, when was it and what is the common pattern?

After dozens of answers, the team arrived to a conclusion. What almost always followed the buying of a milkshake was a long and boring drive to work. Customers have two hands and use one for the wheel, but they need to do something else with the other. Moreover, they know they need to get something into their stomach so that they are not hungry by 10am.

“The customer rarely buys what the company thinks it’s selling them”

That’s the job people needed to get done. A manager has to be well aware of this reality. Thinking of the milkshake as the thing to improve would lead to incorrect conclusions: making it larger, offering it in infinite flavors, etc. To the contrary, thinking of how can the milkshake better get this job done leads to ones that are meaningful for customers; how to make it perfectly adapt to a car’s compartment, how to make it not spill a bit, avoid over-producing certain sizes (because they would be consumed very rapidly and not get the job done), etc.

The anecdote invariably leads to the next piece of advice.

How to think about customers

We are complex beings; we are not really sure about things after 2 or 3 ‘whys’. This is nothing new, but certainly something that’s not always in our conscious minds. Therefore, part of the classic marketing teaching is, I believe, done over very weak foundations. The anecdote very well proves it. Asking customers what they want or how to improve a product will lead nowhere.

Steve Jobs was a phenomenal example of this. He never spent money on market research or things alike because ‘the customer has no idea of what they want’. His biography, written by Isaacson, ends with Steve ‘final words’, out of which I remember the following (paraphrasing):

“When creating great products, there’s no point in asking customers what they want. I think it was Henry Ford who said “If I asked people what they wanted, the answer would have been faster horses””

The dilemma that established firms face

Peter Thiel very appropriately said that companies that don’t create new products will end up failing. Not from Peter, but, similarly, new companies that try compete with established firms will end up failing.

Clayton Christensen found something very curious that helps shed some light on the above claims. He was investigating why do business’ environments changes, why is ‘the history of business a history of new monopolies that replace old monopolies’. One couldn’t help but think that the displaced firms were simply run by fools.

After researching multiple industries, he noticed that the established firms were not only great, but kept innovating, and that their management was superbly intelligent and rational. The curious finding is that the latter, management’s good capabilities, has condemned firms. To provide more background on these statements and find why these brilliant people failed, Clayton wrote The Innovator’s Dilemma.

Simply stated, a company’s problems originated from manager’s rational approach to capital allocation. Established firms have, by definition, at least one product that’s market dominant. Assuming such a product is sold at profitable margins (almost always the case in established firms), management faces the following options for allocating capital:

• Sustaining technology. Improving the productivity of an old product will be close to a guarantee that you remain leading in your market. It helps build brand value as customers see that you are working for them to get better results. It might allow you to charge a premium for the enhancement and, with costs being the same, drive margin expansion. Moreover, returns on capital are high on sustaining technologies, which, combined with margins, it’s the magic formula for investors. Your business will attract capital, because, who wouldn’t want to invest in a business with high returns on capital and expanding margins?

• Efficiency technology. Making a product more efficient means it requires less resources for it to be manufactured. Because efficiency innovations are done on existing products, it is very likely that you don’t need a huge investment to find potential innovations in this regard. Therefore, returns on capital are high, margin expansion is guaranteed, and the probability of success is very high. Capital will flood into your business and customers will be happy if you charge them less for the same product. Fantastic.

• Disruptive innovation. Investing in disruptive technology implies for you to do a zero to one move. There’s no guarantee of success, the initial product will serve almost no one and it will be sold for much smaller margins than the ones you currently offer. Therefore, this product would depress your margins and returns on capital. Investors will criticize you because you are wasting money and customers will find no use in your new technology.

The logical decision is to perform a sustaining or efficiency innovation and that is why successful firms have perished in the past. A manager needs to acknowledge this and proceed accordingly.

Make the company’s size match that of the product

The solution to the dilemma big firms face is either creating a new independent business unit or acquiring a company and keeping it self-managed. Not only big firm managers fail completely to create disruptive products, but also, the teams that build them are not motivated to make it succeed.

When a company gets large enough, you will need hundreds of millions or a couple billion dollars in sales to move the needle. Disruptive products, because they begin on emergent markets, start with very little addressable market. Therefore, a large-firm employee will not feel incentivized to work on this marginal project.

A very different scenario plays out when the organization in charge of a disruptive product is small. Not only will the product be the company’s essence, but if the firm does not have infinite capital (which it shouldn’t), all the team will work towards sales and profitability. Their survivability rely on the product working.

Avoid competition

All our lives we’ve been encouraged to compete with others. Through sports, through academia’s grading system, and, at a deep biological level, it’s as we are wired. Moreover, parallelisms between managing a corporation and war have flooded business literature. One would think competing is the path forward. However, as war, competition is ultimately destructive for both parties.

Capitalism and economic theory lay on the foundation that, whenever a company is able to sell a product above its costs, at a profit, competition will come. In a perfectly competitive market, companies have returns that are equal to their cost of capital, and sell products at no profit. A wise manager would, logically, avoid getting trapped here at all costs.

“You always want to aim for monopoly”

Having a monopoly would mean you are the only player in a market. If you are the only producer of a good, consumers will have no option but buying from you. A business in such a position enjoys high returns on capital and sells at high margins. But be careful, monopolies are a byproduct of disruptive innovation, which mostly means that customers win. Monopolies are not evil rent-collectors.

It’s not only about revenue

The amount of value you create is worth zero unless you are capable to capture a part of it. Walmart, with revenues of 630bn, has a market capitalization of 440bn. Visa, with 31bn in revenue, has a market capitalization of 503bn. Why?

Walmart’s addressable market is gigantic, and management has successfully capture a large portion of it. However, Walmart has a 2.2% profit margin (Target has a 3% margin, Costco a 2.5%). On the other hand, Visa, with less than 1/10 of Walmart’s revenue, operates at a 52% profit margin. To increase earnings by a billion, Walmart has to increase sales by 50bn, while Visa only needs 2bn to produce a billion extra in earnings.

Note and reminder: Cash flow > earnings

Pick your industry with caution

Industries have an inherent set of fundamentals, and you cannot escape them. Industries and products themselves operate at certain margins, have particular reinvestment needs, determine the addressable market, capital intensity, the number of players, pose a sort of cap to returns on capital, etc.

• “A textile company that allocates capital brilliantly is a remarkable textile company – but not a remarkable business “ Warren Buffett

• “These return characteristics persist because good businesses find ways to fend off the competition — what Warren Buffett calls ‘The Moat’”

  “Poor returns also persist because companies which have many competitors, no control over pricing and/or input costs, and an ability for consumers to prolong the life of the product in a downturn (like cars) cannot suddenly throw off these poor characteristics just because they are lowly rated and/or benefit from an economic recovery” Terry Smith

Don’t oversupply the market, the base for competition changes

When a product is not yet fully optimized for clients’ satisfaction, the base upon which companies compete changes. Initially, companies maximize the product’s performance, however measured. Eventually, customers’ get fully satisfied in this respect. Managers have to be cautious because this is the point where they can be left behind.

Once the performance threshold gets met, the customer will be willing to pay a premium for convenience or simplicity, but not for extra performance. Once a dimension of the product satisfies the market, the base for competition pivots to another aspect. This cycle continuous until the product is perfectly adapted for customer’s usage. At such stage, competition on prices begin.

You have to sell

Distributing your product is as important as the product itself. It is a mistake to think that a good product will sell itself. Elon Musk has curiously always stated otherwise, he claimed several times:

“The best marketing is a great product”

Elon has never spent money on sales and marketing, but this doesn’t mean he doesn’t market his product. Musk has been able to leverage social media platforms to an extreme degree. Furthermore, his appearances in conferences and interviews have always captured audiences’ attention due to his passion and polemic forecasts. Marketing is needed. What’s not necessarily needed is to pay for it (in today’s world).

First-mover advantage

‘Being a first-mover is a strategy, it should not be the end goal’. The space you are getting into is the one that defines whether or not you might want to enter first. Clayton’s research uncovered that startups are most likely the ones that will dominate new markets, that is, with new products. However, if you intend to compete with an established business on the basis that your product does the job a bit better, odds won’t be on your side.

For example, if a drug has been developed and its purity is at 50%, you most likely won’t displace the established company by offering the same drug at 55% purity as a new entrant. The leading firm benefits from having a proper and sustainable supply chain, distribution channels built up and paying customers. These resources give the firm time to catch up in terms of products’ performance, however measured, and not lose market share.

Avoid having too many goals

Multiple aims lead to a lack of focus. It splits one’s mental resources. Similar to the concept of reducing tasks to only 1, having many macro goals at the same time will most likely lead to not achieving any of those. Every company has a metric that very well reflects the business’ fundamental health and growth. It is a manager’s task to recognize this metric and maximize it.

A bad plan is better than no plan

Successful startups are well known for their flexibility, pivoting if necessary. However, this doesn’t mean they didn’t have a plan, but rather that they might have had an inaccurate one. A bad plan is better than no plan because at least a bad plan provides a baseline. It includes the macro-structural moves a manager would need to make to carry their company forward. No plan means no focus and, when there is no focus, a company might try to grow horizontally instead of vertically. Ultimately, doing a bit of everything means that nothing is done correctly.

The panda’s thumb

Stephen Jay Gould’s essay lays Darwin’s evolution theory and speaks about the panda’s thumb. Apparently, big pandas have a thumb that’s extremely complex. Nature put it there a long time ago and, because it is difficult to ‘delete’ such things, it made the thumb evolve, building an extremely intricated web around it for it to serve its purpose better. However, it did not consider re-thinking its initial state and re-designing if needed.

Ideas, concepts and methods, begin on a somewhat arbitrary state. We use them to perform certain tasks. But tasks evolve and, in most cases, we act as nature. We improve our method without considering whether the method’s intrinsic design is appropriate or not. Consequently, the final process ends up being an ultimately inefficient mechanism for dealing with the task.

This happens to managers and investors. What practices do you follow only because you’ve always done so? Couldn’t one of them be replaced or even deleted?

“Nature is an excellent tinkerer, not a divine artificer”

Sell, then sell again

Depending on sales and one-ticket events ends up being highly cyclical and unpredictable. It is my view that recurring revenues make up for a much more resilient business, ceteris paribus. It should be one of management’s core tasks to theorize on how could they derive recurring revenue from their existent revenue. A good example of this is what Tesla is trying to get to:

Tesla sells cars for an initial price of X, which they have historically lowered. However, Tesla’s thesis for EVs is not about the vehicles themselves, but the software they’ll utilize, FSD. By selling the car to people (one-ticket event), Tesla would be acquiring millions of customers that would end up paying a monthly subscription for the software.

This turns revenue into recurring revenue.

Pick a business model

Clayton defines business models as how are the following four dimensions managed altogether to deliver value. These are “the value proposition you have for customers (job to be done); the organization’s resources; the processes that it uses to convert inputs to finished products or services; and the profit formula that dictates the margins, asset velocity, and scale required to achieve an attractive return”.

There are three fundamental types of business models:

1. Solution shops. The core of this business is diagnosis and problem-solving (consulting, R&D firms).

2. Value-adding process. Taking something in, adding value to it, and deliver it much better. Also includes putting together many otherwise dispersed components.

3. Facilitated networks. This means owning a network that connects counter-parties and provides them with a valuable service (marketplaces, payments processing networks, insurance).

Because each of the three types of business model commands a different approach to the 4 major aspects described, a sustainable business can only be built on only one of them.

Niche down, then expand

When a business is in its early stages, it is a mistake to aim for large markets. The reason being that such markets, because of their attractive size, do not let companies prosper due to deadly competition. Moreover, at the beginning, it might result easier to solve a problem that 10,000 people certainly have, than to solve 10 problems 1,000,000 people might have.

Monopolizing a small market is what helps build a profit engine to then expand if that’s management’s intention.

Machiavelli

The Prince is one of the core books of history. It laid the foundation for political philosophy. My idea was to bring Machiavelli’s insights to help manage a business, but I need further time to process his writing. I am sure many of his statements can be applied to companies, but I don’t see it very clearly, for which a breakdown attempt would end up being misfocused. I’ll leave you with a couple extracts, which I believe can be linked to the ideas above:

• With what respects to exercising the mind, a prince must read the examples history gives; and consider the actions taken by illuminated men: see how they behaved in wars, analyze the reasons for their victories and defeats, to imitate the former and avoid the latter.

• If the prince is present, he can see how disorders are born and take actions rapidly, whereas if he’s not, disorders only get to his attention when they are too large and have no solution.

• Nothing gives a prince as much prestige as overtaking huge enterprises and being himself an exemplary individual.

• And he has to emulate good archers, who, when they see their objective is too far and knowing the range of their bows, aim for a much higher place than the objective, not to reach those heights with their arrows, but to get to the desired objective with the help of such high aim.

• States that are born rapidly, as all other things that are born and grow quickly in nature, cannot develop the roots and ramifications needed, for which they die with the first freeze (unless the prince is virtuous).

• He who has fortified his cities and has proceeded accordingly with his people, will always be attacked cautiously, for men always show reluctant to engage with difficult enterprises, and there’s no easiness in attacking a man whose territories are well protected and that’s not hated by his people.. and if someone dared to attack him, they would need to retire covered in shame, because events in this world are so diverse that it is almost impossible that someone can maintain a siege for a year without showing results.

Personal commentary

I have a very similar sensation as to when I finished other articles. The concept behind the write-up is wonderful, the execution is not. I find the ideas discussed of extreme complexity and depth. Simplifying them is not easy. In any case, I hope it helped you better think about everyday problems!

Contact: giulianomana@0to1stockmarket.com

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