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7 Powers: The Foundations of Business Strategy by Hamilton Helmer


  1. Helmer sets out to create a simple, but not simplistic, strategy compass. His 7 powers include: scale economics, switching costs, cornered resource, counter positioning, branding, network effects, and process.

Key Takeaways

  1. Strategy: the study of the fundamental determinants of potential business value The objective here is both positive—to reveal the foundations of business value—and normative—to guide businesspeople in their own value-creation efforts. Following a line of reasoning common in Economics, Strategy can be usefully separated into two topics: Statics—i.e. “Being There”: what makes Intel’s microprocessor business so durably valuable? Dynamics—i.e. “Getting There”: what developments yielded this attractive state of affairs in the first place? These two form the core of the discipline of Strategy, and though interwoven, they lead to quite different, although highly complementary, lines of inquiry.
  2. Power: the set of conditions creating the potential for persistent differential returns. Power is the core concept of Strategy and of this book, too. It is the Holy Grail of business—notoriously difficult to reach, but well worth your attention and study. And so it is the task of this book to detail the specific conditions that result in Power
  3. The Mantra: a route to continuing Power in significant markets. I refer to this as The Mantra, since it provides an exhaustive characterization of the requirements of a strategy.
  4. The Value Axiom. Strategy has one and only one objective: maximizing potential fundamental business value.
    1. For the purposes of this book, “value” refers to absolute fundamental shareholder value—the ongoing enterprise value shareholders attribute to the strategically separate business of an individual firm. The best proxy for this is the net present value (NPV) of expected future free cash flow (FCF) of that activity.
  5. Dual Attributes. Power is as hard to achieve as it is important. As stated above, its defining feature ex post is persistent differential returns. Accordingly, we must associate it with both magnitude and duration.
    1. Benefit. The conditions created by Power must materially augment cash flow, and this is the magnitude aspect of our dual attributes. It can manifest as any combination of increased prices, reduced costs and/or lessened investment needs.
    1. Barrier. The Benefit must not only augment cash flow, but it must persist, too. There must be some aspect of the Power conditions which prevents existing and potential competitors, both direct and functional, from engaging in the sort of value-destroying arbitrage Intel experienced with its memory business. This is the duration aspect of Power
    1. Benefits are common, and they often bear little positive impact on company value, as they are generally subject to full arbitrage. The true potential for value lies in those rare instances in which you can prevent such arbitrage, and it is the Barrier which accomplishes this. Thus, the decisive attainment of Power often syncs up with the establishment of the Barrier.
  6. Complex Competition. Power, unlike strength, is an explicitly relative concept: it is about your strength in relation to that of a specific competitor. Good strategy involves assessing Power with respect to each competitor, which includes potential as well as existing competitors, and functional as well as direct competitors. Any such players could be the source of the arbitrage you are trying to circumvent, and any one arbitrageur is enough to drive down differential margins.
  7. The 7 Powers
    1. Scale Economies
      1. Scale Economies—the First of the 7 Powers The quality of declining unit costs with increased business size is referred to as Scale Economies.
        1. Benefit: Reduced Cost
        1. Barrier: Prohibitive Costs of Share Gains
    1. Network Economies
      1. Network Economies: the value of the service to each customer is enhanced as new customers join the “network.” In such a situation, having the most customers is everything,
      1. Industries exhibiting Network Economies often exhibit these attributes: Winner take all.
    1. Counter-Positioning
      1. Counter-Positioning: A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business.
      1. This chapter introduces Counter-Positioning, the next Power type. I developed this concept to depict a not well-understood competitive dynamic I often have observed both as a strategy advisor and an equity investor. I must confess it is my favorite form of Power, both because of my authorship and because it is so contrarian. As we will see, it is an avenue for defeating an incumbent who appears unassailable by conventional wisdom metrics of competitive strength.
      1. But nearly always, these featured the same outcome: the incumbent responds either not at all or too late. The incumbent’s failure to respond, more often than not, results from thoughtful calculation. They observe the upstart’s new model, and ask, “Am I better off staying the course, or adopting the new model?” Counter-Positioning applies to the subset of cases in which the expected damage to the existing business elicits a “no” answer from the incumbent. The Barrier, simply put, is collateral damage. In the Vanguard case, Fidelity looked at their highly attractive active management franchise and concluded that the new passive funds’ more modest returns would likely fail to offset the damage done by a migration from their flagship products.
      1. What are the potential causes of such decrements? They could be numerous, but over several decades of client strategy work, I have noted two that seem common. The first involves two characteristics of challenges to incumbency:
        1. The challenger’s approach is novel and, at first, unproven. As a consequence, it is shrouded in uncertainty, especially to those looking in from the outside. The low signal-to-noise of the situation only heightens that uncertainty.
        1. The incumbent has a successful business model. This heritage is influential and deeply embedded, as suggested by Nelson and Winter’s notion of “routines,” and with it comes a certain view of how the world works. The CEO probably can’t help but view circumstances through this lens, at least in part. Together these two characteristics frequently lead incumbents to at first belittle the new approach, grossly underestimating its potential.
      1. As noted in the Introduction, Power must be considered relative to each competitor, actual and implicit. With Counter-Positioning, this is particularly important, because this type of Power only applies relative to the incumbent and says nothing regarding Power relative to other firms utilizing the new business model.
      1. Though this isn’t always the case, I have noticed a frequently repeated script for how an incumbent reacts to a CP challenge. I whimsically refer to it as the Five Stages of Counter-Positioning: Denial Ridicule Fear Anger Capitulation (frequently too late)
      1. Once market erosion becomes severe, a Counter-Positioned incumbent comes under tremendous pressure to do something; at the same time, they face great pressure to not upset the apple cart of the legacy business model. A frequent outcome of this duality? Let’s call it dabbling: the incumbent puts a toe in the water, somehow, but refuses to commit in a way that meaningfully answers the challenge. Counter-Positioning often underlies situations in which the following developments are jointly observed: For the challenger Rapid share gains Strong profitability (or at least the promise of it) For the incumbent Share loss Inability to counter the entrant’s moves Eventual management shake-up (s) Capitulation, often occurring too late
      1. Such reversals are rare in business, because contests typically take place over extended periods and with great thoughtfulness on all sides. Even a momentary lapse by an incumbent won’t present a sufficient opening. The only bet worthwhile for a challenger is one in which even if the incumbent plays its best game, it can be taken off the board. A competent Counter-Positioned challenger must take advantage of the strengths of the incumbent, as it is this strength which molds the Barrier, collateral damage.
    1. Switching Costs
      1. Switching Costs arise when a consumer values compatibility across multiple purchases from a specific firm over time. These can include repeat purchases of the same product or purchases of complementary goods.
      1. Benefit. A company that has embedded Switching Costs for its current customers can charge higher prices than competitors for equivalent products or services. This benefit only accrues to the Power holder in selling follow-on products to their current customers; they hold no Benefit with potential customers and there is no Benefit if there are no follow-on products.
      1. Barrier. To offer an equivalent product, competitors must compensate customers for Switching Costs. The firm that has previously roped in the customer, then, can set or adjust prices in a way that puts their potential rival at a cost disadvantage, rendering such a challenge distinctly unattractive. Thus, as with Scale Economies and Network Economies, the Barrier arises from the unattractive cost/benefit of share gains for the challenger.
      1. Switching Costs can be divided into three broad groups:
        1. Financial.
        1. Procedural.
        1. Relational.
      1. Switching Costs are a non-exclusive Power type: all players can enjoy their benefits.
    1. Branding
      1. Branding is an asset that communicates information and evokes positive emotions in the customer, leading to an increased willingness to pay for the product.
      1. Benefit. A business with Branding is able to charge a higher price for its offering due to one or both of these two reasons:
        1. Affective valence. The built-up associations with the brand elicit good feelings about the offering, distinct from the objective value of the good.
        1. Uncertainty reduction. A customer attains “peace of mind” knowing that the branded product will be as just as expected.
      1. Barrier. A strong brand can only be created over a lengthy period of reinforcing actions (hysteresis), which itself serves as the key Barrier.
      1. Brand Dilution. Firms require focus and diligence to guide Branding over time and ensure that the reputation created remains consistent in the valences it generates. Hence, the biggest pitfall lies in diminishing the brand by releasing products which deviate from, or damage, the brand image. Seeking higher “down market” volumes can reduce affective valence by damaging the aura of exclusivity, weakening positive associations with the product.
      1. Problem is, the qualities that make Branding a Power also make it hard to change; the considerable risk is dilution or brand destruction.
      1. Type of Good. Only certain types of goods have Branding potential as they must clear two conditions:
        1. Magnitude: the promise of eventually justifying a significant price premium. Business-to-business goods typically fail to exhibit meaningful affective valence price premia, since most purchasers are only concerned with objective deliverables. Consumer goods, in particular those associated with a sense of identity, tend to have the purchasing decision more driven by affective valence. Here’s the reason: in order to associate with an identity, there must be some way to signal the exclusion of alternative identities.
        1. For Branding Power derived from uncertainty reduction, the customer’s higher willingness to pay is driven by high perceived costs of uncertainty relative to the cost of the good. Such products tend to be those associated with bad tail events: safety, medicine, food, transport, etc. Branded medicine formulations, for example, are identical to those of generics, yet garner a significantly higher price. Duration: a long enough amount of time to achieve such magnitude. If the requisite duration is not present, the Benefit attained will fall prey to normal arbitraging behavior.
    1. Cornered Resource
      1. Cornered Resource definition: Preferential access at attractive terms to a coveted asset that can independently enhance value.
      1. Benefit. In the Pixar case, this resource produced an uncommonly appealing product—“superior deliverables”—driving demand with very attractive price/volume combinations in the form of huge box office returns. No doubt—this was material (a large m in the Fundamental Equation of Strategy). In other instances, however, the Cornered Resource can emerge in varied forms, offering uniquely different benefits. It might, for example, be preferential access to a valuable patent, such as that for a blockbuster drug; a required input, such as a cement producer’s ownership of a nearby limestone source, or a cost-saving production manufacturing approach, such as Bausch and Lomb’s spin casting technology for soft contact lenses.
      1. Barrier. The Barrier in Cornered Resource is unlike anything we have encountered before. You might wonder: “Why does Pixar retain the Brain Trust?” Any one of this group would be highly sought after by other animated film companies, and yet over this period, and no doubt into the future, they have stayed with Pixar. Even during the company’s rocky beginning, there was a loyalty that went beyond simple financial calculation.
      1. Our general term for this sort of barrier is “fiat”; it is not based on ongoing interaction but rather comes by decree, either general or personal.
      1. Another way to put this is that a Cornered Resource is a sufficient condition for potential for differential returns.
    1. Process Power
      1. I save it until last because it is rare. I will use the Toyota Motor Corporation as a case.
      1. Perhaps the best way to think of it is this: Process Power equals operational excellence, plus hysteresis. Having said that, such hysteresis occurs so rarely that I am in strong agreement with Professor Porter’s sentiments.
      1. Benefit. A company with Process Power is able to improve product attributes and/or lower costs as a result of process improvements embedded within the organization. For example, Toyota has maintained the quality increases and cost reductions of the TPS over a span of decades; these assets do not disappear as new workers are brought in and older workers retire.
      1. Barrier. The Barrier in Process Power is hysteresis: these process advances are difficult to replicate, and can only be achieved over a long time period of sustained evolutionary advance. This inherent speed limit in achieving the Benefit results from two factors:
        1. Complexity. Returning to our example: automobile production, combined with all the logistic chains which support it, entails enormous complexity. If process improvements touch many parts of these chains, as they did with Toyota, then achieving them quickly will prove challenging, if not impossible.
        1. Opacity. The development of TPS should tip us off to the long time constant inevitably faced by would-be imitators. The system was fashioned from the bottom up, over decades of trial and error. The fundamental tenets were never formally codified, and much of the organizational knowledge remained tacit, rather than explicit. It would not be an exaggeration to say that even Toyota did not have a full, top-down understanding of what they had created—it took fully fifteen years, for instance, before they were able to transfer TPS to their suppliers. GM’s experience with NUMMI also implies the tacit character of this knowledge: even when Toyota wanted to illuminate their work processes, they could not entirely do so.
  8. The Path to Power: “Me Too” Won’t Do
    1. Here’s the first important takeaway from our consideration of Dynamics: “getting there” (Dynamics) is completely different from “being there” (Statics). In other words, to assess which journeys are worth taking, you must first understand which destinations are desirable. Fortunately the 7 Powers does exactly that: it maps the only seven worthwhile destinations.
    1. The first cause of every Power type is invention, be it the invention of a product, process, business model or brand. The adage “‘Me too’ won’t do” guides the creation of Power.
    1. Planning rarely creates Power. It may meaningfully boost Power once you have established it, but if Power does not yet exist, you can’t rely on planning. Instead you must create something new that produces substantial economic gain in the value chain. Not surprisingly, we have worked our way back to Schumpeter.
    1. Power arrives only on the heels of invention. If you want your business to create value, then action and creativity must come foremost. But success requires more than Power alone; it needs scale. Recall the Fundamental Equation of Strategy: Value = [Market Size] * [Power]
    1. Invention has a powerful one-two value punch: it both opens the door for Power and also propels market size.
  9. Other
    1. By far the most important “value moment” for a business occurs when the bars of uncertainty are radically diminished with regards to the Fundamental Equation of Strategy, market size and Power. At that moment, the cash flow future makes a step-change in transparency.
    1. A primary driver of opacity is high flux: if a business is in a fast-changing environment, then the information facing investment pros tends to have much higher uncertainty bars regarding future free cash flow. But high flux also attends the sort of conditions which orbit the “value moment.” So if the 7 Powers can lead to alpha by identifying Power in these situations ex ante, it also promises to be useful in doing the same for those inventors on the ground trying to find a path to satisfy The Mantra.
    1. The 3 S’s. Power, the potential to realize persistent differential returns, is the key to value creation. Power is created if a business attribute is simultaneously:
      1. Superior—improves free cash flow
      1. Significant—the cash flow improvement must be material
      1. Sustainable—the improvement must be largely immune to competitive arbitrage

What I got out of it Helmer provides a simple, but not simplistic, strategy framework in which to analyze, build, invest in companies. SSCCBNP – scale economies, switching costs, cornered resource, counter positioning, branding, network effects, process. The book is well worth reading and re-reading. The real world examples he gives relating to his framework are helpful to better understand it all.

Essays of Warren Buffett: Lessons for Corporate America by Lawrence Cunningham

  1. An organized compilation of Warren Buffett’s annual letters, broken down by concept. “By arranging these writings as thematic essays, this collection presents a synthesis of the overall business and investment philosophy intended for dissemination to a wide general audience.”
Key Takeaways
  1. Focus on the business with outstanding economic characteristics (favorable and durable moats) and management
  2. People are everything – partner with CEOs who will act well even if they could cheat, who act as if they’re the sole owner, as if it’s the only asset they hold, as if they can’t sell or merge for 100 years
  3. Performance should be the basis for executive pay decisions, as measured by profitability, after profits are reduced by a charge for the capital employed in the relevant business or earnings retained by. If stock options are used, it should be related to individual rather than corporate performance, and priced based on business value
  4. True risk is not volatility but permanent loss of capital
  5. Rather be approximately right than precisely wrong
  6. Put eggs in one basket and watch that basket
  7. Price is what you pay, value is what you get
  8. The 3 legs of the investing stool – Mr. Market, margin of safety, circle of competence
  9. Value investing is a redundancy – aim for focused or intelligent investing
  10. Deploying cash requires evaluating 4 commonsense questions based on information rather than rumor
    1. the probability of the event occurring
    2. The time the funds will be tied up
    3. The opportunity cost
    4. The downside if the event does not occur
  11. Guard against the institutional imperative – CEOs herd-like behavior, producing resistance to change, inertia, and blindness
  12. If you aren’t happy owning business when exchange is closed, you aren’t happy owning it when open
  13. Create the business and environment that attracts the people, management, shareholders that you want
  14. Useful financial statements must enable a user to answer 3 basic questions about a business
    1. Approximately how much a company is worth
    2. Its likely ability to meet its future obligations
    3. How good a job its managers are doing in operating the business
  15. Owner earnings –> cash flow = operating earnings + depreciation expense and other non-cash charges – required reinvestment in the business (average amount of capitalized expenditures for PPE that the business requires to fully maintain its long-term competitive position and its unit volume)
  16. Intrinsic value = the discounted value of the cash that can be taken out of a business during its remaining life
  17. Don’t risk what you have and need for what you don’t have and don’t need
  18. Beware weak accounting (EBITDA), unintelligible foot notes, those who trumpet projections
  19. Directors must be independent, business savvy, shareholder oriented, have a genuine interest in the business
  20. Really only 2 jobs – capital allocation, attract and keep outside management
  21. Choose a cold sink (weaker competition) than best management
  22. Conventionality often overpowers rationality
  23. Risk – we continually search for large business with understandable, enduring and mouth-watering economics that are run by able and shareholder-oriented managements
    1. The certainty with which the long-term economic characteristics of the business can be evaluated
    2. The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows
    3. The certainty with which management can be counted on to channel the reward from the business to the shareholders rather than to itself
    4. The purchase price of the business
    5. The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing-power return is reduced from his gross return
  24. When dumb money acknowledges its limitations, it ceases to be dumb
  25. Need to do very few things right if you avoid big mistakes
  26. Changing styles often is a recipe for disaster
  27. Worry most about management losing focus
  28. If you won’t own a business for 10 years, don’t own it for 10 minutes – materially higher earnings in 5-10 years is what you’re looking for
  29. Time is the friend of the wonderful business, the enemy of the mediocre
  30. Have not learned how to solve difficult business problems, but have learned to avoid them
  31. Never in a hurry – enjoy the process more than the proceeds
  32. “Expert error” – falling in love and acting on theory, not reality
  33. You don’t have to make it back the way you lost it
  34. In commodity-type businesses, it’s almost impossible to be a lot smarter than your dumbest competitor
  35. 4th Law of Motion – for investors as a whole, returns decrease as motion increases. a hyperactive market is the pickpocket of enterprise
  36. Attract proper inventors through clear, consistent communications of business philosophy
  37. It pays to be active, interested, and open-minded, never in a hurry
  38. Avoid small commitments – if something is not worth doing at all, it’s not worth doing well
  39. Deals often fail in practice but never in projections
  40. In a trade, what you give is as important as what you get
  41. The goal of each investor should be to create a portfolio (in effect, a “company”) that will deliver him other the highest possible look-through earnings a decade or so from now. An approach of this kind will force the investor to think about long-term business prospects rather than short-term market prospects, a perspective likely to improve results. It’s true, of course, that, in the long run, the scoreboard for investment decisions is market price. But prices will be determined by future earnings. In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard
  42. The primary test of managerial economic performance is the achievement of a high ROE employed and not the achievement of consistent gains in earnings per share
  43. The difficulty lies not in the new ideas but in escaping the old ones.
  44. Ultimately, business experience, direct and vicarious, produced my present strong preference of businesses that possess large amounts of enduring Goodwill and that utilize a minimum of tangible assets.
  45. Nothing sedates rationality like large doses of effortless money
  46. Speculation most dangerous when it looks easiest
  47. Fear is the foe of the faddist but the friend of the fundamentalist
  48. Take into account exposure, not experience
  49. Noah Rule – predicting rain doesn’t count, building arks does
  50. Tolerance for huge losses is a major competitive advantage
  51. Berkshire’s next CEO – temperament is important, independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investing success.
What I got out of it
  1. An amazing collection of investing, finance, accounting, and management ideas

Crossing the Chasm by Geoffrey Moore

  1. Navigating in such the uncharted waters of the chasm requires beacons that can be seen above the waves, and that is what models in general, and the chasm models in particular, are for. Models are like constellations—they are not intended to change in themselves, but their value is in giving perspective on a highly changing world. The chasm model represents a pattern in market development that is based on the tendency of pragmatic people to adopt new technology when they see other people like them doing the same. This causes them to hang together as a group, and the group’s initial reaction, like teenagers at a junior high dance, is to hesitate and watch. This is the chasm effect. The tendency is very deep-rooted, and so the pattern is very persistent. As a result, marketers can predict its appearance and build strategies to cope with it, and it is the purpose of this book to help in that process. To be specific, the point of greatest peril in the development of a high-tech market lies in making the transition from an early market dominated by a few visionary customers to a mainstream market dominated by a large block of customers who are predominantly pragmatists in orientation. The gap between these two markets, heretofore ignored, is in fact so significant as to warrant being called a chasm, and crossing this chasm must be the primary focus of any long-term high-tech marketing plan. A successful crossing is how high-tech fortunes are made; failure in the attempt is how they are lost.
Key Takeaways
  1. Background & Fundamentals of Crossing the Chasm
    1. It is only natural to cling to the past when the past represents so much of what we have strived to achieve. This is the key to Crossing the Chasm. The chasm represents the gulf between two distinct marketplaces for technology products—the first, an early market dominated by early adopters and insiders who are quick to appreciate the nature and benefits of the new development, and the second a mainstream market representing “the rest of us,” people who want the benefits of new technology but who do not want to “experience” it in all its gory details. The transition between these two markets is anything but smooth. Indeed, what Geoff Moore has brought into focus is that, at the time when one has just achieved great initial success in launching a new technology product, creating what he calls early market wins, one must undertake an immense effort and radical transformation to make the transition into serving the mainstream market. This transition involves sloughing off familiar entrepreneurial marketing habits and taking up new ones that at first feel strangely counterintuitive.
    2. The basic forces don’t change, but the tactics have become more complicated. Moreover, we are seeing a new effect which was just barely visible in the prior decade, the piggybacking of one company’s offer on another to skip the chasm entirely and jump straight into hypergrowth. In the 1980s Lotus piggybacked on VisiCalc to accomplish this feat in the spreadsheet category. In the 1990s Microsoft has done the same thing to Netscape in browsers. The key insight here is that we should always be tracking the evolution of a technology rather than a given company’s product line—it’s the Technology Adoption Life Cycle, after all. Thus it is spreadsheets, not VisiCalc, Lotus, or Excel, that is the adoption category, just as it is browsers, not Navigator or Explorer. In the early days products and categories were synonymous because technologies were on their first cycles. But today we have multiple decades of invention to build on, and a new offer is no longer quite as new or unprecedented as it used to be.
    3. If we step back from this chasm problem, we can see it as an instance of the larger problem of how the marketplace can cope with change in general. For both the customer and the vendor, continually changing products and services challenge their institution’s ability to absorb and make use of the new elements. What can marketing do to buffer these shocks? Fundamentally, marketing must refocus away from selling product and toward creating relationships. Relationship buffers the shock of change. Marketing’s first deliverable is that partnership. This is what we mean when we talk about “owning a market.” Customers do not like to be “owned,” if that implies lack of choice or freedom. The open systems movement in high tech is a clear example of that. But they do like to be “owned” if what that means is a vendor taking ongoing responsibility for the success of their joint ventures. Ownership in this sense means abiding commitment and a strong sense of mutuality in the development of the marketplace. When customers encounter this kind of ownership, they tend to become fanatically loyal to their supplier, which in turn builds a stable economic base for profitability and growth.
    4. The fundamental requirement for the ongoing, interoperability needed to sustain high tech is accurate and honest exchange of information. Your partners need it, your distribution channel needs it and must support it, and your customers demand it.
    5. The fundamental basis of market relations is to build and manage relationships with all the members that make up a high-tech marketplace, not just the most visible ones. In particular, it means setting up formal and informal communications not only with customers, press, and analysts but also with hardware and software partners, distributors, dealers, VARs, systems and integrators, user groups, vertically oriented industry organizations, universities, standards bodies, and international partners. It means improving not only your external communications but also your internal exchange of information among the sales force, the product managers, strategic planners, customer service and support, engineering, manufacturing, and finance.
      1. Must see through every stakeholder’s eyes and create win-win relationships. This becomes even more complicated with public, high-tech companies given the number of constituents
    6. The problem, since these techniques are antithetical to each other, is that you need to decide which one – fad or trend – you are dealing with before you start. It would be much better if you could start with a fad, exploit it for all it was worth, and then turn it into a trend. That may seem like a miracle, but that is in essence what high-tech marketing is all about. Every truly innovative high-tech product starts out as a fad—something with no known market value or purpose but with “great properties” that generate a lot of enthusiasm within an “in crowd.” That’s the early market. Then comes a period during which the rest of the world watches to see if anything can be made of this; that is the chasm. If in fact something does come out of it—if a value proposition is discovered that can predictably be delivered to a targetable set of customers at a reasonable price-then a new mainstream market forms, typically with a rapidity that allows its initial leaders to become very, very successful. The key in all this is crossing the chasm—making that mainstream market emerge. This is a do-or-die proposition for high-tech enterprises; hence, it is logical that they be the crucible in which “chasm theory” is formed.
    7. The rule of thumb in crossing the chasm is simple: Pick on somebody your own size.
    8. These are the two “natural” marketing rhythms in high tech— developing the early market and developing the mainstream market. You develop an early market by demonstrating a strong technology advantage and converting it to product credibility, and you develop a mainstream market by demonstrating a market leadership advantage and converting it to company credibility. By contrast, the “chasm transition” represents an unnatural rhythm. Crossing the chasm requires moving from an environment of support among the visionaries back into one of skepticism among the pragmatists. It means moving from the familiar ground of product-oriented issues to the unfamiliar ground of market-oriented ones, and from the familiar audience of like-minded specialists to the unfamiliar audience of essentially uninterested generalists.
    9. Market Development Strategy Checklist. This list consists of a set of issues around which go-to-market plans are built, each of which incorporates a chasm-crossing factor, as follows:
      1. Target customer
      2. Compelling reason to buy
      3. Whole product
      4. Partners and allies
      5. Distribution
      6. Pricing
      7. Competition
      8. Positioning
      9. Next target customer
  2. Technology Adoption Life Cycle – The Cause for the Chasm
    1. To recap the logic of the Technology Adoption Life Cycle, its underlying thesis is that technology is absorbed into any given community in stages corresponding to the psychological and social profiles of various segments within that community. This profile, is in turn, the very foundation of the High-Tech Marketing Model. That model says that the way to develop a high-tech market is to work the curve left to right, focusing first on the innovators, growing that market, then moving on to the early adopters, growing that market, and so on, to the early majority, late majority, and even to the laggards. In this effort, companies must use each “captured” group as a reference base for going on to market to the next group. Thus, the endorsement of innovators becomes an important tool for developing a credible pitch to the early adopters, that of the early adopters to the early majority, and so on. The idea is to keep this process moving smoothly, proceeding something like passing the baton in a relay race or imitating Tarzan swinging from vine to well-placed vine. It is important to maintain momentum in order to create a bandwagon effect that makes it natural for the next group to want to buy in. Too much of a delay and the effect would be something like hanging from a motionless vine—nowhere to go but down. As you can see, the components of the life cycle are unchanged, but between any two psychographic groups has been introduced a gap. This symbolizes the dissociation between the two groups—that is, the difficulty any group will have in accepting a new product if it is presented in the same way as it was to the group to its immediate left. Each of these gaps represents an opportunity for marketing to lose momentum, to miss the transition to the next segment, thereby never to gain the promised land of profit-margin leadership in the middle of the bell curve. The key to winning over this segment is to show that the new technology enables some strategic leap forward, something never before possible, which has an intrinsic value and appeal to the nontechnologist. This benefit is typically symbolized by a single, compelling application, the one thing that best captures the power and value of the new product. If the marketing effort is unable to find that compelling application, then market development stalls with the innovators, and the future of the product falls through the crack.
    2. It turns out our attitude toward technology adoption becomes significant—at least in a marketing sense—any time we are introduced to products that require us to change our current mode of behavior or to modify other products and services we rely on. In academic terms, such change-sensitive products are called discontinuous innovations. The contrasting term, continuous innovations, refers to the normal upgrading of products that does not require us to change behavior.
    3. Of course, talking this way about marketing merely throws the burden of definition onto market, which we will define, for the purposes of high tech, as:
      1. A set of actual or potential customers
      2. For a given set of products or services
      3. Who have a common set of needs or wants
      4. Who reference each other when making a buying decision.
    4. The goal should be to package each of the phases such that each phase
      1. Is accomplishable by mere mortals working in earth time
      2. Provides the vendor with a marketable product
      3. Provides the customer with a concrete return on investment that can be celebrated as a major step forward.                                                                                                                                                    
    1. Innovators
      1. Visionaries are not looking for an improvement; they are looking for a fundamental breakthrough.
      2. In sum, visionaries represent an opportunity early in a product’s life cycle to generate a burst of revenue and gain exceptional visibility.
    2. Early Adopters
      1. What the early adopter is buying is some kind of change agent. By being the first to implement this change in their industry, the early adopters expect to get a jump on the competition, whether from lower product costs, faster time to market, more complete customer service, or some other comparable business advantage. They expect a radical discontinuity between the old ways and the new, and they are prepared to champion this cause against entrenched resistance. Being the first, they also are prepared to bear with the inevitable bugs and glitches that accompany any innovation just coming to market.
    3. Early Majority (Pragmatists)
      1. The real news, however, is not the two cracks in the bell curve, the one between the innovators and the early adopters, the other between the early and late majority. No, the real news is the deep and dividing chasm that separates the early adopters from the early majority. This is by far the most formidable and unforgiving transition in the Technology Adoption Life Cycle, and it is all the more dangerous because it typically goes unrecognized. The reason the transition can go unnoticed is that with both groups the customer list and the size of the order can look the same.
      2. The early majority want to buy a productivity improvement for existing operations. They are looking to minimize the discontinuity with the old ways. They want evolution, not revolution. They want technology to enhance, not overthrow, the established ways of doing business. And above all, they do not want to debug somebody else’s product. By the time they adopt it, they want it to work properly and to integrate appropriately with their existing technology base. This contrast just scratches the surface relative to the differences and incompatibilities among early adopters and the early majority. Let me just make two key points for now: Because of these incompatibilities, early adopters do not make good references for the early majority. And because of the early majority’s concern not to disrupt their organizations, good references are critical to their buying decisions. So what we have here is a catch-22. The only suitable reference for an early majority customer, it turns out, is another member of the early majority, but no upstanding member of the early majority will buy without first having consulted with several suitable references.
      3. Of course, to market successfully to pragmatists, one does not have to be one—just understand their values and work to serve them. To look more closely into these values, if the goal of visionaries is to take a quantum leap forward, the goal of pragmatists is to make a percentage improvement—incremental, measurable, predictable progress. If they are installing a new product, they want to know how other people have fared with it. The word risk is a negative word in their vocabulary—it does not connote opportunity or excitement but rather the chance to waste money and time.
      4. If pragmatists are hard to win over, they are loyal once won, often enforcing a company standard that requires the purchase of your product, and only your product, for a given requirement. This focus on standardization is, well, pragmatic, in that it simplifies internal service demands. But the secondary effects of this standardization—increasing sales volumes and lowering the cost of sales—is dramatic. Hence the importance of pragmatists as a market segment.
      5. When pragmatists buy, they care about the company they are buying from, the quality of the product they are buying, the infrastructure of supporting products and system interfaces, and the reliability of the service they are going to get. In other words, they are planning on living with this decision personally for a long time to come.
      6. Pragmatists won’t buy from you until you are established, yet you can’t get established until they buy from you. Obviously, this works to the disadvantage of start-ups and, conversely, to the great advantage of companies with established track records. On the other hand, once a start-up has earned its spurs with the pragmatist buyers within a given vertical market, they tend to be very loyal to it, and even go out of their way to help it succeed. When this happens, the cost of sales goes way down, and the leverage on incremental R&D to support any given customer goes way up. That’s one of the reasons pragmatists make such a great market.
      7. Overall, to market to pragmatists, you must be patient. You need to be conversant with the issues that dominate their particular business. You need to show up at the industry-specific conferences and trade shows they attend. You need to be mentioned in articles that run in the magazines they read. You need to be installed in other companies in their industry. You need to have developed applications for your product that are specific to the industry. You need to have partnerships and alliances with the other vendors who serve their industry. You need to have earned a reputation for quality and service. In short, you need to make yourself over into the obvious supplier of choice. This is a long-term agenda, requiring careful pacing, recurrent investment, and a mature management team
      8. Conservatives like to buy preassembled packages, with everything bundled, at a heavily discounted price. The last thing they want to hear is that the software they just bought doesn’t support the printer they have installed. They want high-tech products to be like refrigerators—you open the door, the light comes on automatically, your food stays cold, and you don’t have to think about it. The products they understand best are those dedicated to a single function—word processors, calculators, copiers, and fax machines. The notion that a single computer could do all four of these functions does not excite them—instead, it is something they find vaguely nauseating. The conservative marketplace provides a great opportunity, in this regard, to take low-cost, trailing-edge technology components and repackage them into single-function systems for specific business needs. The quality of the package should be quite high because there is nothing in it that has not already been thoroughly debugged. The price should be quite low because all the R&D has long since been amortized, and every bit of the manufacturing learning curve has been taken advantage of. It is, in short, not just a pure marketing ploy but a true solution for a new class of customer. There are two keys to success here. The first is to have thoroughly thought through the “whole solution” to a particular target end user market’s needs, and to have provided for every element of that solution within the package. This is critical because there is no profit margin to support an afterpurchase support system. The other key is to have lined up a low-overhead distribution channel that can get this package to the target market effectively.
      9. Just as the visionaries drive the development of the early market, so do the pragmatists drive the development of the mainstream market. Winning their support is not only the point of entry but the key to long-term dominance. But having done so, you cannot take the market for granted. To maintain leadership in a mainstream market, you must at least keep pace with the competition. It is no longer necessary to be the technology leader, nor is it necessary to have the very best product. But the product must be good enough, and should a competitor make a major breakthrough, you have to make at least a catch-up response.
      10. The key to making a smooth transition from the pragmatist to the conservative market segments is to maintain a strong relationship with the former, always giving them an open door to go to the new paradigm, while still keeping the latter happy by adding value to the old infrastructure. It is a balancing act to say the least, but properly managed the earnings potential in loyal mature market segments is very high indeed.
      11. So the corollary lesson is, we must use our experience with the pragmatist customer segment to identify all the issues that require service and then design solutions to these problems directly into the product.
      12. In sum, the pragmatists are loath to buy until they can compare. Competition, therefore, becomes a fundamental condition for purchase. So, coming from the early market, where there are typically no perceived competing products, with the goal of penetrating the mainstream, you often have to go out and create your competition. Creating the competition is the single most important marketing decision made in the battle to enter the mainstream. It begins with locating your product within a buying category that already has some established credibility with the pragmatist buyers. That category should be populated with other reasonable buying choices, ideally ones with which the pragmatists are already familiar. Within this universe, your goal is to position your product as the indisputably correct buying choice.
      13. In sum, to the pragmatist buyer, the most powerful evidence of leadership and likelihood of competitive victory is market share. In the absence of definitive numbers here, pragmatists will look to the quality and number of partners and allies you have assembled in your camp, and their degree of demonstrable commitment to your cause.
    4. Late Majority
      1. Simply put, the early majority is willing and able to become technologically competent, where necessary; the late majority, much less so. When a product reaches this point in the market development, it must be made increasingly easier to adopt in order to continue being successful. If this does not occur, the transition to the late majority may well stall or never happen.
    5. Laggards
      1. Skeptics—the group that makes up the last one-sixth of the Technology Adoption Life Cycle—do not participate in the high-tech marketplace, except to block purchases. Thus, the primary function of high-tech marketing in relation to skeptics is to neutralize their influence. In a sense, this is a pity because skeptics can teach us a lot about what we are doing wrong
  3. The D-Day Strategy – Choose a Target Niche
    1. Entering the mainstream market is an act of aggression. The companies who have already established relationships with your target customer will resent your intrusion and do everything they can to shut you out. The customers themselves will be suspicious of you as a new and untried player in their marketplace. No one wants your presence. You are an invader. This is not a time to focus on being nice. As we have already said, the perils of the chasm make this a life-or-death situation for you. You must win entry to the mainstream, despite whatever resistance is posed. That’s it. That’s the strategy. Replicate D Day, and win entry to the mainstream. Cross the chasm by targeting a very specific niche market where you can dominate from the outset, force your competitors out of that market niche, and then use it as a base for broader operations. Concentrate an overwhelmingly superior force on a highly focused target. It worked in 1944 for the Allies, and it has worked since for any number of high-tech companies.
    2. The D-Day strategy prevents this mistake. It has the ability to galvanize an entire enterprise by focusing it on a highly specific goal that is (1) readily achievable and (2) capable of being directly leveraged into long-term success. Most companies fail to cross the chasm because, confronted with the immensity of opportunity represented by a mainstream market, they lose their focus, chasing every opportunity that presents itself, but finding themselves unable to deliver a salable proposition to any true pragmatist buyer. The D-Day strategy keeps everyone on point—if we don’t take Normandy, we don’t have to worry about how we’re going to take Paris. And by focusing our entire might on such a small territory, we greatly increase our odds of immediate success.
      1. This isn’t rocket science, but it does represent a kind of discipline. And it is here that high-tech management shows itself most lacking. Most high-tech leaders, when it comes down to making marketing choices, will continue to shy away from making niche commitments, regardless. Like marriage-averse bachelors, they may nod in all the right places and say all the right things, but they will not show up when the wedding bells chime.
      2. “Never attack a fortified hill.” Same with beachheads. If some other company got there before you, all the market dynamics that you are seeking to make work in your favor are already working in its favor. Don’t go there.
    3. One of the most important lessons about crossing the chasm is that the task ultimately requires achieving an unusual degree of company unity during the crossing period. This is a time when one should forgo the quest for eccentric marketing genius, in favor of achieving an informed consensus among mere mortals. It is a time not for dashing and expensive gestures but rather for careful plans and cautiously rationed resources—a time not to gamble all on some brilliant coup but rather to focus everyone on making as few mistakes as possible. One of the functions of this book, therefore-and perhaps its most important one-is to open up the logic of marketing decision making during this period so that everyone on the management team can participate in the marketing process. If prudence rather than brilliance is to be our guiding principle, then many heads are better than one. If marketing is going to be the driving force-and most organizations insist this is their goal—then its principles must be accessible to all the players, and not, as is sometimes the case, be reserved to an elect few who have managed to penetrate its mysteries.
    4. The consequences of being sales-driven during the chasm period are, to put it simply, fatal.
    5. Segment. Segment. Segment. One of the other benefits of this approach is that it leads directly to you “owning” a market. That is, you get installed by the pragmatists as the leader, and from then on, they conspire to help keep you there. This means that there are significant barriers to entry for any competitors, regardless of their size or the added features they have in their product. Mainstream customers will, to be sure, complain about your lack of features and insist you upgrade to meet the competition. But, in truth, mainstream customers like to be “owned”—it simplifies their buying decisions, improves the quality and lowers the cost of whole product ownership, and provides security that the vendor is here to stay. They demand attention, but they are on your side. As a result, an owned market can take on some of the characteristics of an annuity—a building block in good times, and a place of refuge in bad—with far more predictable revenues and far lower cost of sales than can otherwise be achieved.
    6. For all these reasons—for whole product leverage, for word-of-mouth effectiveness, and for perceived market leadership—it is critical that, when crossing the chasm, you focus exclusively on achieving a dominant position in one or two narrowly bounded market segments. If you do not commit fully to this goal, the odds are overwhelmingly against your ever arriving in the mainstream market.
    7. The key to moving beyond one’s initial target niche is to select strategic target market segments to begin with. That is, target a segment that, by virtue of its other connections, creates an entry point into a larger segment. For example, when the Macintosh crossed the chasm, the target niche was the graphics arts department in Fortune 500 companies. This was not a particularly large target market, but it was one that was responsible for a broken, mission-critical process—providing presentations for executives and marketing professionals.
    8. The niche wins—presuming the beachhead strategy is conducted correctly—by getting a fix for its specialized problem. And the vendor wins because it gets certified by at least one group of pragmatists that its offering is mainstream. So, because of the dynamics of technology adoption, and not because of any niche properties in the product itself, platforms must take a vertical market approach to crossing the chasm even though it seems unnatural.
    9. The answer is that when you are picking a chasm-crossing target it is not about the number of people involved, it is about the amount of pain they are causing. In the case of the pharmaeutical industry’s regulatory affairs function, the pain was excruciating.
    10. This is a standard pattern in crossing the chasm. It is normally the departmental function who leads (they have the problem), the executive function who prioritizes (the problem is causing enterprise-wide grief), and the technical function that follows (they have to make the new stuff work while still maintaining all the old stuff).
    11. The more serious the problem, the faster the target niche will pull you out of the chasm. Once out, your opportunities to expand into other niches are immensely increased because now, having one set of customers solidly behind you, you are much less risky to back as a new vendor.
  4. Next Target Segment
    1. The second key is to have lined up other market segments into which you can leverage your initial niche solution. This allows you to reinterpret the financial gain in crossing the chasm. It is not about the money you make from the first niche: It is the sum of that money plus the gains from all subsequent niches. It is a bowling alley estimate, not just a head pin estimate, that should drive the calculation of gain.
    2. First you divide up the universe of possible customers into market segments. Then you evaluate each segment for its attractiveness. After the targets get narrowed down to a very small number, the “finalists,” then you develop estimates of such factors as the market niches’ size, their accessibility to distribution, and the degree to which they are well defended by competitors.
    3. Now, the biggest mistake one can make in this state is to turn to numeric information as a source of refuge or reassurance. You need to understand that informed intuition, rather than analytical reason, is the most trustworthy decision-making tool to use. The key is to understand how intuition—specifically, informed intuition—actually works. Unlike numerical analysis, it does not rely on processing a statistically significant sample of data in order to achieve a given level of confidence. Rather, it involves conclusions based on isolating a few high-quality images—really, data fragments—that it takes to be archetypes of a broader and more complex reality. These images simply stand out from the swarm of mental material that rattles around in our heads. They are the ones that are memorable. So the first rule of working with an image is: If you can’t remember it, don’t try, because it’s not worth it. Or, to put this in the positive form: Only work with memorable images.
    4. Target-customer characterization is a formal process for making up these images, getting them out of individual heads and in front of a marketing decision-making group. The idea is to create as many characterizations as possible, one for each different type of customer and application for the product. (It turns out that, as these start to accumulate, they begin to resemble one another so that, somewhere between 20 and 50, you realize you are just repeating the same formulas with minor tweaks, and that in fact you have outlined 8 to 10 distinct alternatives.)
    5. It is extremely difficult to cross the chasm in consumer market. Almost all successful crossings happen in business markets, where the economic and technical resources can absorb the challenges of an immature product and service offering.
    6. The elements you need to capture are five:
      1. Scene or situation: Focus on the moment of frustration. What is going on? What is the user about to attempt?
      2. Desired outcome: What is the user trying to accomplish? Why is this important?
      3. Attempted approach: Without the new product, how does the user go about the task?
      4. Interfering factors: What goes wrong? How and why does it go wrong?
      5. Economic consequences: So what? What is the impact of the user failing to accomplish the task productively?
  5. Whole Product Package
    1. Systems integrators could just as easily be called whole product providers—that is their commitment to the customer.
    2. The whole product model provides a key insight into the chasm phenomenon. The single most important difference between early markets and mainstream markets is that the former are willing to take responsibility for piecing together the whole product (in return for getting a jump on their competition), whereas the latter are not.
    3. Tactical alliances have one and only one purpose: to accelerate the formation of whole product infrastructure within a specific target market segment. The basic commitment is to codevelop a whole product and market it jointly. This benefits the product manager by ensuring customer satisfaction. It benefits the partner by providing expanded distribution into a hitherto untapped source of sales opportunities.
    4. To sum up, whole product definition followed by a strong program of tactical alliances to speed the development of the whole product infrastructure is the essence of assembling an invasion force for crossing the chasm. The force itself is a function of actually delivering on the customer’s compelling reason to buy in its entirety. That force is still rare in the high-tech marketplace, so rare that, despite the overall high-risk nature of the chasm period, any company that executes a whole product strategy competently has a high probability of mainstream market success.
    5. Review the whole product from each participant’s point of view. Make sure each vendor wins, and that no vendor gets an unfair share of the pie. Inequities here, particularly when they favor you, will instantly defeat the whole product effort—companies are naturally suspicious of each other anyway, and given any encouragement, will interpret your entire scheme as a rip-off.
    6. The fundamental rule of engagement is that any force can defeat any other force—if it can define the battle. If we get to set the turf, if we get to set the competitive criteria for winning, why would we ever lose? The answer, depressingly enough, is because we don’t do it right. Sometimes it is because we misunderstand either our own strengths and weaknesses, or those of our competitors. More often, however, it is because we misinterpret what our target customers really want, or we are afraid to step up to the responsibility of making sure they get it.
  6. Distribution
    1. The number-one corporate objective, when crossing the chasm, is to secure a channel into the mainstream market with which the pragmatist customer will be comfortable.
    2. In other words, during the chasm period, the number-one concern of pricing is not to satisfy the customer or to satisfy the investors, but to motivate the channel.
    3. To sum up, when crossing the chasm, we are looking to attract customer-oriented distribution, and one of our primary lures will be distribution-oriented pricing.
    4. When functioning at its best, within the limits just laid out, direct sales is the optimal channel for high tech. It is also the best channel for crossing the chasm.
    5. All other things being equal, however, direct sales is the preferred alternative because it gives us maximum control over our own destiny.
    6. First and foremost, the retail system works optimally when its job is to fulfill demand rather than to create it.
  7. Positioning
    1. To sum up, your market alternative helps people identify your target customer (what you have in common) and your compelling reason to buy (where you differentiate). Similarly, your product alternative helps people appreciate your technology leverage (what you have in common) and your niche commitment (where you differentiate). Thus you create the two beacons that triangulate to teach the market your positioning.
    2. You can keep yourself from making most positioning gaffes if you will simply remember the following principles:
      1. Positioning, first and foremost, is a noun, not a verb. That is, it is best understood as an attribute associated with a company or a product, and not as the marketing contortions that people go through to set up that association.
      2. Positioning is the single largest influence on the buying decision. It serves as a kind of buyers’ shorthand, shaping not only their final choice but even the way they evaluate alternatives leading up to that choice. In other words, evaluations are often simply rationalizations of preestablished positioning.
      3. Positioning exists in people’s heads, not in your words. If you want to talk intelligently about positioning, you must frame a position in words that are likely to actually exist in other people’s heads, and not in words that come straight out of hot advertising copy.
      4. People are highly conservative about entertaining changes in positioning. This is just another way of saying that people do not like you messing with the stuff that is inside their heads. In general, the most effective positioning strategies are the ones that demand the least amount of change.
    3. Given all of the above, it is then possible to talk about positioning as a verb—a set of activities designed to bring about positioning as a noun. Here there is one fundamental key to success: When most people think of positioning in this way, they are thinking about how to make their products easier to sell. But the correct goal is to make them easier to buy. Think about it, most people resist selling but enjoy buying. By focusing on making a product easy to buy, you are focusing on what the customers really want. In turn, they will sense this and reward you with their purchases. Thus, easy to buy becomes easy to sell. The goal of positioning, therefore, is to create a space inside the target customer’s head called “best buy for this type of situation” and to attain sole, undisputed occupancy of that space. Only then, when the green light is on, and there is no remaining competing alternative, is a product easy to buy.
  8. Pricing
    1. Set pricing at the market leader price point, thereby reinforcing your claims to market leadership (or at least not undercutting them), and build a disproportionately high reward for the channel into the price margin, a reward that will be phased out as the product becomes truly established in the mainstream, and competition for the right to distribute it increases.
  9. Other
    1. So how can we guarantee passing the elevator pitch test? The key is to define your position based on the target segment you intend to dominate and the value proposition you intend to dominate it with. Within this context, you then set forth your competition and the unique differentiation that belongs to you and that you expect to drive the buying decision your way. Here is a proven formula for getting all this down into two short sentences. Try it out on your own company and one of its key products. Just fill in the blanks:
      1. For (target customers—beachhead segment only) who are dissatisfied with (the current market alternative), our product is a (new product category) that provides (key problem-solving capability). unlike (the product alternative), we have assembled (key whole product features for your specific application).
    2. So building relationships with business press editors, initially around a whole product story, is a key tactic in crossing the chasm.
    3. The purpose of the postchasm enterprise is to make money. This is a much more radical statement than it appears. To begin with, we need to recognize that this is not the purpose of the prechasm organization. In the case of building an early market, the fundamental return on investment is the conversion of an amalgam of technology, services, and ideas into a replicable, manufacturable product and the proving out that there is some customer demand for this product. Early market revenues are the first measure of this demand, but they are typically not—nor are they expected to be-a source of profit.
    4. How wide is the chasm? Or, to put this in investment terms, how long will it take before I can achieve a reasonably predictable ROI from an acceptably large mainstream market? The simple answer to this question is, as long as it takes to create and install a sustainable whole product. The chasm model asserts that no mainstream market can occur until the whole product is in place.
    5. The key is to initiate the transition by introducing two new roles during the crossing-the-chasm effort. The first of these might be called the target market segment manager, and the second, the whole product manager. Both are temporary, transitional positions, with each being a stepping stone to a more traditional role. Specifically, the former leads to being an industry marketing manager, and the latter to a product marketing manager. These are their “real titles,” the ones under which they are hired, the ones that are most appropriate for their business cards. But during the chasm transition they should be assigned unique, one-time-only responsibilities, and while they are in that mode, we will use their “interim” titles. The target market segment manager has one goal in his or her short job life—to transform a visionary customer relationship into a potential beachhead for entry into the mainstream vertical market that particular customer participates
What I got out of it
  1. Awesome playbook for building out a high-tech company and framework for how to invest in them (see The Gorilla Game for further notes on the investing portion). The innovators gladly take on new technology but it is the pragmatists or the early majority who need proof of concept, who need evidence that you will be around for a while and that other respected players are using your product or service before they buy in, and they are where the real profits lie. The chasm is formed between these innovators and pragmatists and your strategy, focus, and mindset has to shift when attempting to tap into the mainstream.

And Then They Fired Me by Jannie Mouton, Carie Maas

  1. My business philosophy is really quite simple: I believe in strategic planning, and then follow an entrepreneurial approach. I empower the right people completely, enable them to secure a percentage of the shareholding, and then believe in their ability to, with help and proper corporate control, establish good businesses. Perhaps this definition is not all that easy to digest, but as I explain it, it will be clear how simple the principle is. What it eventually boils down to is that my contribution almost shrinks to that of a possible idea or the creation of a culture of ideas. Other guys do all the hard work. The smaller one’s role as so-called chief executive or chairman, the better for any company and its growth.
Key Takeaways
  1. Early Days & SMK
    1. We had a sense of duty from an early age, because my father, Jan, made us work in his shop, even for a large part of the holidays. Initially I thought it unfair, having to work while everyone else could gallivant on their wide-rimmed bicycles, but later I realised how valuable it was, compared with the nonsense of the so-called gap year that pupils and students insist upon nowadays.
    2. We were young and had lots of plans. Added to that, or maybe because we were that young, we were very enthusiastic and hardly anything scared us. Now, in hindsight, I pale with fright because we had responsibilities, wives, children, cars and houses.
    3. I had grown too big for my boots. I remember phoning Kango Beachbuggies to ask in which colours they had the vehicle available, and then saying I would take one in each available colour – five altogether. Now I can only marvel at the memory. To be that self-confident, and with gearing to the point of bursting, was asking for trouble. Like all bubbles, this one also burst, on October 22, 1987, and a lot of us were cut down to size and got quite a kick in the teeth financially. Let me tell you, there was blood on the walls. It was the mother of all market carnages – the decline of about 30% was the most significant in a single day in living memory. I was almost done for. One day we were the kings of the development capital market, the next day humble servants. As in many other times in my life, I should have listened to Dana, because she used to say when I started pretending to be a sage and it was only “me, me, me”, then the end was in sight. Those were prophetic words. From him I learnt that one’s people and one’s clients are the most important assets. He was a humble leader, armed with vision, courage and cool-headedness.
    4. We had gigantic successes and made excellent profits. The listings of Rand Merchant Bank and Richemont were climaxes, and my children still remember my picture on the front page of Beeld with the listing of Naspers.
    5. Because we were partners and not shareholders, the profits had to be divided every year. In other partnerships the managing director would decide what the share of each partner would be, and the mistake we made was trying to do it democratically. Everyone had to give himself and every other partner a mark out of 100 for the value each had added, in his opinion. Nobody ever scored himself lower than any of the other 19. It was my unpleasant duty to convey the auditors’ calculation of the total to everyone. If the group then gave someone an average of 5% and he thought he really deserved 8% of the total of 100%, it raised suspicion. Instead of motivating someone, I had to call him in and tell him he wasn’t as good as he thought he was. Among the changes I wanted to make was to convert the partnership into a company.
    1. A negative person has never started or established anything positive. The people at PSG also know they shouldn’t come and tell me something doesn’t work – they have to come up with an alternative.
    2. After reading for a while, I decided to do a SWOT analysis on myself and, according to the acronym, started jotting down strong points, weak points, opportunities and threats. I realised my and Chris Otto’s frequent (and long) lunches at Late Night Al’s in Auckland Park were no long-term solution and at age 50 I was not ready for retirement yet. I had to persuade myself that I was doing something useful, that I was devising plans and ferreting out opportunities. I knew I had to fight against the threat of stagnation. The personal space in the office forced me to contemplate my future and that of my family. Thinking would be my new project, and it wasn’t at all the child’s play it appeared to be. I wanted to start a new business and I had to find the key for it. With dedication I started reading and focused on books in the investment world, from Warren Buffett and his philosophies to the management approaches of successful business people. What I read made me think, and to arrange my thoughts I summarised many of the books in Afrikaans. Not every book changes one’s life, in a manner of speaking, but there is always an idea or two that one can use. Apart from the work and academic advantages, this study made me reorient myself. Collecting specialised knowledge demands sacrifice, but it stimulated me and broadened my mind in my planning for the future. Now I realise there were quite a few points that prepared the ground for PAG, the precursor to PSG. I can summarise it as a sounding board, a self-analysis, a dream, a plan of action, a positive attitude, decision making and communication. And I can recommend it to someone who has got into a rut like the one threatening me back then. One has to work through a setback realistically. You need someone to help you if your enthusiasm exceeds your realism, but that person can’t be a yes-man. It needs to be someone with good judgement and enough respect for you to answer the difficult questions honestly.
    3. Honest introspection is not always pleasant, but without it one would struggle to work towards one’s better points and eliminating one’s weaker traits. Yet, clever as it might sound after the fact, my old diary is testimony of how I toiled and bothered and reworked my SWOT analysis until later I knew exactly what I wanted to and could do. The simple question is: What’s your personal mission statement, your goal, your dream? If you know the answer, it unleashes a power that draws you towards the destination. My plan that I wrote down in November 1995 and had typed was: I want to be free and not to work for others. I want to make a difference to the lives of others and have empathy with my fellow human beings. I want to write a book (there you have it). I want to tackle something with my children. I want to take on a new game farm after Nokonya. By doing great things I’m happy. I want to develop a new company successfully. Many things have changed over the years, but the framework is still valid. My plans of action had to direct my dreams: I want to be in control of a listed company. I want to focus on the financial services sector. I want to procure capital for a strong capital base. I want to manage in a decentralised and delegated way. I want to draw in good people. I want to move from Johannesburg to Stellenbosch. I want to have a small, creative head office with a relaxed vibe. I want to think more and do less. To know I had figured out what my dream and final destination were, made me positive. Aiming high requires as much strain as aiming low, as is expressed in this little rhyme by Jessie B Rittenhouse I’ve read so often: I worked for a menial hire, Only to learn, dismayed, That any wage I asked of Life, Life would have willingly paid. Without a decision, one is never wrong, therefore people hesitate to take decisions. Taking a responsible risk brings me freedom and joy. Even now a successful business decision like an SMK or PSG or Capitec that works gives me far more pleasure than the money I gain from it. And if something doesn’t work, close that business and move on. From all the business books I read then and still read, it’s apparent: the most important element of success is to speak out. By conveying one’s dreams and plans to friends, you place yourself under pressure to fulfil them. And that truth applies right through the investment world – your shareholders are interested in where you’re going, your successes and your failures. But even more important than speaking is to listen to them in turn.
    4. Success is not the key to happiness, happiness is the key to success
    5. What has remained with me though is that I never want to be in a position again where I don’t have control over a company. Even in subsidiary companies where we have a stake warranting it, I want to have a say at board level, at least.
  2. PSG
    1. PSG Group is an investment company that acquires strategic stakes in established businesses with strong management, good corporate governance, a history of earnings growth and positive cash-flows, and creates innovative ideas at existing businesses.
    2. Maybe I should start by clearing up a misconception some people have: PSG is not a financial services company; we are an investment company. That means PSG is not an operating company. We don’t manage a business like Plascon or Edgars. We invest in and also start other businesses like manufacturers or retailers or service companies. The group comprises of more or less three main parts. Under PSG there are the financial giants like PSG Konsult and Capitec, but under the tradename Zeder we have unified all our agricultural companies like Pioneer Foods. Some of the smaller private equity investments like Thembeka that don’t belong elsewhere reside under Paladin.
    3. Maybe that’s also one of the reasons why I’m such an avid buyer of PSG shares and have never sold a single share. Advisors of readers of financial pages would be horrified, but I often borrow money to get hold of more PSG shares.
    4. My business philosophy is really quite simple: I believe in strategic planning, and then follow an entrepreneurial approach. I empower the right people completely, enable them to secure a percentage of the shareholding, and then believe in their ability to, with help and proper corporate control, establish good businesses. Perhaps this definition is not all that easy to digest, but as I explain it, it will be clear how simple the principle is. What it eventually boils down to is that my contribution almost shrinks to that of a possible idea or the creation of a culture of ideas. Other guys do all the hard work. The smaller one’s role as so-called chief executive or chairman, the better for any company and its growth. For me, strategic planning is the alpha and the omega. In the book The Art of War the principles of the Oriental military strategist Sun Tzu are expounded: “Strategy is the great work of the organization.” According to the book, that determines survival or extinction in situations of life or death. It inspires people to share the same ideals and expectations. Because they’re in the struggle together, they don’t fear perils. The military strategist said that was why leaders who understood strategy could lead people and determine how stable the venture was. Regarding successful warfare, Sun Tzu strongly emphasised that an understanding of one’s own capabilities and limitations, one’s opponent and the circumstances in which the fight would take place, should be thoroughly contemplated and then integrated into a strategy that was applied in a disciplined way by a leader that inspired his subordinates with trust. I love his wisdom: If you have your strategy, you hit fast and hard, then you win. Colleague Chris Otto says I’m the only person he knows who would go to the seaside for four weeks and use ten of those days to draw up a business plan. That’s true, I can’t simply lounge around. I get bored and then I devise schemes. It was also after a holiday that I returned with my Keerom plan for Naspers, a controversial but quite exciting deal I’ll tell you more about in the next section. Chris has also quipped that I should not get time to think, but let him rather do the talking, because I don’t want to say this about myself: I always tell Jannie one day I’ll write on his tomb stone: “Here lies an unreasonable man.” He has a great ability to think and work out strategies. He always has a plan, and then he can’t imagine that something can’t happen. He challenges us and eventually everyone starts thinking like that – how one makes something happen. He’s not interested in technical details about why something can’t work. I think that’s why PSG often manages to do things others thought impossible. If then, according to Sun Tzu’s searching one’s own heart, one of my abilities is to think, or to want to think, one of my limitations surely remains not always working gently with the people helping with those thoughts and applying them – I still struggle with that even now.
    5. By this time our size makes us look at smaller investments more realistically: corporate management, attending meetings and managerial time are expensive. At Paladin and Zeder we have the framework that we invest in businesses that are easy to understand, and have a cash flow and good management. Our share of the profit after tax has to exceed R10 million. That means if we have a 25% stake in a company it has to make at least R40 million before we would look at it. However, many mice can turn into men and PSG never wants to neglect its entrepreneurial approach. That’s what brought us to where we are.
    6. Shareholders are the owners of a company and an owner should always be in control of his own assets. The board is appointed by the owners – and that’s why I like a company with a strong owner. In PSG’s case, 77% of the shares are in the hands of confidants – relatives, friends and directors. While many similar companies are susceptible to takeovers because a large number of their shares are with the big institutions, we are covered against that in this way
    7. At present my children and I own more than 30% of PSG’s shares and, along with the shareholders mentioned above, Thys du Toit (former KWV chairman) and Christo Wiese have huge stakes.
    8. Let me be honest: one can continue ad infinitum about PSG’s ingenuity, but the role luck sometimes plays can’t be ignored. PAG’s sale price was plain darn luck; don’t let anyone tell you a different story. Sheer luck. That’s how PSG started. We started small and slowly achieved success. Success gives one self-confidence and that’s quite contagious on the market. It makes it a little easier to run risks when one is stronger. If you have capital you can grow, and you can even afford to make mistakes.
    9. Whatever investment you do, you should know in what kind of underlying business you invest and understand that some companies won’t yield the kind of investments you hope for overnight. You can start something new, like a Capitec, develop it while you can take pride in a high price/earnings ratio (PE) of 25, or how much you’re willing to pay for the expected earnings in rand. On the other hand you can be extremely patient and make and keep an investment in agricultural companies with a PE of 4. You would buy at a good price, but then you should not be obsessed with a running clock. Few people understand both kinds of investments.
    10. I knew Keerom was a much cheaper way of securing a stake in Naspers. Some unlisted shares can be bought at a rebate. Therefore one could get a big chunk of Naspers through Keerom or Naspers Investments, as well as control with high voting rights. It’s a principle I’ve applied time and again since then.
    11. The trick is to try to buy where limitations are still in place and when the old board is still in charge. Then one buys cheaply – one might even buy only the buildings at 60% of the real value. That’s something we understand very well at PSG. Yet one needs patience, because at these businesses the change towards being more commercially-minded happens rather slowly. The management are not lying yuppies, but down-to-earth people, honest and upright, whose business has been in existence for years. The opportunity is in the fact that for many years co-operatives have been attuned to delivering a service, rather than seeking profits. The best is that one can take this kind of wisdom even a little further, which is what we are doing through our agricultural arm, Zeder.
    12. The biggest value is unlocked where management is poorest.
    13. With decisions one should not hesitate, and rather apply straight away whatever is agreed upon. A major lesson PSG has learnt often is to immediately admit if a purchase had been a pig in a poke.
    14. At Paladin we refer to the “refinement” of a portfolio over time, perhaps because we do business in the winelands. One should try selling the bad companies systematically and rather invest in the winners. You always want to keep your company streamlined.
    15. It took me several years to figure out what the most important objective of a company is. I struggled with “increasing shareholders’ wealth”, for many years the main goal of PSG. Gradually I started thinking it sounded too arrogant and cheeky, with an overbearing focus on the collection of wordly assets or wealth. It was if one only cares about one’s pocket, and I started developing a different philosophy. There are more people involved than shareholders, like staff and clients. One’s staff members are happy when they feel fulfilled, when they have freedom and a goal – in my opinion that’s the main motivation. I wouldn’t be happy if everyone else around me was unhappy. One’s clients need to believe in one too. A company is a success if the client, shareholder and employee are all happy. If you manage that, the company can grow and you’re doing something right. Growth in client numbers indicates profitability, and that’s why for growth in the share price one has to focus on clients. Moreover, over time people don’t really remember all that much about dividends, special dividends, unbundlings and other windfalls. What they do remember is by how much the share price has risen. It’s a simple criterion and it measures everything – risk, past performance, future prospects, management and the integrity of the figures – yes, everything.
    16. Pure pleasure is what PSG Konsult signifies to me. If you’ve ever seen a business that’s running like a well-oiled machine, that would be Konsult. The only reason I’m still on the board of directors is because every time I want to step down, chief executive Willem Theron persuades me otherwise. The management team is so strong that they don’t need even a little support. Konsult’s business plan is so simple that one can’t believe it hasn’t always existed.
    17. The mistake I then made is a classic one. Instead of appointing a single managing director for the bank, I put a committee of four at the helm of the new entity: Botha Schabort, André la Grange, Charles Turner and Hugh Oosthuizen, all of them strong personalities. I thought the four divisions could work together well and with time the best guy would emerge. How stupid that idea was I did not realise at the time. It was a breeding ground for conflict. Because the guys were fighting amongst one another, that was what they focused on, instead of their divisions.
    18. Many of our branch employees are later lured away by other banks with offers of bigger salaries, but it’s great to see how many of them want to return three or four months later – at their old salary. Capitec is an employer of high calibre, and then people enjoy working there too. Capitec is a dream come true. It’s a reality that shows how many opportunities there really are in South Africa, and what fantastic potential its people have. With access to capital, poverty can be eradicated over time.
    19. I reiterate: it’s a gigantic risk to put all your eggs in one basket, but woven grass or not, PSG as an investment company has many divisions. Apart from the properties and art I own, my own money is only in PSG, the furniture group Steinhoff, on whose board I serve, and the PSG Flexible Fund, the unit trust managed by my son Jan. Do I have the right to talk other people into it? I can honestly believe it’s good counsel, but I would neglect my fiduciary duty by only picking one share for someone.
    20. An irrefutable truth is that you have to have time on your side. A young person might not have money to invest, but he has to learn to save right from the start. It’s amazing how much money can grow if one saves. There’s a reason why it’s called the eighth wonder of the world.
    21. The cornerstones are transparency, honesty and sincerity. And every company does have an issue.
  3. Entrepreneurial mindset
    1. The soul of a company – the culture determines the performance
    2. The role of the entrepreneur is the collection and use of knowledge, his ability and readiness to see and use profitable opportunities and to use scarce resources effectively.
    3. The point is: entrepreneurs create value. They create jobs and they make money. But that’s not easy. A unique talent, coupled with hard toil, is what’s needed. Successful entrepreneurs are attuned to what they’re busy with. They have self-confidence and flair. Their need for success makes them restless and they don’t cower in the face of big risks. Such a person doesn’t lie awake because of spelling errors in minutes of a meeting, but quickly masters his field. This guy spots opportunities and can bring theory and practice together.
    4. PSG Capital chief executive, calls PSG a family of entrepreneurs: A family that gives one the security of being together, but doesn’t shy away from asking straight questions or hauling you over the coals. It’s a bunch of individuals who can and want to function independently. It’s a company that provides one with the great opportunity to convert this freedom and independent thoughts into palpable profits in which you can share.
    5. I have a list of what I regard as the characteristics of successful people, probably an obvious bunch of traits. People who are well read, have well-considered opinions, are honest, can communicate and stick it out, are self-confident and care for people and on top of that can think, are the best. Clear goals direct all these characteristics.
    6. So many people who come to present an opportunity uhm and ah so incoherently that I now ask beforehand whether someone would just like a cup of tea or sell or buy something so I can focus. My patience runs out with a wishy-washy presentation – does one really need more than ten minutes to explain how a business works and maybe ten minutes for a possible deal? And then there are those who just come to fish for advice. Those who don’t shy away from setbacks and are prepared to take hold of the future are the people you want at your side.
    7. The assistance to entrepreneurs or management firstly consists of striving to help someone focus on their goals. Directors have to see to it that a business plan is carried out.
    8. We can, however, help them with the negotiations and contracts and they have to stay alert, then opportunities will appear. One just has to be attuned to them constantly.
    9. It’s amazing what one can come across, and then one has to sit and think. One has to think outside the parameters. That way you will come up with an interesting business opportunity. The same alert attitude can also prevail in your daily dealings. One has to keep wondering all the time. When you have your hair cut . . . where does your hairdresser buy, and why? If you have a cup of coffee . . . what would happen if Famous Brands cut off one of its trademark entities like Mugg & Bean? If you’re driving around  . . . why is somebody erecting such a huge building in a new property development? Who owns the mall where you do your shopping when you furnish your holiday home?
    10. What have I learnt? Don’t generate business from technology, but let technology support and drive the business. I believed the clients of PSG Online had wanted to stay anonymous and preferred no human interaction. That was a big mistake. Online clients prefer a computerised service mechanism, but welcome personal contact from Online’s side.
    11. With e-insurance the trick is that the money you save in brokers’ fees because the client buys directly from you, you spend on advertising.
    12. At a dinner hosted by William H Gates, father of the same Microsoft founder Bill Gates, for a number of hand-picked business people, he asked those present to write down on a piece of paper a single word that they deemed of utmost importance in the business world. Coincidentally two of the guests chose the same word: the host’s son and one Warren Buffett. And the word? Focus. When I read that story I realised how important focus was for discipline and success. I always admire Whitey Basson, chief executive of the Shoprite Group, for the same thing. He is incredibly attuned to trends in the retail industry.
  4. Ultimate Empowerment
    1. After many lessons I only invest in companies I understand, whose management I know and whose character and culture I like. Three questions kept me busy for a long time: How does one make a company grow, when are people happy and what’s the key to making a success of a company? The answer is ultimate empowerment.
    2. The former American president Theodore Roosevelt’s encapsulation is the best, in my opinion: “The best executive is the one who has sense enough to pick good men to do what he wants done, and self-restraint enough to keep from meddling with them while they do it.”
    3. In PSG people are allowed to think and do themselves, and everyone knows that. A company grows when all of the employees perform to the best of their abilities. People perform well when they are happy and people are happy when their talents are recognised and when they are given the space to act and make decisions independently. To me, ultimately empowering someone therefore means delegating authority and responsibility. Empowerment in that sense means everybody is involved and knows how the company is performing. The decision-making process is shortened and the spirit and status are created that no one has terrific titles, but people get a lot of recognition. That creates a company with responsible managers who feel free and proud. People who are encouraged to think strategically themselves take their own future in hand. That freedom means not looking over people’s shoulders, but trusting them. On a more practical level it means that everyone can draft their own business plan, that every unit decides on its own remuneration packages and incentives, and that some services can be contracted out to an entity shared by a few companies in the group.
    4. The group makes significant investments in successful businesses and stands by its entrepreneurs without exception. Jannie’s policy of ultimate empowerment enables entrepreneurs to realise their vision. Ultimate empowerment also means there is no place to hide. It gives you just enough opportunity to engineer your own downfall if you don’t tread carefully. In PSG the prevailing culture entails low overheads, strict financial reporting, a high return on share-holders’ capital and the premise that the shareholder is always king.
    5. That, supposedly, begs the question when a board of directors does step in. A board has to have a relaxed leash on everyday matters and only get involved when overarching problems emanate in or outside the group. One has to concentrate on what’s important.
    6. Jannie builds around the jockey when he sees a business opportunity, provided of course that it’s a special opportunity in PSG’s field of play. Then the business model is almost the jockey’s prerogative, within bounds of course. Often the model is not the point. Jannie would pick the guy and respect his opinion and say: “You tackle it for us.”
    7. Willem Theron, chief executive, got rid of all the stress by devolving all decisions about remuneration to branch level. Each branch may keep 70% of its income and do with it as it likes, including paying bonuses to deserving people. In that way everyone is responsible for their own welfare concerning profits and all is fair in the garden again. Once the thorny issues and the remuneration differences have been sorted out, the satisfaction of the right person in the right job is huge. A testimonial to the calibre of people we draw is how many have remained loyal to the company over the years and how many have even been with us from the time of SMK and the very start in 1995. Another reason for great joy is the number of friends’ children and their spouses working for PSG
    8. Thus I naturally am my own boss, because I believe directors should have big share investments in the companies they represent. They are custodians of the shareholders’ assets and will definitely do a better job if they are big shareholders themselves.
    9. People laugh when I say this, but it’s true. I’ve overdone delegation to the extent that I do almost nothing. I don’t really work at the office. It’s a singular privilege. I want time to think. I want to philosophise and I want to come up with opportunities. There are people who like being involved everywhere, as if that would make them seem important. One should rather become unimportant. It consumes an endless amount of time if you as manager don’t trust people. Chris Otto will also tell you I’m the best delegator he’s ever met. He also knows that in fact I do nothing: Jannie doesn’t want to be on boards. He’s not a control freak, but he expects something to be done, and then it gets done. There’s something else to the art of empowerment. If you trust others to take good decisions, you also have to respect your employees and give credit where it’s due. Labour can never be rewarded with money alone.
  5. On Investing
    1. In a nutshell: start with about four or five good shares in the long term, diversify your investments across more shares for less risk and forget about short-term speculation. Five or six shares are optimal for diversification, as long as you invest in fairly diverse sectors. If you invest over a lifetime, you can afford to keep a cool head. And don’t put all your money in one share. Timing is also an issue to keep an eye on. Look at the profit potential and the net asset value. Long-term investments are like having a happy family – it requires love over a lifetime and not speculative moments. Just as one outburst wouldn’t alarm you, neither would a single share with the hiccups. Just as your good friends carry you through emotional crises, good investments carry you through economic storms.
    2. One gets to know the market over time. If everyone is optimistic and even people who don’t work with the stock exchange every day start chatting about it, it’s selling time, as sure as nails. By that time you have to have the cash in your hand, else you’re going to be very sorry. And if nobody is interested in the stock exchange anymore, it’s buying time. In the long term one has to sit back from the noise, but timing can’t be ignored completely.
    3. In every person’s life there are about four or five investment cycles. One needs to use them and be patient; then you’ll make a lot of money. These five principles are as plain as the nose on one’s face: Even if you’re a layman, you need to understand the company for personal investment, as I’ve written in part three about companies.
      1. If you can’t tell someone else what the company is doing, don’t invest there. I’ve never made money from mining shares, especially gold, because I don’t understand it. Yet one can understand that Sasol produces petrol from gas.
      2. Investigate the people in control of the company. Are they honest and hardworking or flashes in the pan? Through the years PSG has benefited a lot from learning as much as possible about the management before investing in a company.
      3. I’ve tried to explain above that you have to go against the current and buy at a low price-earnings ratio in a bear market, determine a realistic price to the net asset value and be on the lookout for a strong balance sheet and good cash flow. This strategy is as difficult as the opposite, to sell in a bull market, but the pain and insecurity when everybody else keeps swimming with the current will bear fruit.
      4. Do research. Read a lot and develop a feeling for investments. Listen, think and learn from your mistakes and successes. Good investment experts can always help you, but don’t underestimate your own role. The long term is imperative if your focus is on year-on-year growth in the share price.
      5. A share will only grow if the underlying profits of the company grow, which is the challenge of management.
    4. Only once you’ve mastered the management of a first franchise should you dare to borrow money for a second.
    5. Speculation and investment are two different matters. Speculation is short-term positions for which you don’t use your brain and investment is long-term. Speculation is the worst thing there is and you have to stay away from it as far as possible or you’ll get into trouble.
    6. Forget about investment clubs with friends. It only leads to indecision and bad blood. Don’t ever talk about the market as if it’s your pal – nobody ever understands the market. The pain of a loss is worse than the pleasure of a profit. Don’t ever take a loss lightly. If you get worried and sleep badly, you’re in trouble already. Forget about the trendy shares of the day. Don’t invest further in a losing situation. Liquidate your position.
    7. There are many clever investors who only look at listed shares. For those with a lot of perseverance and who want to trust my judgement there might be another option – to watch what PSG is doing and buy the same unlisted ones we buy. As I’ve said in part 3, a share register is public knowledge. With a little effort one can get hold of it. PSG is wide awake and constantly on the lookout for unlisted businesses we can acquire at a discount and where we can help add value. As buyers we want the price to remain low initially, and for that many investors don’t have the patience. But if you have it . . .
    8. Hierarchy paralyses . Colleague Chris Otto will tell you I’ll open a closed door in the office, for closed doors create a vibe we don’t want in PSG. It surprises newcomers that anyone can walk into my office without an appointment. The days of levels have long been numbered and titles are undesirable too.
    9. Drowning in the e-mail ocean of a bureaucracy – formality is stupidity. I detest senseless communication that wastes time and attention. As useful as e-mail can be, there are people who measure “indispensability” by how many e-mails there are in their inboxes when they return from two days out of the office. I simply get worried about my business if I get too many “in case” e-mails. I plainly call it cover your arse, for why do you send me e-mail so you can have the excuse of “I’ve told you about it” if something goes wrong? If something is important enough, someone has to phone me; else I don’t want to know about it. A problem is not solved because you’ve sent e-mail about it.
    10. Directions, rules and regulations stifle a company. We encourage an open, informal and creative environment where decisions can be made quickly. Yes, the more haste the less speed and because of that culture we sometimes make mistakes, but only someone who never takes a decision will go through life without mistakes.
  6. Other
    1. The Scottish-American entrepreneur and philanthropist Andrew Carnegie, the wealthiest American ever apart from John D Rockefeller, used to say one has to use a third of one’s life to get an education, a third for the creation of wealth and the last third for giving it away. Indeed that little yellow note found in his desk drawer after his death indicated that he had got rid of every last cent when he laid his head down.
    2. On a certain income level, giving money naturally gets relatively easy. Time is scarcer. Generosity can also entail giving time and therefore the transfer of wisdom or assistance.
    3. Oh Lord, it’s hard to be humble – humility is admirable
    4. The American columnist and radio presenter Herman Cain rightfully said success was not the key to happiness, but happiness was the key to success – if you’re crazy about what you’re doing, you will achieve success.
    5. “If you can give your son or daughter only one gift, let it be enthusiasm,” said Bruce Baron, American member of congress and author of books on personal success. That same cornerstone I desire for my offspring, PSG. That we don’t break or brake, but build. It took me many years to realise that enthusiastic and positive people inspire me, but the “it won’t work” of negative grumblers make me see red
    6. Next to honesty and work ethics, caring for your company and colleagues and good manners are paramount. I’m passionate about the adages of CJ Langenhoven, one of the fathers of the Afrikaans language, like this one: “Treat your superiors with courtesy because it is your duty; your inferiors because it is your privilege.”
    7. Yet who would one choose: a Warren Buffett who has built up so much; or a Jack Welch who might have managed the largest company in the world, General Electric, but by means of cracking whips and a culture of fear about who would be fired next? PSG subsidiaries have been compelled to retrench people, but I hope I’m leading from the front rather than from behind.
    8. For me, creativity borders on enthusiasm, for the energy levels and success of a business are boosted when people challenge one another with innovative ideas. A sexy plan grabs people and motivates them to take calculated chances. It gives me no end of pleasure to establish something out of nothing.
    9. What has a director contributed by spotting a spelling error in the annual report? If you can generate two or three fresh ideas when the executive committee gets together, it’s a successful meeting, not when you’ve worked through an agenda item by item. I put in some effort to, an hour or two before a meeting like that, come up with a few things that could get the guys to think a little. The possibility of alternatives is what gets the grey matter going. If you think outside of the existing parameters, the result is a Curro; or the investment possibilities of alternative energy; or the financing possibilities of non-redeemable preference shares, where you never have to pay back the loan capital until the business ceases to exist, and which can never land you in hot water during a financial crisis. Curiosity is a winning characteristic. An interesting proposal and a fresh idea or new angle from which to look at an old problem is an approach that needs to be cultivated and encouraged. It has to become a mindset in a company. Creativity is much harder work than the useless buzz-words visions and missions.
    10. One of the major challenges and most exciting aspects of the business world remain identifying opportunities.
    11. Yet I’m convinced that businesses that are started in one’s own interest are more successful and that the impact of successful businesses trickles down into and benefits society as a whole.
    12. The business magazine Finweek published a story in its Piker column on July 30, 2009 about a local economics professor who gave everyone in his class a single average mark in order to illustrate socialism. Before the next test the clever students wondered why they should work hard and the underachievers also thought they didn’t have to do anything, so the second average mark was about 30% lower. And for the third test all of them got close to zero.
    13. The best thing about contributing to a country or a community is that it’s something you do because you want to, and not due to compulsion or for monetary remuneration. It’s great to plough back something of your knowledge and experience or ability because you are so privileged. You often get more out of it than what you put in.
    14. But being generous and wasting are light years apart. And like stinginess is a bad thing and ugly, frugality is a virtue. People who waste money will indeed lose everything, for if you waste something you don’t have respect for it.
    15. We tease him, calling him Radio JFM – and that’s not a station where listeners may phone in and say something of their own! My dad doesn’t believe in complaining and moping in self-pity at all. For him it doesn’t exist.
    16. Apart from PSG I hope what I leave behind for my children are above all a mindset of enthusiasm in everything they tackle, the tireless search for solutions, and the ethos to work hard in order to make a success of whatever they try to achieve.
    17. A negative person sees insurmountable hurdles and the proactive person looks for alternatives
    18. There is a very thin line between being assertive and aggressive, as I probably know better than anyone else. Yet I know even better that stumbling about is an unproductive waste of time. One has to take a decision and that’s it. If you’re wrong, you simply have to take the rap afterwards.
    19. The services of the best lawyer or accountant are for sale, but with a guy with general knowledge you can take anything on, because he can think further than his textbooks. On a board it’s also the guy with the integrated knowledge and well-considered opinion who makes a contribution. The rest only waste your time with superficial questions. Closely connected to that is the will to think. In The fall of the human intellect Swami Parthasarathy writes that people have lost the ability to think and reason. Knowledge is absorbed passively, but it doesn’t develop independent thoughts: “You need to wake up from this slumber. Start thinking, questioning, enquiring as to the cause of all this strife and struggle. Examine the truths of life. Do not accept anything without reason and logic.”
    20. A leader is someone with an interesting vision who knows the environment. He has the power of drawing people to follow him instead of pushing them, and therefore people have respect for him. Eventually leadership is about the ability to get the best from people and to combine their input effectively to reach a common goal.
  7. The PSG Stable
    1. PSG Group is an investment company that acquires strategic stakes in established businesses with strong management, good corporate governance, a history of earnings growth and positive cash-flows, and creates innovative ideas at existing businesses.
    2. Propell is a niche financing company specialising in financial products for the property industry, especially bridging finance, and also…
    3. Capitec Bank is a retail bank that provides accessible and affordable banking facilities to clients via the innovative use of technology, in a manner that is convenient and personalised. Its client base has historically been the… Some highlights have been hidden or truncated due to export limits.
    4. PSG Capital is PSG’s boutique corporate finance division, with teams based in Stellenbosch and Johannesburg. It provides a complete suite of corporate finance and advisory services to a broad spectrum of clients, both nationally and internationally. Its services include capital… Some highlights have been hidden or truncated due to export limits.
    5. PSG Fund Management’s business consists of local and offshore collective investments, asset management, hedge funds and prime broking. The funds include PSG Flexible Fund, PSG Alphen’s bouquet of funds, PSG Preferred Dividend Fund, PSG Money… Some highlights have been hidden or truncated due to export limits.
    6. PSG Futurewealth is an investment facilitator that offers investment solutions to the retail and institutional market. Apart from linked investment products it also offers guaranteed investment… Some highlights have been hidden or truncated due to export limits.
    7. PSG Konsult is an independent financial services company that offers a value-oriented approach to clients’ financial planning requirements. Services encompass investments, short-term insurance, life… Some highlights have been hidden or truncated due to export limits.
    8. Zeder Investments is an investment company that focuses on the agricultural, food, beverages, food-processing and related sectors. It offers investors exposure to the current inherent… Some highlights have been hidden or truncated due to export limits.
    9. Agricol is a seed company with an extended network of branches and agents all over South Africa. Their products include most well-known crops, alternative crops like forage seed and agronomy crops like cereals, canola and hybrid sunflower. It has a strong emphasis on research… Some highlights have been hidden or truncated due to export limits.
    10. BKB’s business entails the handling and marketing of agricultural products; wool, mohair and livestock, the provision of farming requisites and the rendering of related… Some highlights have been hidden or truncated due to export limits.
    11. Capespan is an international integrated logistical supplier of fruit. The company is the major role player in South Africa and sources fruit from 44 countries worldwide and distributes to 55 countries around the world. It is… Some highlights have been hidden or truncated due to export limits.
    12. Capevin is the ultimate investment holding company of Distell, Africa’s leading producer and marketer of fine wines, spirits, ciders and ready-to-drinks. Zeder owns 37% of Capevin Holdings, which… Some highlights have been hidden or truncated due to export limits.
    13. Kaap Agri came into being as a result of the merger between WPK and Boland Agri in 2005. The company’s footprint stretches through the Western and Northern Cape up into southern Namibia where it has recently acquired a number of trading branches. The focus of its retail branches (the Agrimark stores) has… Some highlights have been hidden or truncated due to export limits.
    14. Pioneer Foods is South Africa’s second largest food company and is structured into four divisions that manufacture household food and beverage products: Sasko, Bokomo Foods, Agri Business and The Ceres Beverage Company. Pioneer also has… Some highlights have been hidden or truncated due to export limits.
    15. KLK Landbou is a small but diversified agriculture-focused company headquartered in Upington. The company primarily serves the sheep farmers in the Kalahari and Northern Cape areas through 21 retail branches. The bulk of its profit comes from the distribution and retail sales of BP… Some highlights have been hidden or truncated due to export limits.
    16. MGK Business Investments operates through three divisions: Obaro, Prodsure en All-Gro. Obaro offers agricultural, gardening and pet products and services to the public from 17 commercial retail outlets. Its main clientele requires products and services mainly relating to irrigation agriculture. Its BEE programme has received widespread praise. NWK is a provider of agricultural services and inputs, primarily in the North West province. The company is involved in a wide spectrum of activities in the following fields: grain industry, agricultural management services, trade, financial services and industries. It owns 19% of the country’s grain storage capacity. OVK Operations is a diversified agricultural business. Its primary activities involve general trade, fuel distribution, the sales, servicing and repairs of agricultural machinery, motor dealerships, short-term insurance broking, grain handling, storage and marketing, livestock slaughtering and marketing of carcasses, and client financing. Its service area includes the Free State, Eastern Cape and Northern Cape. Suidwes Investments operates in the maize-producing area of North West, with its head office in Leeudoringstad. It is involved in all aspects of meeting the needs of grain and other farmers, from supplying inputs and requisites to grain handling, storage… Some highlights have been hidden or truncated due to export limits.
    17. Paladin Capital is an investment company with a private equity bias and PSG’s preferred investment vehicle in areas other than financial services and agriculture. Paladin Capital’s investment principles are based on the following: not industry-specific, encompassing listed and unlisted companies; strong sustainable… Some highlights have been hidden or truncated due to export limits.
    18. African Unity Insurance provides illness benefit management, a range of life insurance and funeral schemes for groups and individuals. Algoa Insurance merged with African Unity in 2009 and it has 29% BEE ownership. Curro Holdings is the parent company of all Curro private schools. Their role is to establish new private schools and to back each school with a solid management team experienced in the field of education. The schools offer parallel medium education in Afrikaans and English, have a Christian ethos, positive discipline and balanced academic, sport and cultural activities. Erbacon is a construction company predominantly in infrastructure (roads and bridges) and general construction (through Armstrong). It also has a tool hire division. Civicon operates on contract sites throughout Southern Africa. Its services include general civil engineering construction, industrial and process plants, mining infrastructure and support both surface and underground, and design and construction of turnkey industrial projects. GRW is a manufacturer of steel and aluminium tankers and specialised liquid containers. Apart from South Africa it also has clients in the UK and Middle East. It has a highly advanced robotic plant. Iquad Group is a specialised outsourcing company, focusing on treasury management, investment incentives and BEE verification services. Petmin is a minerals, mining and processing company that services the metallurgical and industrial sectors. It is listed on the JSE and the aim in London, and has two operations mining in silica and anthracite. Precrete specialises in the production and distribution of pre-mixed concrete for the construction, support and other related mining applications. Its wholly owned subsidiary, GFC Construction, focuses on guniting or shotcreting, which involves applying concrete pre-mixes to walls of mine shafts. Protea Foundry is a non-ferrous casting operation based in Gauteng, the largest in South Africa. Top Fix Holdings’ business comprises the following: the supply and leasing of scaffolding and scaffolding personnel to industrial plants and construction sectors; the supply of personnel to the chemical, petro-chemical, power generation, construction and coal mining industries; and supply of safety surveillance and access control equipment on chemical and petro-chemical plants. Thembeka Capital is a broad-based… Some highlights have been hidden or truncated due to export limits.
    19. Think & Grow Rich, Napoleon Hill. The single book that has changed my life and positively inspired me to start PSG. It’s not only about money and wealth, but rather about the philosophy of believing in oneself
What I got out of it
  1. Ultimate empowerment, alignment, people above everything, long-term, speak your mind, be authentic to yourself, speak out for what you believe in and make sure you have a voice/control, delegate fully and the best companies allow the head to be least involved on a day to day level, absolute enthusiasm / curiosity / looking for opportunities and scheming

I Love Capitalism: An American Story by Ken Langone

  1. This is Ken Langone’s love song to capitalism. Everyone can and should dream big – it works for anybody. “You want my whole philosophy in a nutshell? I want everybody to do well. The world is a lot more fun if we’re all rich instead of just some of us.”
Key Takeaways
  1. Background
      1. A parents’ main job: unconditional love, live the values you want to teach, stress hard work and education
      2. Ken came from humble beginnings but was taught the value of hard work from a young age and is proof of the American dream
      3. Always ravenous about learning – libraries on Saturdays when others were partying
      4. Out of army in 1963 which later saw a huge market crash. Counterintuitive at the time but he saw this as his opportunity to get his feet in the door at Wall St.
    1. Business lessons
      1. Loving what you do is one of the greatest joys in life. I learned early how essential it was to love the work I was doing. Sometimes I look back and wonder, how did all this happen? Then the answer comes. Shit, I know how it happened: I was at a place where I was having the time of my life! I still remember what Hudson Whitenight said to me 60 years ago: “If you really love your work as much as I think you’re going to, you’re going to be a big success. So, I’m saying to a kid, I learned that ex post facto; you should learn it in front!
    1. Great salesmen
      1. “How do you know I can be a great salesman?” I asked. “I can tell,” he said. “You listen. You’re sensitive to the person you’re talking to. You’ll know when to go in for the kill and when to back off. That’s something most salesmen don’t do – can’t do. They want to just charge, charge, charge in, and they wind up pissing everybody off.”
      2. My research background from the Equitable, plus the fact that I was teaching at NYU, put me a few cuts ahead of the typical salesman, because I could talk quite knowledgeably about what I was selling
    2. You have only one boss – the customer. You treat them right and you have nothing to worry about.
    3. Start with the negatives, the downside. Build trust, show honesty and that you’ve truly done the hard work
    4. “Think I can help you guys. But, first, tell me what your definition of ‘help’ is.” – have to agree on definitions and what you’re working towards or else you could be talking in circles
    5. Some guys who get to be wealthy like to brag about being self-made men. I can’t imagine they’re not leaving somebody out of that equation. The thing I can’t say and never will say is that I’m self-made. To make that claim would be to commit a grave sin against all the many, many people who helped me get to where I am; you could fill Yankee Stadium with them, and then some. That’s how I got rich. Not by myself: I’m just one guy. I like to think I have a skill for assembling outstanding people, but the fact is also that I’m a collage of many people’s efforts.
    6. Knowing what’s important is half the game. Told he only had 30 minutes with Perot when trying to convince him to use his firm for EDS’ IPO but Perot talked for 29 of those minutes so Ken said he should just leave and talk to him some other time. Perot told him to stay and wanted to get Ken’s honest opinion on what other banks were offering. Ken was honest and told him what Perot needed to know, not what he wanted to know, and they ended up talking for 13 hours and built a relationship, leading to Langone’s firms first IPO
    7. Always under promise and over deliver
    8. Customers much more likely to buy if they feel they have choices
    9. In your business, when people don’t want something you mark it down. In my business, we mark it up (difference between retail and banking)
    10. Always take on the difficult, not the impossible
    11. Never underestimate the power of a great product
    12. What a tech company needs to do during the precious period when it has product exclusivity is spend a lot of money to obsolete itself. That’s what IBM used to be the best at, but it lost its way through sheer arrogance.
    13. Nardelli (former GE exec who they hired to become the CEO of The Home Depot), was vengeful, closed minded, short-sighted, totally numbers based, not win/win, always felt like he was getting ripped off, him vs. the world, and all this pitted him against Ken and the rest of The Home Depot board.
    14. Frank Blake (chairman and CEO of Home Depot) not only has a superb intellect; he’s the best listener I’ve ever met, hands down. If he’s talking with a group of people and someone says something interesting, Frank will stop speaking immediately and give the floor to that person. He has the greatest quantity of humility I’ve ever seen in a man. I don’t need to tell you how rare that is in a CEO. When we first negotiated his salary, he had 3 stipulations: 1) he didn’t want his compensation to be such that it would be on the front page of the Wall Street Journal; 2) he didn’t want it to be an embarrassment to Home Depot sales associates – the kind of thing customers might bring up in a critical way; 3) he wanted 90% of his pay to be in stock. “When the shareholders win, I win” he said. Talk about having skin in the game.
  1. Negotiating and a Win-Win Mindset
  1. Early in his career, Langone approached his boss about changing incentives. “Mr. Brown, I want to do something, and I’d like you to agree to it. I want to allocate a certain percentage of those commissions to the R&D department for the analysts who helped bring in this business. Mr. Brown, these guys downstairs are great; I don’t think you understand the quality of talent you’ve got down there. They’re a lot better than alright. Maybe it’s how we use them that’s not all right. But I can tell you right now, I can take these guys anyplace and do a lot of business. Rather than giving them a bonus from my end, I have another idea. Let’s you and I pick a total dollar amount off the top of whatever I bring in from Standard-Jersey, or any other company going forward, for analyst bonuses. Now, you’re going to only have to pay 70% of it because I’m going to pay 30%. I’ll tell you which analysts are higher on the approval list at Standard-New Jersey, and you can decide how much you want to allocate to each analyst. It’s completely fair. He didn’t like that so I said, “I’m going to take a portion of Unit 15’s 30% and give it to them directly. It’ll cost you nothing.” Why would you do that? he asked. “Because, Mr. Brown, when I pick up the phone and call the research department, I want those guys to jump through the phone. I want these guys to keep doing as great a job as they’ve been doing, and I want them to be excited about it…
  2. Capitalism is brutal, but it’s rarely a zero-sum game. Both sides of any transaction should get something out of the deal. Valeant, the pharmaceutical company, had a whole roster of important medications, but when it got caught charging obscene prices for them, its stock went down 90%. The market spoke, and Valeant had to listen. I can’t think of one deal I’ve ever done where I couldn’t have gotten more out of it than I did. As I’ve made clear, I like making money. I’m not some Buddhist monk who wants to eat beans the rest of his life. But it’s amazing what you can accomplish when you look beyond sheer profit to getting buy in by other people. I’d rather own 10% of a billion-dollar company than 100% of a $100m company. The numbers are exactly the same but by owning a piece of the billion dollar company, I get the benefit of everybody else pulling with me, and that’s a huge benefit
  3. One of the most important lessons in my life is this; leave more on the table for the other guy than he thinks he should get. And one of the most important rules in capitalism is incentive. I didn’t get rich by accident. I’ve always been very conscious of terms and conditions and trading, and I bargain back and forth. But I never wanted to reach a point on a deal where the other guy feels he was had. I’d rather have him feel he got me than I got him. I can live with that. If the other guy does better than I do, there’s a good chance he’ll want to come back to me and make a number of deals. On the other hand, he has to be straight with me
  4. The human element
  1. Ignore the human element in any situation at your own peril
  2. Everybody talks about the bottom line, but as I’ve seen time and again, you ignore the human element of business at your peril. Most of the seven deadly sins can and do come into play, and chemistry between people – good chemistry or bad – always has an effect, sometimes a huge effect: in boardrooms, in executive offices, in sales meetings. I’ve had quite a few chemistry lessons over the years.
  3. The only problem was that Home Depot’s great strength was (and still is) its culture, and our culture isn’t about statistics. In our culture, you don’t measure the intangible value of a sales associate saying to a customer, “Can I help you?” or, “You don’t really need that. Come over here and look at this. It doesn’t cost as much, but you’ll be fine with it.” A customer was told to buy an 89 cent screw rather than replacing his whole sink for $200. A couple months later, the guy’s wife wants a new kitchen, and she wants to go to some foo-foo kitchen showroom place. The husband says, “Oh no, I want to go see my friends at the Home Depot.” They spent $100,000 on the job. There’s nothing like these people in our stores. They’re special. Now, how do you get special people? Well, you start by treating them special. You let them know they matter. You let them know you appreciate their opinion. You let them know if they think there’s a better way of doing things than the way they’re doing them, they have an obligation to tell us, and we have an obligation to listen. You also let them know that anybody can build a big store space and put all kinds of inventory in it; the glue that holds Home Depot together are these values. We don’t just say them. We believe them, and we practice them consistently
  4. Management teams that rack up great numbers but ignore the human equation will eventually have a problem on their hands. In business, good numbers can be like sunlight: blindingly bright.
  5. Arrogance is the enemy. For many years, Bernie Marcus and I never, ever went into a Home Depot store – never once – unless we were pushing carts in from the parking lot. I sued to pray I would see a piece of trash on the floor so I could pick it up. Why? Those are entry-level tasks for the kid who works in that store. When he sees the top guys doing them, he can say to himself, “If it’s not too small for them, it’s not too small for me.” The minute you take away all the artificial barriers between you and your people, you’re on your way to phenomenal success. But it takes a bit of humility. To this day, if I walk into a Home Depot and see a customer who looks lost and confused, I walk up to him and say, “I have something to do with this company; can I help you?” if he has a question that’s beyond me, I’ll go grab a kid and say, “can you help this customer?”
  6. We’ve never paid anyone minimum wage at Home Depot. We had a simple belief: minimum wage, minimum talent. We always wanted to have good kids who wanted careers and not feel they had to compromise their pay. We paid them two or three bucks an hour more than minimum. We reviewed them every six months. And from the beginning we were growing like a weed, so we created enormous upside mobility.
  7. If there’s anything I would take a bow for throughout this whole process, it would be this: never giving up, and thinking creatively, instead of just reactively, when the chips were down. It’s a style I recommend highly. You get to enjoy lemonade instead of the lemons God gives you, and chicken salad instead of the much less tasty alternative
  8. As I began my tenure at Home Depot, my first role was just to lift morale. It was a big lift. I decided to do some of the same things we did at Home Depot: hold town meetings, walk the halls, talk to the staff. Put my arm around people’s shoulders, tell them how much we appreciated them and what we were going to do for them – and deliver. In other words, don’t promise pie in the sky unless you’ve got the recipe to make it
  9. No grand plans
  1. You noticed I originally named my little-startup Invemed because I was so fascinated by the health-care field, and how here I was, in 1976, up to my ass in the home-improvement business. And happy to be there. Contradictory? Sure! Life is full of left turns, and I’ve taken quite a few of them, following my nose, which has very often pointed me in the right direction. The truth is I can’t help myself: I am a deal junkie. If the phone rings, I’m like the proverbial fire-house dog – off to the races. Who knows who might be calling? More often than not, it’s someone who has a very interesting business proposition. Doesn’t matter what kind of business it is.
  2. Life Lessons
  1. It wasn’t just wealth itself that put me in that position; a lot of it was sheer stubborn curiosity. Whenever I served on a corporate board, I was notorious for asking more questions than any other director on that board. I didn’t give a shit if my question showed how stupid I was. A lot of people are scared to ask questions because they don’t want people to know how dumb they are. I’ve never had that problem. A lot of people are also afraid of falling down and hurting themselves along the way. Capitalism works, but you’ve got to make the effort, and you’ve got to be able to take the lumps. You have to have the kind of stamina that, when you get knocked down, allows you to pick yourself up and brush yourself off and move on just as if you’d never been knocked down. When I almost went broke in 1970, when I fell almost overnight from the highest mountain to the lowest valley, when I’d go home every day at 4:00pm and weed the garden and cry, I managed to go on afterward
  2. Don’t be in awe of anyone – public and private personas differ greatly
  3. Nothing more important than the name I leave my kids
  4. The big picture depends on a lot of smaller pictures.
  5. Never count the money while the game is still going
  6. Too many people measure success the wrong way. Money should be at the bottom of the list, not the top. I woke up soon enough to realize that if the only way you can define my life is by the size of my bank account, then I’ve failed. Fifteen or twenty years ago, a guy asked me how much I was worth and I answered without thinking, “my net worth is what good I do with what I have.”
  7. What distinguishes the winners from the losers is the ability to turn adversity around: resilience and creativity.
  8. The beautiful thing is that as much as we give, it keeps coming back: we’ve made back all the money we’ve given away, and more. What Elaine and I can’t make more of for ourselves is time. We spend it, but we can’t get it back
What I got out of it
  1. A really fun read with some great stories and lessons. Main ones: in any deal, always leave more on the table; think longer-term and build relationships; add more value than you take away; do the hard work and prepare; be candid, truthful, honest, yourself

Am I Being Too Subtle: Straight Talk From a Business Rebel by Sam Zell

  1. Sam Zell discusses what has made him successful in building his commercial real estate companies as well as launching the trillion dollar real estate investment trust and other companies in energy
Key Takeaways
  1. Willing to be gruff in order to be direct. Has a sense of urgency and doesn’t understand why others don’t
  2. Willing to sacrifice conformity for effectiveness. Listens to everyone but is willing to do what makes sense to him. No assumptions and willing to act
  3. Sam lives and breathes risk. Always be deeply respectful of risk
  4. In any business, it is all about long term relationships, trust, transparency, always leaving something on the table, sharing the risks,
  5. Reputation is your most important asset
  6. Always keep learning, thinking for yourself and making your own decisions
  7. Sam and his parents escaped Poland just before the Nazi’s took over to settle down in Chicago
  8. Where there’s scarcity, price is no issue
  9. You learn so much from seeing people in their own environments – spend the time and money to travel to meet people on their turf
  10. Being comfortable with rejection is fundamental for entrepreneurs or anyone pushing the limits. However, can only push the limits and go against convention if you know the rules
  11. Started off developing housing in Ann Arbor and after some initial success he expanded to other second tier cities where he had pricing power and limited competition
  12. Jay Pritzker became a mentor and good friend who taught him how to evaluate and think through deals and how to understand risk
  13. Use simplicity as a strategy. Organize your thinking, break each step and decision down to its core and determine what the key is
  14. Bet on people over project
  15. In deal making, speed and certainty are superpowers. Often more even than price paid.
  16. Never underestimate the power of optionality
  17. The essence of an entrepreneur is someone who recognizes a problem and provides a solution
  18. Saw there was a huge oversupply if real estate in the 1970s so began accumulating capital in order to buy properties once the timing was right. In an inflationary environment he got a fixed rate return through his non recourse debt
  19. You can be a genius but if you’re in too competitive a market it won’t matter that much. Spend your time in areas with weak competition
  20. Don’t rely on people unless you understand their motivation and your interests align with theirs
  21. Leaders have to find ways to delegate and find ways to keep level headed. Especially during difficult times
  22. Liquidity = Value
  23. Sam describes himself as a professional opportunist and doesn’t care about external opinions. This was clear when he took over manufactured home corporation which made trailer homes and RVs. People called him names and wouldn’t invest because of the stigma of the industry but he goes to where the opportunities are. MHC, later renamed ELS, has been one of the most consistently profitable companies in the space
  24. Sam has been known as “the grave dancer” after an article he penned with the same title. This refereed more to him giving valuable but rundown assets new life rather than dancing on the graves of dying companies or industries
  25. Didn’t found but helped establish and build up the REIT industry – making it a central holding of most large portfolios and making brick and mortar buildings liquid assets
  26. In real estate, replacement costs are the most important metric because this determines the price of future competition
  27. Mitigating risk comes from understanding all angles and knowing which factors will make or break you
  28. 2-3 years before a country becomes investment grade is when they’re the most disciplined and is the best time to invest in them
  29. Hire people based on whether they’d fit the culture and not on a job description or resume. Once they have the basic skills, you can teach them the rest
  30. Keep your eyes and mind open. Read voraciously, meet with a broad range of people, experience different things, travel and try new things
  31. Do the right thing. When you’re in it for the long haul, there is no other way to act. Deals with a winner and loser rarely are truly successful and likely won’t lead to another deal between the parties in the future
  32. Prize loyalty above all else in self and others
  33. Be able to laugh at yourself and maintain perspective and humility
  34. Search for and make people owners as this makes them go all in and always search for better ways to do something, new opportunities
What I got out of it
  1. Working hard, following your gut, not worrying about what others think about you and having the courage to act on your convictions is key in any pursuit. Always be deeply respectful of risk

The Most Important Thing: Uncommon Sense for the Thoughtful Investor by Howard Marks

  1. Not a how to guide for investing but Howard’s investing philosophy, his guideposts
Key Takeaways
  1. Focus on risk over returns
  2. Goal is to have people say, “huh, I never thought of it like that before”
  3. Experience is what you got when you didn’t get what you wanted. The most powerful lessons come in tough times
  4. No idea can be any better than the action taken on it
  5. Some influencers and mentors: Galbraith, Buffett, Taleb, Munger, Greenblatt, Rothschild
  6. Getting average results is easy, simply invest in an index fund. But, to be successful and best the market and other investors, it takes a deep commitment. To understand business models, psychology, history and a whole host of other disciplines
  7. Second level thinking requires you to see past the short term, see how other are thinking and see the effects of that, takes into account second order consequences, it is deep, complex, convoluted, uses probabilities to see future outcomes, takes many things into account, knows the consensus opinion
  8. Do you have the confidence to be above average? Can you use second order thinking? In order to be successful, you have to hold on consensus views and be correct
  9. Second most important thing is understanding market efficiency and its limitations. Howard’s take us that markets are efficient in that they quickly incorporate new information but they are not necessarily right
  10. Everything moves in cycles, including accepted wisdom
  11. When you have a great idea or thesis on an investment, ask “and who doesn’t know that?”
  12. The starting point and foundation for all investing is an accurate calculation of intrinsic value. Easier said than done
  13. Understanding risk is key. Risk is not volatility but the fact that more things can happen than will happen. He three steps are understanding it, knowing when its high and then controlling it. Risk is different for every investor so creating a broad stroke for it is not possible but the Sharpe ratio may be the best alternative
  14. The greatest investors are subject to some of the greatest periods of underperformance because of their unconsensus views and methods
  15. Improbable things happen and probably things don’t happen all the time
  16. People expect the future to resemble the past which sometimes it does but it leads to be people expecting change to be less impactful than it often is
  17. The most dire and negative situations can in fact be the most riskless as all optimism has been drive out of the price. Quality is not tied to risk. A high quality company can be very risky above a certain price
  18. “This time is different” should cause you to pay extreme attention
  19. Combative negative influences such as desire for more, desire for a sure thing, biases, fear of missing out, greed, fear, comparing self to others, ego and poor psychology is vital. This may be one of the greatest sources of advantage one can achieve
  20. It is essential to find bargains by being willing to invest in what others are seemingly over pessimistic about. Boil it all down in order to find bargains perception house sitter of work in reality for whatever number of
  21. Investing is the discipline of relative selection
  22. Should not go out and try to find out investments – let them find you
  23. Most people, although they have many holdings, are not truly diversified. Own is only diversified if you can expect the holdings to perform differently in changing environments. It is the rare investor who understands these correlations
What I got out of it
  1. One of my favorite investing books – focus on risk rather than return, understand how difficult the game is if you decide to play, must be a second/third level thinker…

Investing: The Last Liberal Art by Robert Hagstrom

  1. Hagstrom walks the reader through why and how to incorporate fundamental principles from multiple fields to become a better thinker, decision maker, investor, etc.
Key Takeaways
  1. Worldly Wisdom
    1. Combine key ideas from all disciplines and then develop a latticework in head to ‘hang’ all mental models on
    2. Chances of good decisions improve when many, disparate models yield the same conclusion
    3. Educate self and then train to see problems by seeing/thinking differently
      1. Learn big ideas so well that they are always with you
    4. Key is finding linkages and connecting one idea to another
      1. Connectionism – we learn by analogy, more connections leads to more intelligence
      2. Massive number of connections more efficient than raw speed (small world networks are everywhere)
    5. Two keys to innovative thinking – understand basic disciplines we draw knowledge from and be aware of the benefits and uses of metaphors
      1. Concise, memorable, colorful way to depict thought, action, ideas and more importantly translate ideas into models – stimulating understanding and new ideas
  2. Physics
    1. The bridge between equilibrium in physics, economics and the stock market
    2. Equilibrium – state of balance between two opposing forces, powers or influences
      1. Static vs. dynamic
      2. Rational actions lead to stock market equilibrium – where the shadow price (intrinsic value) = stock price
        1. Now argue market is complex adaptive system – a network of many individual agents all acting in parallel and interacting with one another. The critical variable that makes a system both complex and adaptive is the idea that agents in the system accumulate experience by interacting with other agents and then change themselves to adapt to a changing environment
          1. Irrational, organic, not efficient
  3. Biology
    1. Evolution and natural selection to law of economic selection
    2. After crashes, market and economy best understood from a biological perspective as equilibrium could not account for them
    3. Struggle between species and individuals of same species leads to natural selection and evolution
    4. Schumpter – economics essentially an evolutionary process of continuous and creative destruction
      1. Innovation, a visionary and action-oriented entrepreneur and access to credit are all necessary
      2. Innovation leads to periods of punctuated equilibria – creative destruction
    5. 4 distinct features of economy
      1. Dispersed interaction – what happens in the economy is determined by the interactions of a great number of individual agents all acting in parallel
      2. No global controller
      3. Continual adaptation (co-evolution)
      4. Out of equilibrium dynamics – constant change leads to a system constantly out of equilibrium
    6. Evolution takes place sin stock market via economic selection and capital allocation
    7. Living systems make themselves up as they go along
    8. Efficiency and evolutionary / behavioral not necessarily exclusive – times of less emotions leads to more efficient market
  4. Sociology
    1. Study of how individuals function in society and ultimate goal is predicting group behavior
    2. Relationship between individual investor and stock market a profound puzzle
    3. All human interactions and systems are complex adaptive – can’t separate part from the whole and behavior constantly changes as agents and therefore system adapts
    4. Self-organization and self-reinforcement found in physics, biology, economics, etc.
    5. Emergence – larger entities arise out of interactions of simpler, smaller entities and have characteristics that the smaller entities do not exhibit
      1. Crowds can be collectively intelligent IF diverse and independent
      2. Smart and dumb agents lead to better outcomes than a group of just smart people
      3. Information cascades, which lead to diversity breakdowns happen when people make decisions based on others rather than private information and leads to inefficient system
        1. Can even happen with small groups if have a very dominant leader
      4. Self-organized criticality – market one example where instability is inherent, unpredictable and small fluctuations lead to big changes
        1. Different meta-models of reality (quant vs. fundamentally oriented…) leads to instability
      5. Complex adaptive, self-organization leads to emergence which leads to instability, unpredictability, criticality
  5. Psychology
    1. Anchoring, framing, overreaction, overconfidence, mental accounting, loss aversion key biases
    2. Equity risk premium is puzzling – people hold bonds because of loss aversion and mental accounting
    3. Loss aversion makes people short-term focused
    4. Longer investor holds an asset, the more attractive it becomes IF not evaluated frequently – advises checking prices only once per year!
    5. Information overload can lead to illusion of knowledge
    6. Don’t be  Walter Mitty investor – feed during difficult times!
    7. Decisions we make based on skill lead to higher risk taking and luck to lower
    8. Mental models are imprecise ways of modeling reality but very helpful and simplify life
      1. Mistakes – believe models equiprobable, focus on  few or one, ignore what is not easily seen
    9. Innate pattern seeking leads to magical thinking and superstitions by people trying to explain the unexplainable
      1. In this case, beliefs precede reasoning, beliefs dictate what you see
        1. Why people listen to forecasters – quells anxiety we hate to live with even if we rationally know how stupid it is
    10. Reduce noise via accurate communication of information makes for better rational decisions
      1. Correction device – get information from first-hand sources and then do your best to remove prejudices and biases
  6. Philosophy
    1. Forces us to think and can’t be transferred intact from one mind to another
    2. Metaphysics – ideas independent of space and time (God, afterlife)
    3. Aesthetics / ethics / politics three main branches
    4. Epistemology – study of the nature/limits of knowledge; thinking about thinking
      1. Develop rigorous, cohesive epistemological routines
    5. Failure to explain caused by failure to describe – Mandelbrot 
    6. Disorder simply order misunderstood
    7. Wittgenstein – world we see is defined and given meaning by the words we choose
      1. Reality is shaped by the words we select
      2. Stories very powerful description tools – beware of the overconfidence they can deliver
    8. Pragmatism – true belief defined by actions and habits it produces (William James)
      1. Idea or action is real, good, true if it makes a meaningful difference
        1. Our understanding of truth evolves as it is based on results
        2. No absolutes
  7. Literature
    1. Read selectively but analytically
    2. Always evaluate its worth in the larger picture and then either reject or incorporate what you learn into your mental models – the importance of reflection!
    3. Improves understanding (over fact collecting) and critical thinking
    4. Critical mindsets evaluate the facts and separate facts from opinion
    5. Fiction important because it helps us learn from others’ experiences
    6. Detectives best practices
      1. Develop a skeptic’s mindset; don’t automatically accept conventional wisdom
      2. Conduct a thorough investigation
      3. Begin an investigation with an objective and unemotional viewpoint
      4. Pay attention to the tiniest details
      5. Remain open-minded to new, even contrary, information
      6. Apply a process of logical reasoning to all you learn
      7. Become a student of psychology
      8. Have faith in your intuition
      9. Seek alternative explanations and redescriptions
  8. Mathematics
    1. Bayes’ Theorem – updating initial beliefs with new information leads to new and improved belief
      1. AKA Decision Tree Theory
    2. Probability theory – analysis of random phenomena
    3. Kelly Criterion – how to size bets
      1. 2p – 1 = x (p = probability of winning)
      2. To compensate people not having an infinite bankroll or time horizon, halve (or take some fraction) of the Kelly Criterion
    4. Never fail to take variation into account – trends of system vs. trends in system (individual winners even during sideways overall market)
    5. Never fail to take into account regression to the mean
  9. Decision Making
    1. Intuition helpful when situation is reliable enough to be predictable and when can learn regularities through prolonged practice (mostly linear systems)
      1. Intuition nothing more than recognition – increase store of knowledge and connections leads to improved intuition
    2. How you think more important than what you think
    3. Humans cognitive misers and stop thinking the minute they’re satisfied with an answer
    4. Building blocks from many disciplines used to form mental models must be dynamic and updated with new information
What I got out of it
  1. A fascinating read which was helpful to get a good, broad understanding of what it means to be a multi-disciplinary learner

The Manual of Ideas: The Proven Framework for Finding the Best Value Investments by John Mihaljevic

  1. Describes some of the world’s most respected investors’ proven, proprietary frameworks for finding, researching, analyzing, and implementing the best value investing opportunities
Key Takeaways
  1. Each investor must carve out a personal way to invest in order to succeed
  2. A share of a stock is a share in the ownership of a business
  3. investors tend to buy after a period of good performance and withdraw after a period of bad performance, which is bad for the funds results
  4. Those considering an investment in a hedge fund may first wish to convince themselves that their prospective fund manager can beat Buffett. Doing this on a prefee basis is hard enough; on an afterfee basis, the odds diminish considerably.
  5. Becoming a smart asset allocator is key to managerial success
  6. believe that our investment decisions affects the world
  7. Losses have a perverse impact on long-term capital appreciation, 20% drop in book value requires a 25% subsequent gain in order to offset the loss
  8. Increase in size makes it increasingly difficult to maintain same level of success
  9. Thinking like a capital allocator is coupled with thinking like an owner. looking to the business rather than the market for return on investment
  10. Graham-style investing starts with price of a stock.  If it does not look like a bargain based on tangible metrics, Graham-style investors are not interested.
  11. Eugene Fama and Kenneth French have found through their studies that equities with high book-to-market ratios outperform those with low ratios.
  12. Uncovering equities that provide both asset protection on balance sheet and own businesses with high returns on capital are treasures.  This is hard to find unless the business has experienced a steep near-term profit decline.
  13. by prioritizing return of cash to shareholders, low-return businesses can assist investors in earning a strong investment return, assuming the equity purchase price was favorable.
  14. Investors may overestimate liquidation values, as the reality of a dying business tends to hide some nasty surprises
  15. Acceptance of discomfort can be rewarding in investing, as fearful equities frequently trade at exceptionally low valuations.
  16. investing in asset-rich but low return business, time may be working against you.  As long as management can hold on to the assets and keep reinvesting at low returns, shareholders may earn unimpressive returns despite a bargain purchase price. As result, catalysts become a relevant consideration.
  17. Businesses trading at deep value prices are among those most likely to be creatively destroyed. It seems unwise to allocate a large portion of investable capital to any one deep value opportunity, even if it promises a large expected return
  18. Several considerations may augment the likelihood that a Graham-style screen yields a list of market-beating investment candidates.  Share re-purchases, insider buying, and cash generated through working capital shrinkage may be used as screening factors.
  19. When we value a company based solely on readily ascertainable balance sheet values, we run the risk that those values erode over time, negatively impacting future equity value.
  20. Many companies can be appraised most accurately by analyzing each of their distinct businesses or assets separately and then adding up those components of value to arrive at an estimate of overall enterprise or equity value.
  21. A reason for the market’s occasional mispricing of companies with multiple sources of value may be investors’ unwillingness to value assets that differ materially from a company’s core assets.
  22. Companies with distinct components of value often enjoy greater strategic flexibility, as they may divest a fairly valued asset to improve the balance sheet, repurchase undervalued shares, or reinvest capital in a high-return business.
  23. Sometimes investors, in their zeal to create a sum-of-the-parts opportunity, slice a company into too many parts, creating an attractive investment thesis in theory but not in reality
  24. We normally do not require a catalyst, but we find that situations with multiple sources of value are more prone to becoming value traps in the absence of strategic action.
  25. It matters tremendously whether the offer is “buy one get one free” or if it is “buy ten get one free”.  As shoppers we recognize the former as a more compelling offer. As investors, we often overlook this important distinction.
  26. sum-of-the-parts opportunities come in a few different flavors, each of which demands a slightly different approach to screening. excess assets typically consist of cash and cash like assets, stakes in other businesses, real estate holdings, or a combination of these asset types.
  27. Some hidden asset stories are so compelling that they attract quite a few smart investors, potentially eliminating both the valuation discount and the hidden nature of the assets.  Investors may become patsies by failing to realize how many other smart investors have bought into the same story of hidden value.
  28. Whenever hidden assets motivate us to consider an equity security, the question of how the assets will cease to be hidden becomes important.  In this context, we are less interested in the speculative question of what will prompt other investors to see what we are seeing.  rather, we focus on the economically important issue of how the value inherent in the hidden assets will accrue to us as shareholders– and when.
  29. Buying good companies when they are cheap is invaluable advice, as demonstrated in Greenblatt’s “the Little Book That Beats the Market”.
  30. Higher return on capital employed indicates a good business.  Typically calculate capital employed as net working capital plus net fixed assets.
  31. Greenblatt’s use of operating income to enterprise value as the way of determining cheapness is congruent with his use of operating income to capital employed as the way of determining quality, as the effects of leverage and taxes are stripped from both calculations.
  32. Greenblatt’s magic formula suggests that it will keep outperforming markets over time despite the fact that its success, in theory, would attract a flock of investors and therefore eliminating its prospective attractiveness.
  33. Mr. Market makes two mistakes with some consistency: it over values high-return businesses whose returns on capital derive from explosive but ultimately transitory trends or fads. On the flip side, the market may undervalue unhyped quality businesses with sustainable high-return  reinvestment opportunities.
  34. The future is what counts in investing, and while historical data has the advantage of certainty, forward-looking estimates have the advantage of relevance.
  35. High returns on existing capital – the capital already employed in a business – are almost meaningless without the ability to invest new capital at above-average returns.  Returns on existing capital, whether high or low, are already reflected in a company’s operating income.
  36. Business executives can distinguish themselves in two ways: business value creation and smart capital allocation
  37. Distinguish between business performance and stock price.  Better management results generally mean better business outcomes, but in terms of the stock beating the market also depends on market quotation at time of investment.
  38. Eliminate the bad actors when it comes to finding better management, even when some are esteemed by the business establishment.
  39. Some factors that reflect CEO attitude towards owners
    1. Communication with shareholders open and honest
    2. Composition of board of directors
    3. What does financial leverage tell us about the management
  40. Determinations like shareholder friendliness, alignment of interests and the ability to run a business not only involve many variables but also an element of judgment.  while we cannot exactly screen for jockey stocks, we can use screens to move a step closer toward finding companies with good management
  41. Screening for close alignment involves two proxies, stock ownership and insider buying activity.
  42. Most capital allocators view reinvestment as a default option, giving little consideration to the alternatives.
  43. Making a list of great capital allocators represents a continuous process of discovery and curation.  Corporate executives come and go, and seemingly great managers may reveal themselves as not so great over time.
  44. Subjective assessment of management in a one on one meeting likely adds value to the investment process, assuming the investor is aware of the biases involved and judges correctly that awareness will render inconsequential any biases.
  45. in addition to selecting a proper focus for a meeting, investors may want to prioritize meetings likely to produce incremental, differentiated insights.
  46. hedgefundletters.com
  47. One of the best pieces of advice “Do your own work and do not trust the tips of others”. nonetheless, following the moves of super investors can be both smart and profitable, if done correctly.
  48. Common traits of super investors, Other than remarkable returns, are clear thinking, lucid communication, a visible passion for the process of investing and surprisingly humble attitude toward success.
  49. Even if we accept that super investors are likely to outperform the market, it is not entirely clear that copying superinvestors also leads to outperformance
  50. The problem is not that all investors make mistakes but also that our ability to stick with an investment is diminished if we have not done the research to give ourselves a certain level of conviction in an idea.
  51. Investors may invest in macro theme or political outcome that makes them invest in individual stocks that they may not be entirely sure about.  Viewing these stock purchases as endorsements from such investors would be a mistake
  52. Factors to track superinvestors: decide which type of investors to track, concentration of portfolio, average portfolio turnover, propensity to employ short selling, and congruence between one’s own investment approach and that of a superinvestor
  53. Turnover is important because as outside observers we receive only delayed notice of other investors’ buy-sell activity.  the higher the turnover, the higher the chance that an investors is considering selling a holding by the time we consider buying it.
  54. Context is paramount when assessing the purchase and sale activity of superinvestors.  imagine three investors, each of whom has invested five percent of their respective equity portfolios in Bank of America.  It would be wrong to infer that each investor’s position has comparable significance for our purposes.
  55. Several key developments have created opportunities for small stock investors, including an increase in the size of institutional portfolios, an escalation of compensation expectations, exclusion of small stocks from major market indices, and scant research coverage by sell-side firms.
  56. Major shareholders have more influence on small-company CEOs than they do on their large-company counterparts, as more investment firms can credibly put small companies in play.
  57. We find that small stocks outperform large stocks by a statistically significant margin over time.  while the results differ based on the time periods examined and the definitions used, the verdict is clearly in favor of small stocks.
  58. Even if small caps as a group stop outperforming large caps, the differential between top and bottom performers should continue to be greater in the case of smaller stocks, providing opportunities for research-driven investors.
  59. While underfollowed situations generally offer fertile ground for research-driven investors, it is not always necessary that many people analyze an investment for pricing inefficiency to be eliminated.
  60. In small cap arena, moving beyond quantitative screens is valuable because few professionals are willing to start at A and work through Z in their appraisal of qualitative value drivers of small companies.
  61. Small company executives are also generally more forthcoming than are corporate executives whose ability to communicate spontaneously has been lawyered into oblivion.  Ask a small company CEO how business is going and you might get an answer.
  62. one well-known drawback of small stock investing is the, at times, severely constrained trading liquidity of smaller companies.  Wider bid-ask spreads, greater market impact, and perhaps greater trading commissions conspire to make entering and exiting the equity of small companies a costly affair.
  63. Many of the best small stock opportunities elude discovery by quantitative screens.  the reasons include rapid change in company fundamentals, the disproportionate impact of management quality on value, and the tendency of small companies to lump nonrecurring items into financial reports.
  64. we may uncover hidden inflection points by scouring the small-cap landscape for companies with two or more businesses, one of which is typically a large, declining legacy business.  if the other business is a profitable growth business, we may have found a compelling opportunity.
  65. Special situations encompass equities whose near to medium term stock price performance is largely independent of the performance of equity markets.
  66. the flood of talent and capital has taken some areas of special situation investing from obscurity to popularity, reducing prospective investment returns.
  67. the more obscure a market niche, the higher the likelihood that diligent investors will generate market beating returns.
  68. in markets that exhibit informational inefficiency, rewards may accrue to those who make the effort to obtain timely, accurate and relevant information.
  69. Analytical inefficiencies may play an even greater role in driving outperformance in special situations. While information is generally available to investors willing to dig for it, many market participants struggle to overcome the analytical hurdles.
  70. Investing rules, as distinct from laws, need to be broken occasionally in the pursuit of investment excellence. In this context, rules include the financial formulas we have memorized along the ways.
  71. Some insights can be gained only if we launch the process of inquiry at the relevant point in time.  If we do so, we may enrich the process with new insights at a later date, but if we fail to launch the process, we may never capture the available insights.
  72. Special situations are one of the few investment areas in which it makes sense to pay at least as much attention to the time component of annualized return as to the absolute return expected in a particular situation.
  73. Special situations crystallize the meaning of value.  In a liquidation, value is determined solely by when and how much cash we will receive in exchange for the cash we give up today. When no terminal value remains, we cannot base the investment thesis on what other investors might pay for a business.
  74. In the absence of identifiable drivers of inefficiency, the probability may be higher that our appraisal of value contains an oversight or flaw.  If we can identify a non-fundamental factor that explains the low valuation, we gain confidence in an estimate of value that differs from the market price.
  75. Passive returns to investing in leveraged equities reveal little about the merits of such an approach.  On the other hand, the all-but-certain wide dispersion of returns strikes us as crucial.
  76. It would be difficult to overstate the importance of judgment in this area.  Even if all investors possessed comprehensive data on equity stubs, their investment decisions, and outcomes, would differ materially.
  77. We need to be careful not to overreach when our judgment turns out to be correct.  The payoffs in equity stubs may exert an intoxicating effect on the successful investor.
  78. Do to the lopsided payoff in leveraged equities, the probability of winning on any one investment may be well under 50 percent.  The low batting average increases the size of the sample required to estimate the ex ante likelihood of success with any confidence.
  79. It helps to commit our investment theses to paper, and then test and refine them over time. In leveraged equities, experience can be an investor’s key asset, it interpreted properly.  We add this qualification because a danger exists that we overlearn.
  80. The tendency of investors to think about the likely outcome rather than the range of possible outcomes represents a key stumbling block to success in leveraged equities.
  81. Assuming we wish to wade into treacherous but potentially rewarding equity stubs, one of the key considerations in each situation is the ownership of the debt on a company’s books.
  82. We distinguish between two types of equity stubs for screening purposes: first, we look for companies that have been designed as equity stubs, namely, private equity type investments available in the public market.  Second, we target companies that have become equity stubs due to some kind of stumble.
What I got out of it
  1. Good overview of where to look for and how to look for value investments

Seeking Wisdom: From Darwin to Munger by Peter Bevelin


  1. Through real life examples, many of them centered around Warren Buffett and Charlie Munger, Peter Bevelin helps the reader learn how to think better, make fewer poor decisions  understand ourselves and others better. Discusses mental models, human fallibilities, heuristics, instincts, human psychology, biology and more.

Key Takeaways

  1. Main goal is to understand why people behave the way they do. “This book focuses on how our thoughts are influenced, why we make misjudgments and tools to improve our thinking. If we understand what influences us, we might avoid certain traps and understand why others act like they do. And if we learn and understand what works and doesn’t work and find some framework for reasoning, we will make better judgments. We can’t eliminate mistakes, but we can prevent those that can really hurt us.”
  2. Learn from other’s mistakes
  3. Learn the big ideas that underlie reality and develop good thinking habits (namely, objectivity)
  4. This book is a compilation of what Bevelin has learned from reading some of the works of the world’s best thinkers
  5. Book is broken down into 4 parts – what influences our thinking, examples of psychological reasons for misjudgments, reasons for misjudgments caused by both psychology and a lack of considering some basic ideas from physics and mathematics and lastly describes tools for better thinking
What I got out of it
  1. Seriously good read if you’re at all interested in understanding how and why we make decisions (both bad and good) and how we can go about improving our thought processes and tools. Fantastic read and couldn’t recommend more highly
Part 1 – What Influences Our Thinking?
  • Brain communicates through neurochemicals and genes are the recipe for how we are made
  • Behavior is influenced by genetic and environmental factors
  • The flexibility of the brain is amazing as it can change due to our thoughts and experiences
  • Mental state (situation and experience) and physical state are intimately connected – beliefs have biological consequences, both good and bad
  • World is not fixed but evolving – evolution has no goal
  • Pain (punishment) and reward (pleasure) have evolutionary benefits with pain avoidance being our primary driver
  • Hunter-gatherer environments have formed our basic nature – competitive, access to limited resources, many dangers, self-interest, ostracism = death
  • Cooperation leads to trust, especially amongst relatives
  • Fear is our most basic emotion and it guides almost everything we do. Repeated exposure lessens instinctual reactions
  • Novelty is always sought out
  • Reputation, reciprocation and fairness are big human motivators
  • Very painful to lose anything, especially status, once obtained. Higher status linked to higher health and well being
  • People learn their behavior from their culture
  • Assume people will act in their self-interest
  • Don’t blindly imitate/trust others – think rationally and form your own opinions
Part 2 – The Psychology of Misjudgments
  • Outlines 28 reasons for misjudgment. These are never exclusive or independent of each other. Many of these echo similar sentiments to Cialdini’s Influence
    1. Bias from mere association
    2. Underestimating the power of rewards and punishment
    3. Underestimating bias from own self-interest and incentives
    4. Self-serving bias
    5. Self-deception and denial
    6. Bias from consistency tendency (only see things that confirm our already formed beliefs)
    7. Bias from deprival syndrome (strongly reacting when something is taken away)
    8. Status quo bias and do-nothing syndrome
    9. Impatience
    10. Bias from envy and jealousy
    11. Distortion by contrast comparison
    12. Bias from anchoring
    13. Over-influence by vivid or the most recent information
    14. Omission and abstract blindness
    15. Bias from reciprocation tendency
    16. Bias from over-influence by liking tendency
    17. Bias from over-influence by social proof
    18. Bias from over-influence by authority
    19. Sensemaking
    20. Reason-respecting
    21. Believing first and doubting later
    22. Memory limitations
    23. Do-something syndrome
    24. Mental confusion from say-something syndrome
    25. Emotional arousal
    26. Mental confusion from stress
    27. mental confusion from physical/psychological pain, the influence of chemicals or diseases
    28. Bias from over-influence by the combined effect of many psychological tendencies working tougher
  • Behavior can’t be seen as rational/irrational alone – must have context
  • People can take bad news, but we don’t like it late
  • Evaluate things, people and situations by their own merits
  • Past experiences are often context dependent. Just because some stimulus caused you earlier pain, doesn’t mean that is still the case today
  • Create a negative emotion if you want to end a certain behavior
  • Good consequences don’t necessarily mean you made a good decision and bad consequences don’t necessarily mean you made a bad one
  • Frequent rewards, even if smaller, feels better than one large reward
  • The more “precise” people’s projections about the future are, the more wary you should be
  • Munger looks for a handful of things in people – integrity, intelligence, experience and dedication
  • Recognize your limits. How well do you know what you don’t know/ Don’t let your ego determine what you should do
  • Bad news that is true is better than good news that is false
  • People associate being wrong as a threat to their self-interest 
  • Labeling technique – when somebody labels you, whether you agree or not, you are more likely to comply and behave in ways consistent with that label
  • Avoid ideology at all costs
  • “There is nothing wrong with changing a plan when the situation has changed.” – Seneca
  • Base decisions on current situations and future consequences
  • Don’t fall in love with any particular point of view
  • Know your goals and options
  • Remember that people respond to immediate crisis and threats
  • People favor routine behavior over innovative behavior and similarly, people feel worse when they fail as a result of taking action than when they fail from doing nothing
  • Deciding to do nothing is also a decision. And the cost of doing nothing could be greater than the cost of taking an action
  • People give more weight to the present than to the future. We seek pleasure today at a cost of what may be better in the future
  • “We envy those who are near us in time, place, age or reputation.” – Aristotle
  • “The best way to avoid envy is the deserve the success you get.” – Aristotle
  • How we value things depends on what we compare them with
  • Sometimes it is the small, invisible changes that harm us the most
  • Accurate information is better than dramatic information. Back up vivid stories with facts and numbers
  • We see only what we have names for
  • Always look for alternative explanations
  • We see available information. We don’t see what isn’t reported. Missing information doesn’t draw our attention
  • A favor or gift is most effective when it is personal, significant and unexpected
  • Always try to see situations and people from their POV
  • People tend to like their kin, romantic partners and people similar to them more as well as those who are physically attractive. We also like and trust anything familiar
  • Concentrate on the issue and what you want to achieve
  • The vast majority of people would rather be wrong in a group than right in isolation
  • “It is easy in the world to live after the world’s opinion; it is easy in solitude to live after our own; but the great man is he who in the midst of the crowd keeps with perfect sweetness the independence of solitude.” – Ralph Waldo Emerson
  • When all are accountable, nobody is accountable
  • Being famous doesn’t give anybody special expertise – beware ads with celebrity endorsements
  • “We don’t like uncertainty. We have a need to understand and make sense of events. We refuse to accept the unknown. We don’t like the unpredictability and meaninglessness. We therefore seek explanations for why things happen. Especially if they are novel, puzzling or frightening. By finding patterns and causal relationships we get comfort and learn for the future.”
    • Consider how other possible outcomes might have happened. Don’t underestimate chance
  • Any reason, no matter how flimsy, often helps persuade others
  • 5 W’s – A rule for communication – must tell who was going to do what, where, when and why.
  • Memory is very selective and fallible – keep records of important events
  • Don’t confuse activity with results. There is no reason to do a good job with something you shouldn’t do in the first place
  • “Wise men talk because they have something to say; fools, because they have to say something.” – Plato
  • Awareness of ignorance is the beginning of wisdom
  • When we make big decisions, we could compare our expected feelings with those of people who have similar experiences today. In that sense, we are not as unique as we think we are
  • Understand your emotions and their influence on your behavior. Ask – Is there a reason behind my action?
  • Hold off on important decisions when you have just gone through an emotional experience
  • Cooling-off periods help us think things through
  • Stress increases our suggestibility
  • Stress is neither good nor bad in itself. It depends on the situation and our interpretation
  • “I’ve suffered a great many catastrophes in my life. Most of them never happened.” – Mark Twain
  • People tend to overestimate personal characteristics and motives when we explain the behavior of others and underestimate situational factors like social pressure, roles or things over which there are no control
  • The less knowledgeable we are about an issue, the more influenced we are by how it is framed
  • Advice from Munger – can learn to make fewer mistakes than others and how to fix your mistakes faster when you do make them. Were the factors that really govern the interests involved, rationally considered and what are the subconscious influences where the brain at a subconscious level is automatically doing these things – which by and large are useful, but which often mis function. And, take all the main models from psychology and use them as a checklist in reviewing outcomes in complex systems
Part 3 – The Physics and mathematics of Misjudgments
  • 9 Causes of Misjudgment/Mistakes
    1. Systems Thinking
      • Failing to consider that actions have both intended and unintended consequences. Includes failing to consider secondary and higher order consequences and inevitable implications
      • Failing to consider the likely reactions of others
      • Overestimating predictive ability or using unknowable factors in making predictions
    2. Scale and limits
      • Failing to consider that changes in size or time influence form, function and behavior
      • Failing to consider breakpoints, critical thresholds or limits
      • Failing to consider constraints – system’s performance constrained by its weakest link
    3. Causes
      • Not understanding what causes desired results
      • Believing cause resembles its effect – a big effect must have a big, complicated cause
      • Underestimating the influence of randomness in good or bad outcomes
      • Mistaking an effect for its cause
      • Attributing an outcome to a single cause when there are multiple
      • Mistaking correlation for cause
      • Drawing conclusions about causes from selective data
      • Invert, always invert! – look at problems backwards
    4. Numbers and their meaning
      • Looking at isolated numbers – failing to consider relationships and magnitudes. Not differentiating between absolute and relative risk
      • Underestimating the effect of exponential growth
      • Underestimating the time value of money
    5. Probabilities and number of possible outcomes
      • Underestimating the number of possible outcomes for unwanted events. Includes underestimating the probability and severity of rare or extreme events
      • Underestimating the chance of common but not publicized events
      • Believing one can control the outcome of events where chance is involved
      • Judging financial decisions by evaluating gains and losses instead of final state of wealth and personal value
      • Failing to consider the consequences of being wrong
    6. Scenarios
      • Overestimating the probability of scenarios where all of a series of steps must be achieved for a wanted outcome. Also, underestimating the opportunities for failure and what normally happens in similar situations
      • Underestimating the probability of system failure
      • Not adding a factor of safety for known and unknown risks
      • Invest a lot of time into researching and understanding your mistakes
    7. Coincidences and miracles
      • Underestimating that surprises and improbable events happen, somewhere, sometime to someone, if they have enough opportunities (large enough or time) to happen
      • Looking for meaning, searching for causes and making up patterns for chance events, especially events that have emotional implications
      • Failing to consider cases involving the absence of a cause or effect
    8. Reliability of case evidence
      • Overweighing individual case evidence and under-weighing the prior probability considering the base rate or evidence from many similar cases, random match, false positive or false negative and failing to consider relevant comparison population
    9. Misrepresentative evidence
      • Failing to consider changes in factors, context or conditions when using past evidence to predict likely future outcomes. Not searching for explanations to why past outcome happened, what is required to make past record continue and what forces change it
      • Overestimating evidence from a single case or small or unrepresentative samples
      • Underestimating the influence of chance in performance (success and failure)
      • Only seeing positive outcomes and paying little or no attention to negative outcomes and prior probabilities
      • Failing to consider variability of outcomes and their frequency
      • Failing to consider regression – in any series of events where chance is involved unique outcomes tends to regress back to the average outcome
      • Postmortems – Record your mistakes! Instead of forgetting about them, they should be highlighted
        • What was my original reason for doing something?
        • What were my assumptions?
        • How did reality work out relative to my original guess? What worked and what didn’t?
        • What worked well? What should I do differently? What did I fail to do? What did I miss? What must I learn? What must I stop doing?
Part 4 – Guidelines to Better Thinking
  • This section helps provide tools which create a foundation for rational thinking
  • 12 Tools for rational thinking
    1. Models of reality
      • A model is an idea that helps us better understand how the world works. Helps explain “why” and predict “how” people are likely to behave in certain situations
      • Ask yourself, “Is there anything I can do to make my whole mental process work better? And I [Munger] would say that the habit of mastering multiple models which underlie reality is the best thing you can do…It’s just so much fun – and it works so well.”
      • A valuable model produces meaningful explanations and predictions of likely future consequences where the cost of being wrong is high
      • Considering many ideas help us achieve a holistic view. No single discipline has all the answers – need to consider mathematics, physics, chemistry, engineering, biology, psychology and rank and use them in order of their reliability
      • Must understand how different ideas interact and combine
      • Can build your own mental models by looking around you and asking why things are happening (or why things are not happening).
    2. Meaning
      • Truly understand something when “without using the new word which you have just learned, try to rephrase what you have just learned in your own language.”
      • Meaning of words, events, causes, implications, purpose, reason, usefulness
      • “Never express yourself more clearly than you are able to think.” – Niels Bohr
      • Use ideas and terms people understand, that they are familiar with and can relate to
      • We shouldn’t engage in false precision
    3. Simplification
      • “If something is too hard, we move on to something else. What could be more simple than that?” – Charlie Munger
      • Make problems easier to solve. Eliminate everything except the essentials – break down a problem into its components but look at the problem holistically – first dispose of the easy questions
      • Make fewer but better decisions
      • Dealing with what’s important forces us to prioritize. There are only a few decisions of real importance. Don’t bother trying to get too much information of no use to explain or predict
      • Deal with the situations in live by knowing what to avoid. Reducing mistakes by learning what areas, situations and people to avoid is often a better use of time than seeking out new ways of succeeding. Also, it is often simpler to prevent something than to solve it
      • Shifting mental attention between tasks hugely inefficient. Actions and decisions are simpler when we focus on one thing at a time
      • Some important things we can’t know. Other things we can know but they are not important
      • Activity does not correlate with achievement
    4. Rules and filters
      • Gain more success from avoiding stupid decisions rather than making brilliant ones
      • Filters help us prioritize and figure out what makes sense. When we know what we want, we need criteria to evaluate alternatives. Try to use as few criteria as necessary to make your judgment. Then rank them in order of their importance and use them as filters
      • More information does not mean you are better off
      • Warren Buffet uses 4 criteria as filters
        • Can I understand it? If it passes this filter then,
          • Understanding for Buffett means thinking that he will have a reasonable probability of being able to assess where the business will be in 10 years
        • Does it look like it has some kind of sustainable advantage? If it passes this filter,
        • Is the management composed of able and honest people? If it passes this filter,
        • Is the price right? If it passes this filter, we write a check
      • Elimination – look for certain things that narrow down the possibilities
      • Checklist procedures – help reduce the chances of harm (pair with Gawande’s The Checklist Manifesto)
        • Should think about – different issues need different checklists, a checklist must include each critical item necessary for “safety” and avoiding “accidents” so we don’t need to rely on memory for items to be checked, readily usable and easy to use, agree with reality
        • Avoid excessive reliance on checklists as this can lead to a false sense of security
    5. Goals
      • How can we make the right decision if we don’t know what we want to achieve? Even if we don’t know what we want, we often know what we don’t want, meaning that our goal can be to avoid certain things
      • Goals should be – clearly defined, focused on results, concrete, realistic and logical, measurable, tailored to individual needs and subject to change
      • Goals need target dates and controls stations measuring the degree to which the goal is achieved
      • Always ask – What end result do I want? What causes that? What factors have a major impact on the outcome? What single factor has the most impact? Do I have the variable(s) needed for the goal to be achieved? What is the best way to achieve my goal? Have I considered what other effects my actions will have that will influence the final outcome?
    6. Alternatives
      • Opportunity cost – every minute we choose to spend on one thing is a minute unavailable to spend on other things. Every dollar we invest is a dollar unavailable for other available investments
      • When we decide whether to change something, we should measure it against the best of what we already have
    7. Consequences
      • Consider secondary and long-term effects of an action
      • Whenever we install a policy, take an action or evaluate statements, we must trace the consequences – remember four key things:
        • Pay attention to the whole system, direct and indirect effects
        • Consequences have implications or more consequences, some which may be unwanted. We can’t estimate all possible consequences but there is at least one unwanted consequence we should look out for,
        • Consider the effects of feedback, time, scale, repetition, critical thresholds and limits
        • Different alternatives have different consequences in terms of costs and benefits. Estimate the net effects over time and how desirable these are compared to what we want to achieve
    8. Quantification
      • How can you evaluate if a decision is intelligent or not if you can’t measure it against a relevant and important yardstick?
      • We need to understand what is behind the numbers
        • Buffett says that return on beginning equity capital is the most appropriate measure of single-year managerial performance
    9. Evidence
      • Evidence helps us prove what is likely to happen or likely to be true or false. Evidence comes from facts, observations, experiences, comparisons and experiments
      • Occam’s Razor – if we face two possible explanations which make the same predictions, the one based on the least number of unproven assumptions is preferable, until more evidence comes along
      • Past record is the single best guide
      • The following questions help decide if past evidence is representative of the future – observation (will past/present behavior continue?), explanation (why did it happen in the past or why does it happen now?), predictability (how representative is the past/present evidence for what is likely to happen in the future?), continuation and change (what is required to make the past/present record continue or to achieve the goal?), certainty and consequences (how certain am I?)
      • Falsify and disprove – a single piece of evidence against something will show that it is false
      • Look for evidence that disproves your explanation and don’t spend time on already disproved ideas or arguments or those that can’t be disproved
      • Engage in self-criticism and question your assumptions
      • Find your mistakes early and correct them quickly before they cause harm
      • The mental habit of thinking backward forces objectivity – because one way  to think a thing through backward is by taking your initial assumption and say, “let’s try and disprove it.” That is not what most people do with their initial assumption. They try and confirm it.
    10. Backward thinking
      • Avoid what causes the opposite of what you want to achieve and thinking backwards can help determine what these actions are
        • Should also make explicitly clear what we want to achieve
      • “Wise men profit more from fools than fools from wise men; for the wise men shun the mistakes of the fools, but fools do not imitate the successes of the wise.” – Cato
    11. Risk
      • Reflect on what can go wrong and ask what may cause this to turn into a catastrophe?
      • Being wrong causes both an actual loss and an opportunity cost
      • To protect us from all unknowns that lie ahead we can either avoid certain situations, make decisions that work for a wide range of outcomes, have backups or a huge margin of safety
    12. Attitudes
      • “Life is long if we know how to use it.” – Seneca
      • Know what you want and don’t want
      • Determine your abilities and limitations. Need to know what we don’t know or are not capable of knowing and avoid those areas
      • Ask – what is my nature? what motivates me? what is my tolerance for pain and risk? what has given me happiness in the past? what are my talents and skills? what are my limitations?
      • Be honest – act with integrity and individuality
      • Trusting people is efficient
      • Act as an exemplar
      • Treat people fairly – must be lovable
      • Don’t take life too seriously – have perspective, a positive attitude, enthusiasm and do what you enjoy
      • Have reasonable expectations – expect adversity
      • Live in the present – don’t emphasize the destination so much that you miss the journey. Stay in the present and enjoy life today
      • Be curious and open minded and always ask “why?”
Munger Harvard School Commencement Speech 1986
  • Avoid drugs, envy, resentment, being unreliable, not learning from other’s mistakes, not standing on shoulders of giants, giving up, not looking at problems from different POVs, only reading/paying attention to information that confirms your own beliefs
  • Be objective
  • “Disraeli…learned to give up vengeance as a motivation for action, but he did retain some outlet for resentment by putting the names of people who wronged him on a piece of paper in a drawer. Then, from time to time, he reviewed these names and took pleasure in nothing the way the world had taken his enemies down without his assistance.”
Wisdom from Charles Munger and Warren Buffett
  • Appeal to other people’s interests over your own
  • Institutional imperative – tendency to resist change, make less than optimal capital deployment decisions, support foolish initiatives and imitate the actions of peer companies
  • Board of directors have few incentives (unless large owners) to replace CEO
  • Type of people to work with – need intellectual honesty and business owners must care who they sell to
  • Need role models early on
  • Emulate what you admire in others but also be aware of what you don’t like
  • Know your circle of competence
  • Use all available mental models, not just what you’re comfortable with
  • Scale extremely important – efficiencies, information (recognition), psychology (fit in), and in some industries leads to monopolies and specialization
    • Disadvantages of scale – specialization often leads to bureaucracy
  • On what something really means – ask “and then what?” to truly get at somethings core
  • There is a certain natural tendency to overlook anything that is simple and important
  • Avoid commodity businesses
  • Deal only with great people and you will avoid 99% of life’s headaches