Silver Bullet Culture

Competitive Advantages, The Silver Bullet, What’s really bothering you? by Adam Howard

Last week I discussed dry ol’ theory again, looking at competition theory and the continuum from perfect competition to monopolies, but with some real world examples thrown in to show that the dismal science (economics) can actually has some real world applications. 

The conclusion was that all market participants try to make, or wish their market segment was as close to a monopoly as possible. This would allow that business to charge whatever it wanted, and make larger profits as a result.

That’s what businesses are trying to do when they make themselves a little different from their competitors; they are trying to create a market within a market where they are the only supplier. If they do this well enough the results can be spectacular.

I also discussed “rent seeking” (charging higher than reasonable prices to create larger profits) in competitive markets and the way markets force all players to bring their prices closer to each other, particularly where the product being sold is fairly similar. 

Well, what about instances where players have an advantage? 

This is really what I am talking about above where all business owners are trying to create their own mini-monopolies. They can do so by making their product a little different (hopefully a little better/different, not a little worse/different). In economics circles this is called competitive advantage, where a product acquires certain attributes that its competitors don’t. Not to be confused with comparative advantage, which is where a supplier is able to produce the same good at a lower cost than its competitors. 

Think about the now closed Spanish restaurant El Bulli, created and run by the Spanish chef Ferran Adria, the creator of molecular gastronomy. Only open 6 months of the year and located in a remote bay on the Catalan coast, all seats were often booked out 12 months in advance by diners from all around the world.

One could only obtain the Adria-created dishes featuring, amongst other things, the use of liquid nitrogen as a cooking agent and reduction of food stuffs to foam, at that location. The quality and exclusivity was such that Adria created a mini-monopoly. This in an industry that is renowned for competition where a mini monopoly was created by new skills and technology, and was completely supply-side driven. There’s no question that demand existed, it just took someone to innovate to provide the supply to meet the demand. 

Adria’s impact was such that it spawned a new generation of celebrity chefs, chief among them Heston Blumenthal, recently seen on Masterchef. And now Adria’s monopoly is over and his “rent seeking” prices are no more as his competitors have taken his technology/skills and flooded his market. Maybe that’s why he closed El Bulli, as he knew the window had closed?

Another example of this type of “point of difference” is the resurgence of vinyl records as a medium for music fans, however this example shows how a near monopoly can be broken. 

Another of my mates, let’s call him The Audiophile, put me onto the unusual case of the resurgence of vinyl, with the chart below showing sales over the past few years.

Vinyl had a monopoly on recorded music distribution until 1989, when compact discs (CDs) entered the market. Between 1989 and 1993 there was a battle for market share, with CDs winning comprehensively and almost killing vinyl completely. Records were only kept alive by the aficionados, who often claimed the sound quality was richer and more real than CDs.

I would argue that the near death experience suffered by vinyl was caused by supply-side effects as although there was growing demand for more portable music, CDs were cheaper to produce and were smaller and easier to store and ship.

The CD boom coincided with sharp decline in the number of independent record/music stores, as the market consolidated down to a few large chain retailers.

The Audiophile is a passionate man, much as The Proprietor and The Trader from past Updates. I have a sub-woofer in use at my place built from scratch by The Audiophile and have always consulted him on all matters acoustic. Vinyl had declined as a medium for recorded music to such an extent that once, almost a decade ago, when I travelled to Hong Kong, The Audiophile had me purchase a particular turntable stylus as that model wasn’t available in Australia….and it was expensive.

Now, however, consumer tastes have changed and vinyl sales have exploded, but was it demand-side or supply-side forces that re-established this market? It certainly appears that it was pent up demand.

But, look at the year vinyl sales started to trend upwards; 2007/2008.

The near monopoly over online music sales held by iTunes, and the potential loss of revenue flowing from pirated music were motivating factors in the establishment in 2007 of Record Store Day, which happens worldwide on the 3rd Saturday of each April.

This movement was started to celebrate the culture of the independently owned record store and includes Metallica, REM, Vampire Weekend, Billy Bragg and others as unofficial ambassadors.

As well as an annual event, Record Store Day is also now an organisation that coordinates events all year round, creating a more vibrant market for vinyl music. So it appears that once again it was supply side action that breathed some life into a market.

And The Audiophile couldn't be happier.

So, in competitive markets where demand for a product, in a broad sense, already exists, it is possible for new suppliers to do something new or different and make good profits…even if it has been done before.

Even if the product being supplied is highly discretionary and involves the customer paying a premium.

You just have to be good at it… whatever it is.

I suspect this is actually the point a lot of people miss when they decide to open a new cafe or restaurant. On a more cynical note I suspect this is a point most large corporations are very aware of, but more on that later.

It appears people may be attracted by the romance of being self-employed, as well as the glamour of being the owner, and as a result one or more of the calculable risks are forgotten. Sometimes I even think the same romance is to blame for the boom in Reality TV shows and wannabe stars.

I call it our “Silver Bullet Culture”.

I have stated previously that 80% of employees are not particularly good at what they do, but after watching a particular Technology Entertainment Design (TED) Talk on YouTube, I think this is actually because 80% of employees hate their job, and as a result are pretty poor at it. There was absolutely no thought put into what type of work the employee wanted to do when they started their career and they have lurched from one job to another, always chasing either the money or suffering from a bad case of “the grass is always greener.”

These types of statistics are at the root of the lack of workforce productivity currently being bemoaned by the leaders of industry. Anyway, as 4 out of 5 people hate their job it stands to reason that they are seeking a way out…and not always a reasonable way out.

This lack of planning is endemic, as shown by a 2011 survey which found 17% of Australians still based some or all of their retirement funding plans on winning the lottery (I know, I couldn't believe we would be that stupid but apparently we are.).

So, people want a way out of their meaningless, soulless jobs. Some do a bit of research and introspection and decide on a career change, while others apply for reality TV shows or open restaurants.

Seriously…

The hope is that lightning will strike and they will be rescued from their banal existence and be granted instant stardom and wealth. That Matt, Garry and George from Masterchef will walk in the door, declare their establishment the next El Bulli and riches will follow.

But we all know it doesn’t happen in real life. Despite this the hope being sold by reality TV and new business ventures keeps being bought.

If we use this prism to look at the WA experience I would be confident in saying large parts of the WA work force have suffered from a bad case of short term-ism regarding their careers. 

What does short term-ism mean, I hear you ask?

Making decisions to pursue jobs purely on the basis of money. Recall I mentioned in the Update of two weeks ago that opening your own small business purely to chase the money wasn't an acceptable reason? Well, neither is chasing the money an acceptable reason for an employee taking a role.

I have heard a lot of anecdotes about engineers being lured away from smaller firms to work for Leighton Holdings, Monadelphous, etc.

Yesterday I was talking with another mate we will call The Grinder (a friend from tennis days) who recounted a tale where a friend in the law industry took a role with the late Forge Group and boasted about the money versus effort required. This friend tried to get The Grinder to join him at Forge, but fortunately The Grinder declined, electing to stay with the firm he had been at for years.

Forge goes BOOOOMM! And The Grinder gets a call from his mate apologising for giving him advice that if taken would have yielded the shortest of short term benefits, then been followed immediately by a long period of uncertainty.

And that type of story is emblematic of the WA workforce over the past 5 years. The macroeconomic signals that the good times are over for workers are a rising unemployment rate, which at 5.9% is the highest it’s been since Dec 2003, Dun and Bradstreet reporting that consumer debt stress is at the second highest point on record and a flat or negative trending State Final Demand (recall SFD is the dollar value of goods and services bought and consumed within WA, so exports are excluded).

What about small businesses? It’s all good talking about markets and their competitive nature, but if your market is shrinking do you have cause to worry?

Not really. Once again, if you are good at what you do you have nothing to worry about. Having said that, the number of businesses failing is rising, up by 20% in WA from the same time a year ago, but that statistic is what’s called a lag indicator as it reflects what has happened, not what’s going to happen.

The forward looking statistics are unfortunately a bit more qualitative, but fortunately a bit more positive. Dun & Bradstreet report that 19% of small businesses are planning to purchase new assets in the next 12 months, while 64% of business owners are more optimistic about 2014/2015 compared to 2013/2014.

Here are the results of two key areas of Dun and Bradstreet’s survey in table form.

Major Area of Concern for 2014/2014
Cash flow 32%
Value of Aussie Dollar 16%
Wages and Salaries 12%
Interest Rates 11%
Fuel Prices 7%
Access to Credit 6%
Undecided 16%
Barriers to Growth
No Barriers at all 32%
Slow Demand Growth 23%
Online Sales by Competitors 11%
Shortage of Skilled Labour 9%
Utilities/Operating Costs 7%
Unpaid Invoices 5%
Access to Funding 4%
Undecided 9%

Do these results match your thoughts?

Food for thought…

Outliers, Ten Thousand Hours, and Seven Critical Human Errors by Adam Howard

8/8/14

Economic Update

Last week’s Update finished with a couple of tables from a recent Dun & Bradsteet survey of small to medium size business owners about their thoughts and feelings regarding the prospects for the 2014/2015 financial year.

The entire report actually concluded that the future looked bright, largely based on the concerns/results included last week, which I thought a little strange.

Why, you ask?

Well, in order to explain I have applied a median, or middle.

The areas of concern were fairly understandable; the respondents were primarily concerned about cash flow (32%) and the value of the Aussie dollar (16%), with some concern about wage costs (2%).

So, a concern about cash flow, at least from a banker’s perspective, is a concern about revenue; its volume and velocity.  Volume, the amount, and velocity, how fast and often it flows.

Where is the demand coming from and is it growing or falling?  If and when are my debtors going to pay me?

Fairly raw and visceral concerns.

Followed by the value of the Aussie dollar, which at mid 90s against the US dollar is about 30% above its long term value of mid 70s.  Anyone wanting to buy Australian goods or invest in Australia at the moment has to be pretty keen to do so as its going to cost them 30% more than it would normally.

What is a concern about the value of the Aussie dollar really about? Demand!  How is the high cost of buying my goods going to impact demand?

My summary would be nearly 50% of business owners surveyed were concerned about demand levels and whether they were going to get paid.  Those don’t sound like the concerns of people who are overly positive.

Next, the results regarding barriers to growth. 32% responded they saw no barriers to growth, with the remaining 18% to our median saying they felt slow demand growth was the largest barrier.  That sounds pretty positive, right?

Well, a further 9% responded they were undecided about barriers to growth.  I would be inclined to say a large proportion of those saying they saw no barriers to growth were actually saying “I dunno…”

Once again, my opinion would be maybe 40% of respondents were actually undecided on any barriers to growth, with the next highest response being slow demand growth.

Bottom line, primary concerns are about demand, with demand growth also a primary barrier to growth.

But the overall report was quite positive.  What the….?

I am not a pessimist, just a realist, and I talk to a lot of people, and the sentiment seems to be that things are difficult and they are likely to stay that way for a while.

PLEASE correct me if I am wrong.

Unless of course you get struck by lightning, like 24 year old Kelsey Zachow who this week won a $66m lottery in the US.  Single mum with two jobs as an admin assistant and bartender and BANG!  It all changes.  That’s luck, baby.

Which brings me back to a topic raised in last week’s Update; our Silver Bullet Culture.

There seems to be a common misconception that innate talent and luck leads to spectacular success with limited need in the purists’ view for much hard work.  As Australians we laud those who succeed with this seeming lack of effort, with this particularly noticeable in the sporting arena.

Think Shane Warne.  Tubby, mullet wearing, smoking Warney who becomes the greatest bowler in history just because he had the gift.

Or what about Pat Cash?  Could have been an AFL footballer, but chose tennis and with little training and just his innate athleticism went on to win Wimbledon.

Those are the myths.

In business circles, what about our own Michael Malone, the founder of Iinet?  Started the business in his parent’s garage and 20 years later he was miraculously a multimillionaire.

And the mining industry has them by the bucket load, but the one who always springs to my mind is the prospector Mark Creasey, who got lucky and found gold, and then nickel. 

This misconception fits very well with Australian egalitarianism where we believe, culturally, that we are all equal.  If anyone rises up we have a tendency to lash out, and cut down the tall poppy. 

The exceptions are those who are born with innate talent and/or whom experience amazing luck, and this belief system means that social and financial mobility are still very much possible in the Lucky Country.  Where you can start with nothing, living in the back of beyond, until you catch your lucky break and end up a gazillionaire.

Sound familiar?

We share this cultural belief with the US (the land of opportunity), and I think it is born of both nations being newly colonized by the white man, with less established class lines and more perceived opportunity.

And that’s where my point lies.  Opportunity.  We have confused opportunity with blind, dumb luck, whereas most real opportunities come disguised as hard work, which also feeds into my comment that money is a poor reason for doing anything.  If it’s only for the money, it’s unlikely you will enjoy it much, and the work required to succeed will be painful and hence overwhelming.

Opportunity and capitalising on that opportunity are two different things.  Gary Player, the dour South African golfer, once quipped that he found it funny that the more he practiced, the luckier he got.

I recently read Outliers by Malcolm Gladwell, which is poorly marketed as a book about success; it’s actually about seeking to uncover why extraordinary events occur.  Below is a standard distribution curve used to show IQ distributions, which is often used to display probability.  The distribution is meant to be as follows:

  • 65% of a population falls within the main body of the bell.
  • 12.5% each fall within the bell’s shoulders; and
  • 5% each fall in the tails.

An outlier is a group or individual that falls well outside the standard bell curve’s range.

 

Basically, the following are present if spectacular results are to occur:

  1. A strong work ethic;
  2. A love of the task or subject matter;
  3. The opportunity to build a base of 10,000 hours of practice; 
  4. A series of extraordinary opportunities; and
  5. A demographic or technological event or epoch that coincides with the individual's entry into a market.

Another point made is that in instances of catastrophic failure (an airplane crash or similar) there are on average 7 critical human errors made that create or feed the failure.  

I think it's reasonable to assume that on the flip side, for spectacular success there needs to be a similar number of critical moments which feed the success; which lead to an exponential or scalable leap forward.

Now, it's unreasonable to hope we will all fall into the category of outlier in the global sense, but I think it's completely reasonable to use the above points to help become an outlier in your given sector or industry.  

Before I go on, what about that 10,000 hours of practice? If you break it down its 20 hours of practice every week for 10 years, or 3 hours of practice a day, 7 days a week for 10 years. 

It's easy to understand if I use sports as an analogy. The Audiophiles daughter, who is 7 years old, was identified as naturally talented at gymnastics and was selected for an AIS training squad.  She enjoyed it and had good natural balance and strength. 

The ageing curve, which identifies peak performance ages for different athletes, shows the peak performance age for Olympic gymnasts is mid to late teenage years, so The Audiophile's daughter was promptly told her training program would start immediately with up to 10 hours of training per week. 

10 hours per week, building to 20 if she enjoys it and continues to improve, builds to 10,000 hours by the time she is 16 and you have an Olympic athlete.  That's the theory. 

Additionally, this anecdote includes three of those extraordinary opportunities noted above;

  1. Having the natural ability at a discipline;
  2. Having it identified by someone connected to that discipline; and
  3. Being offered the opportunity to train in that discipline.

And The Audiophile's daughter almost immediately decided gymnastics wasn't fun anymore and moved onto something else, which isn't surprising as very few people would enjoy gymnastics sufficiently to forsake nearly everything else in their life. 

I've got to say, I saw this happen many times when I was a tennis coach, and it’s just another example of how many things have to go right for someone to achieve phenomenal success.

Now I'll go back to The Proprietor as an example. He has worked in and around restaurants since he was 16 years old, and is now in his late 30s. A normal working week would be 50 hours, so over the past 20 years he has built up his 10,000 hours.  He also loves his business and is constantly thinking about how to improve and innovate.

He had some extraordinary opportunities such as:

  • his family was successful in this industry and had some very good contacts;
  • he immediately loved the subject matter;
  • he enjoys alcohol but doesn't have a problem with it (a very common problem in the industry);
  • secured a wonderful leasehold in an area that was just about to soar in popularity; and
  • met an individual who provided enormous operational assistance who also had access to other individuals with capital.

So he is successful.  An outlier in his industry. Certainly on the shoulder of the bell curve, in the top and maybe into the tail and in the top 5% of his market.

But what about global scalability?  How does he become the next Jamie Oliver?

There needs to be at least one but probably many more opportunities presented that come disguised as hard work which he grasps and smashes. 

Sounds like a slippery proposition....and it is otherwise the world would be full of outliers.  

So, the question for readers is, what have you spent a lot of time doing? Have you got 10,000 hours in the bank in any area?

Finally, I have spoken about risk and probabilities a bit over the past few Updates as it’s something I am becoming more and more interested in.  Risk and uncertainty are a part of every area of our lives, where I had previously thought about them almost exclusively in a financial sense.

Over the weekend I had a long chat with a bloke who used to be Managing Director with a large betting agency and we spoke about risk management.  Pretty interesting stuff and next week that’s what I will focus on.

As some homework for next week I will pose a question. How would you interpret it if I told you there was an 80% chance of an event occurring? 

Is that event now a sure thing?  Or is it still risky?  And does your answer change depending on the event?

Food for thought...