“I like to study failure… we want to see what has caused businesses to go bad" Warren Buffett
"If I were ordaining rules for running boards of directors, I'd require that three hours be spent examining stupid blunders" Charlie Munger
Most business schools spend time studying the ingredients for business success. Many of the Investment Masters acknowledge the benefits of inverting a concept, looking at an investment question or problem in another way. Instead of asking what are the ingredients that make for a successful business, try to identify what the commonalities are that will kill a business. Identifying these factors can help you avoid potential losses and identify businesses worth pursuing.
The book "The Ten Commandments for Business Failure" by Don Keough is a great starting place. Don Keough, a philosophy major, a former CEO of the Coca-Cola Company, is a close friend of Warren Buffett and sits on the Board of Berkshire Hathaway. The book is introduced by Warren Buffett.
Mr Keough notes "A company doesn't fail to do anything. Individuals do, and when you probe a bit you usually find that failure lies not in a litany of strategic mistakes - though they all may be present in one form or another - but the real fault lies, as Shakespeare noted, in ourselves, the leaders of the business".
"Businesses are the products and extension of the personal characteristics of its leaders - the lengthened shadows of the men and women who run them. They are the main actors on the business stage and when, through one of more personal failings, they take a business in the wrong direction, then the business is headed for failure".
Mr Keough recognises the commandments aren't "startling breakthroughs in management thinking. They just make common sense". Mr Keough challenges the reader to "Show me a failed business, even one based on the latest wikinomics, and I will bet you with considerable assurance that their leaders have violated more than one of these commandments. One step towards failure unchecked, leads to another".
I've outlined the Ten Commandments and added some comments along the way..
1) QUIT TAKING RISKS - when you are comfortable in your position there is a temptation to quit taking risks. The one constant for a business is change. A business must adapt to change, try out new products, processes and services and respond to changing technology, economics and customer needs.
In light of the speed of technological change disrupting industries it is paramount businesses continue to evolve. Evolving means taking risks. I recently read an interview with Jorge Paulo Lemann, the 19th richest person in the world, and a founder of 3G. 3G is an investment company that has had enormous success buying and growing global businesses.
"Something that I always thought college doesn't give is the ability to assess and take risks. It will teach you how to assess risks mathematically or theoretically, but hardly. And in general, it teaches you not to take risks, which is to say be careful. And I think in life, you have to take risks, and I think the only way you learn to take risks is practicing, practicing. So I practiced on the waves, playing tennis tournaments, later in business etc. I only mention this because I think a lot of people study hard, and I think in order to do more, or do exceptional, you have to take risks" Jorge Paulo Lemann
In the book 'Adapt - Why success always starts with failure', Tim Harford discusses failure when there is a pathological inability to experiment. He offers a method for experimentation known as the 'Palchinsky principles'; first, seek out new ideas and try new things; second, when trying something new, do it on a scale where failure is survivable; third, seek feedback and learn from your mistakes as you go along".
Phil Fisher touched on this concept in his writings 'Developing an Investment Philosophy' .. “The company that doesn’t pioneer, doesn’t take chances, and merely goes along with the crowd is liable to prove a rather mediocre investment in this highly competitive age” .
2) BE INFLEXIBLE - companies, and investors, that refuse to change when it is clearly evident a strategy or process isn't working are bound for failure. The newspaper companies that failed to adapt to the rise of the internet are a case in point. They lost their edge in real estate classifieds, employment advertising and general advertising. So too have the TV networks that failed to recognise the global reach of the internet will far surpass free-to-air and cable networks limited geography.
Mr Keough believes "flexibility is a continual, deeply thoughtful process of examining situations and, when warranted, quickly adapting to changing circumstances. It is, in essence, the key to Darwin's whole notion of the survival of the fittest. Flexibility. Adaption"
3) ISOLATE YOURSELF - CEO's who isolate themselves from their businesses or who surround themselves with only "yes" people are likely to fail. Managers that do well understand their marketplace, understand their customers, their staff and their competitors.
Mr Keough points out Charles Kettering, the great engineering genius who helped steer GM during its glory years, said "Don't bring me anything but trouble. Good news weakens me". If you isolate yourself you will not only not know what you don't know about your business, but you will remain supremely and serenely confident that what you know is right.
So too, the great investors are seekers of truth. They ask what they do and do not know. They look to have investment ideas tested.
4) ASSUME INFALLIBILITY - Mr Keough notes "Annual reports often amuse me, particularly the letter to shareholders. In one report after another, even if the company has had a thoroughly disastrous year, the chairman's letter is frequently an artful exercise in finger pointing at a number of causes ranging from unforeseen currency fluctuations to the unusually active hurricane season".
Once again, like good investors, managers must acknowledge and address mistakes, learn from them and move on. Ignoring or sweeping problems under the rug or finger pointing will lead to failure. "If you want to increase your chances of failure, deny the possibility that you are not always 100% perfect in your judgement' Ignore the fact that sometimes others do know a thing or two". Do the same in investing, and you'll fail too.
5) PLAY THE GAME CLOSE TO THE FOUL LINE - trust is an essential foundation of any business. Mr Keough notes "All business finally boils down to matters of trust - consumers trust the product will do what it promises it is supposed to - investors trust that management is competent - employees trust management to live up to it's obligations" .
Many of the great investors focus on companies whose culture is win-win. Over time studies shows businesses with good cultures outperform those with poor cultures.
6) DON'T TAKE THE TIME TO THINK - There are plenty of example of business failure which could have been averted if management stopped to think about the consequences of their decisions. Being human, business managers suffer the same emotional biases investors do.
Confirmation bias, greed and fear and groupthink are a few examples. Like investors, managers can test ideas, study similar situations/mistakes, and invert concepts to aid their thinking process. Mr Koeugh notes "If you want to fail, don't take time to think. If you want to succeed, take lots of time to think. Thinking is the best investment you'll ever make in your company, in your career, in your life".
“Thinking is the hardest work there is, which is probably the reason so few engage in it.” Henry Ford
7) PUT ALL YOUR FAITH IN EXPERTS AND OUTSIDE CONSULTANTS - experts and consultants have vested interests, biases and shortcomings. Just like stock market forecasters, business and industry forecasters track records usually tell you more about the forecaster than what will happen. Be skeptical of companies that cite and rely on industry analysis to support acquisitions or major corporate change.
Mr Keough notes "you'll fail if you don't stop to think. Well, you'll also fail big time if you let yourself be flattered, and there is never a shortage of charming con artists in just about every field who will use flattery as a sales tool".
“Anyone who says businessmen deal in facts, not fiction, has never read old five-year projections.” Malcolm Forbes
“I have never seen a management consultant’s report in my long life that didn’t end with the following paragraph: “What this situation really needs is more management consulting.” Never once. I always turn to the last page. Of course Berkshire doesn’t hire them, so I only do this on sort of a voyeuristic basis. Sometimes I’m at a non-profit where some idiot hires one." Charlie Munger
"Organizations that take the word of overconfident experts can expect costly consequences … however, optimism is highly valued, socially and in the market; people and firms reward the providers of dangerously misleading information more than they reward truth tellers” Daniel Kahneman
8) LOVE YOUR BEAURACRACY - the same limitation and dangers a committee has when investing applies to running a business. Committees suffer from Groupthink. "Warren Buffett reported that in one of the companies Berkshire Hathaway took over, in the first month they eliminated fifty-four committees that were eating up about ten thousand man-hours". Berkshire Hathaway operates with 25 people at head office.
To combat bureaucracy at the Coca-Cola Company, Mr Keough focused on the core of what his business was about .. "every expense we made, every department we created, every project we took on had to answer to the basic question: Will this help to create and serve customers? If the answer was not a ringing and positive "Yes?" whatever it was we were spending or undertaking had to be eliminated. Once you decide you have fifty things to do that are unrelated to your customer, soon you have fifty bureaucracies composed of individuals doing things extremely well that they shouldn't have been doing because it didn't serve the customers in any way".
In his 2014 letter Warren Buffett made the point that his successor would need one other particular strength.. "the ability to fight off the ABC's of business decay, which are arrogance [see point 4 above], bureaucracy and complacency [see point 1 above]." He noted "When these corporate cancers metastasise, even the strongest of companies can falter."
9) SEND MIXED MESSAGES - Mr Keough notes "sending mixed or confused messages to your employees or your customers will jeopardize your competitive position, and result in failure.
Companies need to make sure their employees are focused on the right things. In part this has a lot to do with incentives and unintended consequences. History is littered with companies that move into unrelated businesses and lose focus on their core businesses.
“A majority of life’s errors are caused by forgetting what one is really trying to do.” Charlie Munger
10) BE AFRAID OF THE FUTURE - Mr Keough notes "When you focus on the failures of the world day in and day out, it shapes your whole attitude toward life and the future.
One optimist in a sea of pessimists can make all the difference. If you want to succeed, approach the future with optimism - and passion.
11) LOSE YOUR PASSION FOR WORK - FOR LIFE - Mr Keough added a little bonus - an eleventh commandment. He notes "I have never met a successful person who did not express love for what he did and care about it passionately. He suggests making an emotional connection with your customers. Remind yourself every day as to just what the customer is looking for, expects, wants from your company.
As in investing, management must have a passion for what they do. The business environment does not afford the luxury of complacency.
The same human foibles that undermine investors undermine management and their businesses. Mr Keough states "Human nature is the reason I have, regrettably, such confidence in the principles of this little book".
Being aware of the common factors that result in business failure can help investors avoid companies that will fail. Avoiding the permanent loss of capital - is a key to successful investment.