Dick Erickson was impressed as he entered the sixth Les Schwab Tires store of the day. He was struck by the bustling activity and immaculate presentation. The modern stores were open early and everything, from the workshops and restrooms to the well-groomed and friendly staff, was spotless. The customers were all smiles. Les Schwab Tires, a tire business in the west, was known for earning margins more than double the industry average, sparking Erickson's curiosity. That day, he was determined to uncover the secret behind their success.
Charlie Munger, one of the world's most accomplished investors, has shared valuable lessons on the importance of curiosity, the power of incentives, and the value of emulating successful strategies. Erickson, the founder of Sun Tires, exemplified these principles.
Erickson spent that day visiting Les Schwab Tires closely observing and studying the methods and identifying key strategies to implement in his own business. Like other successful business leaders, such as Sam Walton, Jeff Bezos, and Jim Sinegal, Erickson understood the value of emulating successful strategies and was not hesitant to adopt them in his own business. So much so, that over the next two decades, he made an annual pilgrimage to the Les Schwab Tires stores, returning consistently with new and innovative ideas to enhance Sun Tires' operations and performance.
One key strategy he identified was Les Schwab's defined profit-sharing plan, which he implemented at Sun Tires and found to be highly effective. This unique incentive structure is at the top of the list of strategies recommended by Charlie Munger for studying incentives.
In addition to implementing a profit-sharing plan, Erickson ran each store as a separate profit and loss centre and implemented the practice of sharing weekly store performance metrics to drive internal competition, which is a common strategy among successful companies. However, what sets Sun Tires apart is the concept of "Specialized Work Units" for the business units that provided support functions. Erickson benchmarked industry norms to establish cost targets based on a percentage of revenues and then incentivized staff to support the revenue-driving functions and minimize costs, to maximize their take-home pay. This strategy fostered employee unity, decreased dependence on middle management, and removed bureaucracy.
The human capital practices of employee empowerment and incentives have been instrumental in driving Sun Tires' success in a highly competitive industry. This approach is a unique way to build a successful business, and more information on how these concepts were implemented at Sun Tires can be found in Dick Erickson and Danny Murphy's excellent book, ‘How the Rubber Meets the Road.’
I’ve included some of my favourite extracts from the book below.
Tone at the Top
“In any leadership role, if the leader is not walking his or her talk, the follower or the subordinate will become sceptical of what the leader is saying. You must be a living example of what you’re telling people.”
“Good customer service isn’t magic. The focus on customer service must come from the top down in any organisation.”
Hiring Policies and the Spirit of Service
“When I was hiring people for any form of customer service, I was always trying to detect whether they had the spirit of service in them.”
“I’ve seen people lose control of their payroll, thinking that if they hired in advance to prepare for an increase in business, the customers would show up. That’s not necessarily so. Sun Tire hire people as they were needed, and I recommend that approach to others.”
Copy Ideas
“Need a game plan? Copy one. You can’t copy patented devices or processes, copyrighted information, or trademarks. On the other hand, you can observe the way a successful business operates and incorporate some of what they do in your plan.”
“Copying someone else’s successful plan can be very efficient way to build a business. However many entrepreneurs have a problem with copying a game plan. They have their own strong opinions about how to do things. They’d prefer to make their own mistakes and learn as they move forward.”
“What I’ve figured out in business has been by watching successful people and imitating them.”
Exceed Customer Expectations
“Start with a game plan that you know will exceed customers’ wants and needs.”
“Exceeding customers’ wants and needs should always be the top priority.”
“Excellent customer service leads to longevity in business. When customers know that your company is going to solve their problems, they will keep coming back. He will tell their friends about your company. That leads to growth. Excellent customer service also gives employees something to take pride in.”
“Treating customers in ways that build trust is one way to beat the competition.”
“When you work in customer service, you must stay upbeat no matter what’s going on in your personal life.”
“Tires are a commodity. We had plenty of competition that sold and serviced similar products. Tire stores usually had three ways to compete: low price , association with name brands (Michelin, Goodyear, Firestone), and customer service. It was like a three-legged stool which must have all three legs balanced to function well. Most tire stores focused on brand names and competitive prices. Customer service was last on the list and there were only few competitors working in that direction. There were several reasons:
Good service is hard to perform consistently.
Marketing good service is also a challenge.
Training blue-collar workers to focus on customer service and perform to customers' satisfaction isn't easy.
Since most tire stores were concentrating on name brands and competitive prices, customer service appeared to be the best way to set Sun Tire apart. We sold name brands and made tires available at competitive prices, just like most of the other stores. If customers wanted Michelins, we had them. If customers wanted competitive prices, we had something for them. However, I saw customer service as the best way to win at the tire game. It wasn’t just a business strategy though, I wanted customers to be happy.”
Word-of-Mouth Advertising
“Excellent service is the key to developing loyalty from customers and clients. Excellent service is also the best way to turn customers into members of your booster club. It’s a well know fact that the most effective advertising isn’t advertising in the traditional sense at all. The best advertising is by word-of-mouth, someone telling a friend how great it was to do business with an organisation. When people get truly excellent service, they tell their friends about it because they know that their friends like excellent service as much they themselves do.”
Appearances
“Whether your operation involves showrooms, waiting rooms, dining rooms, or meeting rooms, the cleanliness and neatness of the facilities are evidence of your attitude towards customer service. Customer areas should always be neat and clean. Work areas should also be neat, and as much as possible, clean. In the tire business, you can’t expect the work areas to be sparkling clean like a hospital. Still, even in work areas that are hard to keep clean, everything should look neat.”
Reward and Empower Employees
“Employees should be given the opportunity to earn the best compensation in the industry.”
“There’s value to empowering employees. When a customer came back with some problem, the manager could take care of it up to $500. For problems up to that level, they didn’t have to get an approval from a superior. By allowing employees to make decisions at levels they are capable of, the need for supervision is reduced and the customer gets taken care of more quickly. A positive by-product is that employees feel engaged and empowered and that gives them positive feeling about their work.”
“When profit sharing is substantial, most employees do their best to improve profitability. Since other organisations didn’t have anything like Sun Tire’s program, it gave us an edge in terms of recruiting and retention.”
Sensible Growth
“Due to ego, some business owners pursue growth for the sake of growth. Growing at a moderate pace is sometimes better than trying to grow too quickly. A Sun Tire manager once remarked to me that he didn’t understand why we didn’t have fifty stores. I explained that good managers are the key to growth, and I believed in having a manager ready for any new store.”
Expect Tough Times, Learn from Them
“There are going to be tough times in every business. The important thing is to learn from them, make appropriate changes, and be prepared to do better next time.”
Humility
“I never got caught up in the expensive trapping of success. I didn’t get a second home, or a luxury car, or an Armani suit.”
“A good mentor will share with you what he thinks you need to hear, not necessarily what you want to hear.”
Complacency
“I’m convinced that complacency can absolutely destroy a company. If I ever become complacent, it didn’t last long. I’ve been consistent about looking for better ways to get things done.”
Transparency and Internal Competition
“The ‘Iron Man Report’ was a weekly report to provide transparency about how each store was performing compared to the other stores. I started with twelve items, but one of my mentors told me that was too many. People can’t concentrate on more than a handful of things at the same time. When the Iron Man Report came out, it was bragging rights to the achievers. The tire business is competitive, and I always wanted managers who liked to compete. The Iron Man Report provided an opportunity to compete within the company. Sharing the reports gave each store a picture of how they stacked up with the other stores. Nobody wanted to be on the bottom month after month.”
“It’s particularly important for a profit-sharing plan to be defined and transparent. That way, employees can see and understand how the amounts are calculated.”
Store Location
“When people talk about getting a great deal on a secondary location, I shake my head. For retail, you must have a good primary location.”
Develop Trust
“Trust reduces the cost of doing business. When more trust is placed in workers, less management oversight is needed. Lower management expenses translates into a better bottom line. Trust and honesty are like brother and sister. Trustworthy employees do not steal from the firm. Trust among team members fosters efficiency.”
Train Staff
“Train, train, train. Employees should continually receive the training they need to be successful in their jobs.”
Community Engagement
“It’s important you support whatever community you are in with your time and money. Business owners need the support of their communities. In turn, they should find ways to give back to their communities.”
Merit-based Competition
“Some companies have non-compete clauses in their employment contracts. Sun Tire never did. I always thought that if someone felt like he or she could do better elsewhere, he or she ought to be free to move on.”
Profit Share Program / Seperate Profit & Loss
“In many companies that have profit-sharing, the profits are calculated at the end of the year. Then a percentage of the profits are distributed to employees based on salary and/or position. In many organisations, the numbers are mysterious to anyone outside of upper management or the accounting department. At Sun Tire, we did things differently. Here are some of the things we wanted in a profit-sharing program.
Every employee would get a fair shot at earning a substantial amount in addition to his or her salary. The amount would be based on the productivity of his or her store or department in the company. Your position and your time in the company would define your bonus program
A program that would keep tire changers and mechanics, our front-line employees, engaged and motivated throughout the year.
Each employee would have a retirement account paid for out of company profits.
Profits would be transparent to all employees. Profits from each store or department were recorded and placed into a trust account.
To measure the profit coming in from a store is straightforward. Each store had a Profit and Loss (P&L) ledger. Subtract the expenses from the revenues and you have your profit amount. End-of-year profit-sharing checks were paid out of the trust to managers. Tire changers and mechanics received a monthly bonus based on the profits of the stores they were in.”
‘Specialised-Work-Units’
“We had other departments Administration, Warehouse Operations, and our Call Center which were important contributors to the company's growth and success. However, they didn't generate revenue. How could a bookkeeper or warehouse workers be rewarded for their valuable contributions to the profit-ability of the company? This was one challenging part of the plan.
We developed what I referred to as Specialised Work Units (SWUs). These included Administration and Warehouse Operations. Another one for the Call Center was in development at the time Sun Tire was sold. For profit-sharing to work for the whole organisation, there had to be a customised P&L ledger for each of the SWUs as well as the stores.
How did I come up with an ‘income’ figure for the Administration Department? I discovered that administrative costs throughout the tire industry were three to four percent of revenue. That's the percentage an owner of a tire business could expect to pay out for administration. For example, a tire company with annual revenues of ten million dollars would have about $300,000 to $400,000 in annual expenses for administration. I used three percent to develop a baseline figure for income for Sun Tire's Administration Department.
In the Sun Tire Defined Profit-sharing plan, the owner would split the difference between the hypothetical $300,000 and the actual expenses for Administration. If the Administration Department, which consisted of three employees, reduced their costs by $100,000, I would split that amount with the department. That would equal $50,000 into the trust for Administration. Within the department, there was a formula for dividing up the payout at the end of the year. Obviously, the employee who headed the department got a larger percentage than her subordinates.
With this method of profit-sharing in place, employees were engaged and highly motivated to work efficiently. The game wasn't just to punch in your hours on a timecard and get a check every week. At the end of the day in the stores, when the tire changers and mechanics asked their managers how the store had done for the day, they were sincerely interested. Being part of an SWU produced a sense of ownership for employees. The SWUs also had a degree of autonomy so that they could do what they needed to do to stay productive and efficient as a unit. At Sun Tire, The Administration Department, The Warehouse, and The Call Center all worked for and supported the stores. They had an interest in the continuing profitable growth of the stores.
When I first developed this plan for Administration, my outside accountant told me that nobody else he knew of was doing anything like it. There were people whose opinions I respected who told me I was being foolish to put a plan like that in place. I went ahead, and the program worked. The Administration Department reduced their expenses from the industry average of three to four percent down to 1.75 percent.
The Administration Department was very efficient. I know that similar companies had as many as six employees in Administration compared to our three. Also, with weekly store performance reports and weekly paychecks plus monthly profit-sharing checks for many employees, our Administration Department was doing more than the departments in similar organisations.”
Ownership Mentality
“Since our employees were thinking more like managers, there was no need for a layer of middle management to oversee them. They wanted their units to be productive and efficient because they stood to reap substantial rewards for their efforts. The more they saved for the company, the larger their share of the profits would be. So, when a copy machine started getting clunky, our employees were more inclined to try to get another year out of it rather than requesting a new one. And when they got a new one, they might decide they didn't need all the latest features. At some point, it appeared to me that we needed to add an employee to the Administration Department. Our office manager said the department could continue to get all the work done without adding another employee. Another employee would have been one more expense on the P&L ledger and one more person to split the profit-sharing with. As long as the department was efficient and effective, I learned to keep my mouth shut about adding another employee.”
“Another benefit of defined profit-sharing was reduced shrinkage. If a tire changer sees thievery that results in a lower profit-sharing check, he's going to take an interest in that. I remember one mechanic who asked me how the profit-sharing program worked. After I answered his questions, he told me about a manager who was stealing. If the profit-sharing had been too low, that employee might have taken less of an interest.”
“Some organisations put in cameras to fight shrinkage. I put in a defined profit-sharing program and I think it worked better than cameras.”
Summary
The practice of emulating successful strategies and models employed by other businesses has been a prevalent tactic in the creation of highly successful companies throughout history. Charlie Munger has acknowledged the utilization of this approach in the development of Berkshire Hathaway, stating that "All Berkshire Hathaway does is copy the right people."
The importance of having a strong and capable team, particularly in the customer service industry, has been a recurrent topic of discussion. Herb Kelleher, the founder of Southwest Airlines, has noted that the significance of individuals and their attitudes cannot be overstated in the customer service business. Service that exceeds customer expectations is a distinct competitive advantage, as it drives customer loyalty and fosters positive word-of-mouth advertising for the business. This is often achieved when employees are empowered, respected, trusted, and rewarded for their efforts.
It is noteworthy that the three tire businesses we’ve covered, which have generated results that are the envy of the industry, possess many similar characteristics. The ‘confederation of partnerships’ model is a particularly powerful business model that can lead to attractive long-term returns when executed effectively.
Source: ‘How the Rubber Meets the Road,’ Dick Erickson and Danny Murphy, 2020.
Further Reading:
‘Learning from National Tire’s Bruce Halle,’ Investment Masters Class 2023.
‘Learning from Les Schwab,’ Investment Masters Class, 2018.
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