Conflicting incentives – MBA Learnings

In my last post about the tension between debt, shareholders, management and taxes, I ended with a line that leads straight into today’s post – “But, if there’s one thing I’ve learnt about markets, they’re rife with conflicts of interest.”

Let’s now take a look at the life of John Doe. John is an executive at a leading Fortune 500 company headquartered in the US. He gets paid $1 million in cash, 4 million in stock, and 20 million in various incentive related bonuses that are tied to “EPS” or earnings per share.

Now, let’s think about the many decisions he needs to make as a CEO that impact other constituents –
– How much debt should the company take on?
– How much tax will the company pay? (vs. how much of income will it recognize in low tax jurisdictions?)
– Should we pay dividends or repurchase shares?
– Should I take riskier investment bets or less risky bets?

Every one of these has an implication on the company’s profitability. And, a company’s profitability directly affects it share price. However, they do so in different place.

Let’s take dividends vs. share repurchases. When John’s company has a $100 in extra cash, they can either choose to pay the money in dividends to shareholders or choose to buy back their own shares from shareholders. Technically, they are both ways of returning money to shareholders. However, dividends inevitably reduce the share price (a company’s share price reflects the value of future cash flows – less cash available = less share price) while share repurchases generally have a positive effect on EPS.

While there are other impacts of making a dividends vs. repurchase decision, this difference alone highlights a conflict of incentives. John Doe and his executive team are often compensated on EPS. And, the markets often price stocks as a multiple of EPS. So, when the firm increases of EPS, it inevitable leads to an increase in share price. Now, it is great when that happens because of excellent management and/or smart investment bets. But, financial re-engineering, e.g. taking on excess debt, avoiding taxes, and/or repurchasing shares vs. paying dividends can also increase executive compensation significantly. John knows that he’s, at best, got a few good years as the CEO of this firm before he inevitably gets fired. So, why not make the most of it and swing these decisions in his favor?

There’s been a lot of discussion in the news about executive compensation as such decisions frequently come under scrutiny. In some ways, these conflicts make the markets fascinating. In other ways, they can make us cynical about decisions made by companies. My take has been to examine decisions more carefully to really understand what is going on and to understand the incentives in place. More often than not, the behavior we reward is the behavior we get.

One final plug on executive compensation – there are huge implications on the importance of ethics in these conversations. There has probably been an uptick in these conversations post the Enron debacle. I don’t think these conversations happen nearly as often as they should.

Happiness is not a station we arrive at

It is a manner of traveling.

And, every once a while, we need to drown out all the noise to understand our manner of choice. Our manner of traveling won’t work with every person in every environment.

But, that’s why happiness is described as either a “journey,” “pursuit” or “search” – it is all of that. And, it is up to us.

Howard Moskowitz and Spaghetti Sauce – The 200 words project

Here’s this week’s 200 word idea thanks to Malcolm Gladwell’s TED talk with a hat tip to Prof Jen Brown @ the Kellogg school for sharing.

Campbell soup went to psychophysicist Howard Moskowitz to help fix their Prego brand of spaghetti sauce in the 1980s. Prego was struggling and Campbell wanted Moskowitz to find the perfect Prego recipe.

So, Howard looked through mountains of data about how American people felt about spaghetti sauce. But, instead of looking for a perfect variety (a hypothesis that completely neglected diversity), he tried to see if there were clusters. And, sure enough, he found people who liked 3 kinds of sauces – plain, spicy and extra chunky.

Prego were shocked at his findings because there was no extra-chunky spaghetti sauce in the market. So, Prego completely reformulated their spaghetti sauce, and came out with a line of extra chunky that immediately and completely took off, making 600 million dollars in 10 years. It was a powerful insight – there is no “one” spaghetti sauce – one that economists call horizontal differentiation.

We often find ourselves looking for one perfect solution to solve a problem (or find happiness). But, Gladwell shares what he thinks is the most beautiful lesson from Moskowitz’s work – in embracing the diversity of human beings, we find a surer way to true happiness.

Howard Moskowitz spaghetti sauceSource and thanks to: The Daily Eater

That’s when everyone else in the industry looked at what Howard had done, and they said, “Oh my god! We’ve been thinking all wrong!” And that’s when you started to get seven different kinds of vinegar, and 14 different kinds of mustard, and 71 different kinds of olive oil. – Malcolm Gladwell

Distinctly un-cool

A butterfly’s lifecycle is a great example of the lifecycle of something cool.

Source: Milkweed for Monarchs

You go through many stages that look distinctly un-cool until something beautiful appears.

Behind any kind of greatness lies years spent in activities that are distinctly un-cool at the time – days spent in self doubt, weekends spent working on that dream, and years spent in lonely practice. There is no guarantee that these efforts will lead to the desired rewards. Sometimes it all works out. And, sometimes it doesn’t.

And, even when it doesn’t, it is just the desired reward that doesn’t work out. What follows whole-hearted effort are character, happiness, and a persistent spirit that moves onto working on the next thing.

The best thing about those riches is that they’re eternal..

Audible app for iOS – Product Review 1

A big part of this blog has been about learning “how to see.” I see failure as learning today. And, getting to that has been an incredible journey. I’ve wanted to learn how to “see” and understand products for a while now. So, thanks to a suggestion from a wise friend, I’m going to review interesting products and services. In looking at products and services critically, I hope to understand what makes great products/services and also develop an awareness while I use them so I can, hopefully, design great experiences myself.

My framework for reviews will be based on Jeff Weiner’s 5 attributes of a great product. Hope you enjoy these posts.

 

My first product will be Audible’s app for iOS.

Attribute #1. Delivers on a singular value proposition in a world-class way (purpose): Grade – A+
The Audible app exists to enable users to read audio books. It does that better than any other app out there. The Audible audio book library is fantastic and the app ensures easy access to it.

Attribute #2. Simple, intuitive, and anticipates needs (design): Grade – C
The app does okay on being simple and intuitive. You click it open, pick a book from “your library” and start reading. The other tabs are easy to understand.

I definitely think there still is room for improvement – for example –
– I’d like it to play and pause no matter where I touch
– I wonder if the “more” tab could do with less options
– I wish they did something useful with the badge collection
– And, I’d love for them to analyze my reading data and push insights and/or reminders to read

However, it isn’t a bad experience so I would still give it a B. But, it gets a C because it fails in anticipating my needs. Audible has great improved its app over time but its recommendation engine / “Discover” tab remains woeful. For instance, I have 91 titles and a quick scan will tell you that I read certain kinds of book on audible – always non fiction with a heavy bias to topics like psychology and technology. And, yet, the Discover tab never does anything except list out current fiction best sellers.

Attribute #3. Exceeds expectations (customer love): Grade – A+
I have contact Audible many times over the past 7 years and I’ve been well taken care of every time. And, every once a while, I’ve been blown away. They do a great job here.

Attribute #4. Emotionally resonates (feel): Grade – A+
3 words that come to mind when I think of how Audible makes me feel – learning, productive, and happy. 

Attribute #5. Changes the user’s life for the better (impact): Grade – A+
I’ve been thankful to Audible many a time over the past years. It has helped me read a lot and enabled me to learn and grow as a person. Definitely among the highest impact app that’s been an ever present on my home screen and the quick access bar.

Overall Grade – A-
The team has improved the app a lot over the years. And, I’m hoping the team keeps improving. It is a “star” product. A few changes could make it an “all star” product.

Fitbit and lifestyle

Since receiving a Fitbit as a wedding gift from a couple of close friends 2 years ago (thanks guys!), I’ve carried a Fitbit around most days. Thanks to traveling to my California, my new temporary location, without my fitbit charger, I went three weeks without wearing a Fitbit. As far as my lifestyle went, I’d been exercising as per normal. So, I assumed all was normal.

I finally managed to borrow a charger on Monday and realized within a few hours that all was actually not normal. I was barely walking a couple of thousand steps a day. I walk a lot more from home to school on normal days but, thanks to driving everywhere here, there’s barely any walking done. So, I stopped taking the elevator on Monday and have been trekking up and down our five floor building since. The step counts are getting closer to normal and I feel much happier.

I realized 3 things –

1. It is so easy to let things slip when you don’t measure them. The degradation may be gradual but it is degradation nevertheless.

2. Not walking much may seem like a small thing. But, over time, the effects of these small habits compound. Leading a healthy lifestyle, in my eyes, involves standing enough (go standing desks!), walking enough and exercising. And, the 10,000 steps on Fitbit / 8.7km / 5.4 miles is a great proxy for whether I’ve walked enough in a day.

3. I love how transformative a product can be. I know there are many fitness trackers out there these days but I associate the whole space with my Fitbit. I just want to express my gratitude to the Fitbit team for what they’ve done. To anyone on the Fitbit team who’s reading this, congratulations on your IPO – well deserved!

Amazon pop up stores and retail

I saw this at a mall close by last weekend. I’d read about Amazon opening up pop up stores in a couple of locations but I hadn’t seen one myself.

Amazon Pop up

The question in the mind of anyone who is interested in Amazon is – is this a sign of Amazon’s commitment to physical retail? My hunch is that it isn’t clear anyone, including Jeff Bezos, knows for sure. Amazon’s growth has been nothing short of stunning. However, of late, that growth, especially in retail, has slowed. And, it is clear that the retail behemoth is looking for ways to continue accelerating the growth. However, online retail as a percentage of physical retail has been hovering at the 10% mark for a couple of years now – this means 9/10 retail purchases are still made offline. And, Amazon definitely wants in. Or, does it?

The downside for Amazon is that it’ll lose a significant part of its cost efficiency if it takes the plunge into retail. But, on the other hand, it might help Amazon make its 1 hour delivery ambitions real. It all depends on how retail shakes out.

Retail, in the past, was pretty much physical. Aside from a few niche services that allowed you to call and order, you had to show up at a store and buy things. Thanks to the internet, we saw players like Amazon run e-commerce stores that did not have a retail presence. Over time, 10% of shopping in North America has shifted to e-commerce. This proportion will undoubtedly increase, but, it isn’t clear by how much. There are, after all, many who actually enjoy the physical shopping experience. In the last few years, Europe, and more recently the US, has experienced a rise of the hybrid experience – order online and pick up at store. If retail stores still stock a reasonable selection, this has a best-of-both-worlds effect as it enables shoppers to save time on the essentials by having them pre-ordered, packaged and ready and leaves them to enjoy the pleasure of shopping. It also saves money for the retailers as they can enjoy the savings due to scale.

All of this leads to the big question – what does retail look like in the future? I think, in 10 years, we will see –
1. 30% physical/traditional
2. 30% online
3. 40% hybrid

I don’t believe physical retail will ever go away. I just think the experience will need to be differentiated and unique so it caters to those who really enjoy the physical retail experience. It’ll also mean we’ll see physical do well in goods that are unique – e.g. clothes (think Bonobos) – and no longer need to worry about choosing a bottle of vinegar from 73 options. I think online will continue to grow but I think there are too many advantages for the hybrid model not to work.

So, if I were Amazon, I’d double down on the pop up store test. This could be key to whether they’ll thrive as a retailer. (Note: the key word is retailer. I am bullish on Amazon thriving as a company as long as Bezos is leading it)

The small things

If you see someone come in to a non critical meeting prepared and with an agenda, take notice.

There are many who brush away the “small things” because they’re saving themselves for the “big things.”

Why bother showing up on time for a meeting at school? I’ll do that at work.
Why bother keeping up my promises with my peers? I’ll do that when my boss asks me to.
Why bother? I’ll do that when I have to.

Many of these folk do actually bring their A game when they have to or when the big boss asks them to.

But, the way life works, very few meetings or opportunities come with the right labels. Very often, it is the small meetings and interactions that lead to the big meetings and interactions.

Watch for how we approach the small things. Because, it is the small things that become the big things.

Huger mistakes and better processes

I make mistakes like the next man. In fact, being–forgive me–rather cleverer than most men, my mistakes tend to be correspondingly huger. | Albus Dumbledore

As we grow older, and hopefully smarter and wiser, our mistakes generally become bigger. We may make fewer mistakes but the stakes are generally much higher than they used to be. That’s part of the natural growth process. Sometimes, this process is accelerated – as in the case with young entrepreneurs who’ve created successful companies and find themselves making huge mistakes – and sometimes, it happens slowly. But, if you’re learning, growing and doing more, it generally happens nevertheless. Bad judgment -> mistakes -> experience -> good judgment.

The response when we make such mistakes should not be to attempt to avoid them. Instead, it should be to check if our processes are better today than they were yesterday. Here are a couple of examples –

Example 1 (good) – when I went on school trips as a kid, a loss of possessions was guaranteed. I’ve lost many clothes and shoes on these trips. Over time, I’ve learnt that I’m pretty careful with others’ possessions but tend to be careless with my own. I’ve also learnt to be aware of this and modify my processes. So, today, as I finished up a camping trip, I actually double checked our tent to make sure I didn’t leave anything behind.
Does this mean I’m going to stop losing stuff? Absolutely not. I misplaced a water bottle just a week ago, after all. But, the processes are getting better and I hope to lose less stuff in the future.

Example 2 (not good) – I bought a $25 extra protective sole for my shoe last weekend and promptly threw the receipt and the box. It seemed to work fine at the store but the daily reality was that it wasn’t right. And, unfortunately, I can’t return it without a receipt or a box. That’s $25 I will never see again. This, however, is a mistake that I kicked myself for – in my ongoing attempts to keep clutter out of life, I’ve disposed off receipts too quickly in the past. And, yet, I haven’t quite learnt – a perfect example of a bad process. A moment’s thought made me realize that I could easily have taken a quick photo on my phone and then disposed the receipt.

Lesson hopefully learnt and process hopefully improved.

The mistakes will keep coming and will continue to get bigger. But, the goal with examining processes is to make sure we make newer, better mistakes and learn from them. With every mistake, we can get better. Like all good things in life, the choice is ours.

Realistic job preview – The 200 words project

Here’s this week’s 200 word idea thanks to Decisive by Chip Heath and Dan Heath..

At a time when call-centers kept revisiting their hiring process because the average employee left within 3 months, Evolve tried a different approach. They called it “a realistic job preview.”

On day 1, the trainers showed applicants everything negative about the job. They took them through an example of a bad customer call with an irate customer who insulted them, then spoke about the bad hours and the difficulties to commute to their center.

Almost as soon as they started this practice, they experienced decrease in turnover with savings of $1.6M in a call-center that employed 5000. The reason for the success of the job preview was not because it scared off applicants. Very few actually change their decision. Instead, it simply ensures vaccinated them to surprises and made them decide they would succeed.

As a result, the author’s advise – when starting on a new project, try getting a preview from others who have done it. These experiences trigger coping mechanisms and help us trigger responses long before we face real problems.

Realistic job previewSource and thanks to: www.EBSketchin.com

When we are no longer able to change a situation, we are challenged to change ourselves. – Viktor Frankl