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IC book club: crisis points and how to survive them

Tom Dines looks to two business classics to understand how investors can manage the corporate world's inherent uncertainties
March 28, 2019

In some ways, crises are what makes the business world go round. Changes in technological capability, customer preferences or market needs drive the constant churn in the stock market, allowing companies to grow, overtake their predecessors and eventually fall away, to be replaced themselves by plucky new upstarts. Changes create buying and selling opportunities for investors with the insight – and luck – to get in on a good thing early. But is there a reliable way to identify these continuous waves of disruption so they might be surfed, instead of watching them wash your holdings away?

 

The books we read

Only the Paranoid Survive, Andy Grove, (1996, Profile Books)

Business Adventures: Twelve classic tales from the world of Wall Street, John Brooks (1959, republished in 2014 by JM Learning)

Two business classics help us understand the problem from more than one angle. First up is Andy Grove's Only the Paranoid Survive. As the long-serving chief executive of Intel Corporation (US:INTC), Mr Grove built the company into one of the most significant players in the global memory chip market, before identifying the growing threat from its ascendant Japanese competitors and successfully transforming the business into a world leader in microprocessors. The book deals with how to identify and survive what he calls “strategic inflexion points”, when the “balance of forces shifts from the old structure, from the old ways of doing business and the old ways of competing, to the new”.

Business Adventures is a collection of business articles first published in The New Yorker magazine by journalist John Brooks, detailing various aspects of Wall Street and business life. The book includes detailed looks at failed product launches, corporate misdeeds and market bubbles. Mr Brooks does not take the expressly didactic, ‘how-to’ approach of Mr Grove, but his articles are nonetheless instructive about the more subtle ways businesses and individuals can fall prey to echo chambers, misguided ideas and greed. If Only the Paranoid Survive is about the way outside forces can sweep your investments away before you realise what is happening, Business Adventures looks at how people can gradually undermine themselves. Bill Gates described it as “the best business book ever written” after being given a copy by Warren Buffett.

 

Change is coming

One of the key lessons taught in both books is the fact that the business environment is always changing, and people must continuously look to try to understand how it is shifting. As Mr Grove puts it, “all businesses operate by some set of unstated rules, and sometimes these rules change… They creep up on you as they crept up on us, without warning”.

Helpfully, he provides a framework for where these changes might appear. Mr Grove adapts Porter’s Five Forces – the five dimensions that affect a company’s competitiveness, developed by Harvard professor Michael Porter – and adds his own. Put simply, a company’s competitive landscape is dictated by the strength of its customers, suppliers, competitors – existing and possible – and businesses with complementary products, known as “complementors”. The sixth “force” is the possibility that what the business does can be done in a different way. Companies reach an inflexion point when one of the six forces undergoes a change that is an order of magnitude greater than anything the business has prepared for or expected.

Investors must be alive to the fact that such changes are inevitable. In Business Adventures, Mr Brooks quotes Canadian philosopher Marshal McLuhan to drive the point home: “There is no possible protection from technology except by technology. When you create a new environment with one technology, you have to create an anti-environment with the next.”

 

Keep your finger on the pulse

It will surprise nobody to learn that both authors talk about the importance of having up-to-date, high-quality information. Having a clear picture of what is going on in a business and its markets allows investors to make sensible decisions and change direction when necessary. 

Mr Grove’s prescription is to spend as much time as possible speaking to people who operate on the edges of the business, meaning customers and those closest to the customers. Looking for the edges can also mean talking to people in different geographies and departments. As he puts it, “when spring comes, snow melts first at the periphery”.

Indeed, while Mr Grove’s view of business puts management at the centre, he explains that often those at the top are the least in touch with the business itself. Nobody likes to be the bearer of bad news, and so “news from the outside has to percolate through layers of people from the periphery where the action is”.

Timeliness is also a factor, and operating with information that is only a little out of date can be extremely damaging if the direction of events has changed. Mr Brooks illustrates this in an article about the ‘flash crash of 1962’, when high trading volumes caused lengthy delays to the market news traders received by teleprinter. Mr Brooks notes that at one point the market had turned from negative to positive, but the news reports were delayed by 56 minutes. “Therefore, apart from fleeting intimations supplied by a few ‘flash’ prices, the ticker was engaged in informing the stock-market community of a selling panic at a moment when what was actually in progress was a buying panic.”

“The fear of a new environment sneaking up on us should keep up on our toes,” says Mr Grove. However, there is a limit to how much even high-quality information can help in a changing environment, as the very definition of what constitutes pertinent information may change. As Mr Grove warns: “Data are about the past, and strategic inflexion points are about the future.”

 

Don’t get emotional

While information is crucial, it is not enough on its own. Investors face the challenge of trying to root out the vital information and weigh it up, all the while being alive to the fact that new information may render it almost entirely irrelevant.

Mr Brooks captures this dichotomy brilliantly with an article about the fate of the Edsel, a much-hyped car launch by Ford (US:F) that drastically underperformed. Ironically, the team behind designing and launching the car started well. They sought out information through customer research and even identified changes in taste. Mr Grove notes that shifts in customer motivations can form a strategic inflexion point, highlighting how Ford marketed the Model T to the utilitarian early automobile customers – “it takes you there and brings you back” – to how General Motors marketed to more style-conscious customers following World War One – “a car for every purse and purpose”. The Edsel team exhaustively researched the motivations of customers when it came to their identities and how they wanted a car to feel, without consideration for what they wanted a car to do. The research “dealt exhaustively with practically everything having to do with automobiles except such matters as how much they cost, how safe they were, and whether they ran,” says Mr Brooks. As a result, the cars were “dramatically imperfect”.

It was more than just overlooking the basics that led the car to fail, however. Mr Brooks notes that the research, while properly conducted, was at times disregarded and “old-fashioned snake-oil selling methods, intuitive rather than scientific, crept in”.

In fact, management seemed to become aware of the flaws of the process before the car’s release. The Edsel was marketed widely and received a lot of media attention. However, these efforts were very successful, and public enthusiasm reached the level where a letdown began to look inevitable. One member of the Ford team noted that “the public was getting to be hysterical to see our car, figuring it was going to be some kind of dream car”. Before the launch, he claims – albeit with the benefit of hindsight – that he said to a colleague “when they find out it’s got four wheels and one engine, just like the next car, they’re liable to be disappointed”.

This example of being damned by success gets to the heart of what Mr Grove says about the difficulty of changing tack, even once a looming crisis has been identified. Mr Brooks quotes a Ford executive as having said “if the company weren’t in so deep, we never would have brought it out now”. However, while the Ford executives pressed on, if a little halfheartedly, with what they felt would be a wasted endeavour, Mr Grove managed to change direction.

He describes talking to a fellow executive during a troubling period for Intel. Well-funded Japanese rivals were aggressively taking market share. Mr Grove had seen a memo from a competitor instructing sales teams to quote memory chip prices 10 per cent lower than those of Intel and its American rival AMD (US:AMD) and to keep cutting 10 per cent until they won the customer. Mr Grove and the executive were considering what would happen if the board fired them and brought in a new team. After concluding that the new team would probably pull the group out of the memory business, the two decided they would do it themselves. The sunk cost fallacy can help to explain why such a shift is difficult. People find it difficult to abandon something after they have already invested time, money or effort into it, even if they know it is a bad idea to continue. As Mr Grove says, “people who have no emotional stake in a decision can see what needs to be done sooner”.

 

Getting it done – kill your darlings

Mr Grove provides a three-question checklist to give an early indication whether a change might signal an inflexion point. Investors should ask themselves if previously successful people – managers or investors – seem to have become unable to operate in their environment. They should also ask if a company’s key complementors or competitors are about to change. For an example of the impact customer change can have, one need only look at the share price drop at Bunzl (BNZL) in November 2017 when an analyst note suggested Amazon (US:AMZN) was about to emerge as its principal competitor.

As the Edsel story illustrates, however, even when a threat has been identified it can be difficult to change direction. Getting it right is a matter of timing, and timing it right depends on being able to change course while things are going well. Mr Grove says investors should make the shift when the existing strategy is still working, and the business is still highly thought of by customers and complementors, “yet there’s enough evidence of blips on your radar screen to warrant, at a minimum, exploring their significance”.

The key then is cultivating a healthy level of paranoia and always looking for evidence to disprove your seemingly successful investment hypotheses. Like the physicist Richard Feynman used to say, “the first principle is that you must not fool yourself, and you are the easiest person to fool”.