| Denial of Risk and Peril An Overview of “How the Mighty Fall” by Jim Collins November, 2012 Sorry for last month’s departure from my overview of “How the Mighty Fall.” I really felt that with the pending election I needed to share a bit of my own personal philosophy since so much of the election focused on our economy and how we should move forward. The nation has spoken and hopefully we don’t see four more years of the same policies that are hindering our long term growth while digging us deeper into debt. I really hope both sides of the aisle can come to terms, but only time will tell… The third stage of decline is somewhat apropos to where the nation currently sits; teetering at the top of the fiscal cliff. The next few decisions are critical to either reverse the decline or send us spiraling down into another recession or worse yet, a depression.
In the late 1980’s Motorola began to invest seed capital in a new technology that would guarantee a phone connection from any point on Earth; the new service was called Iridium. After a series of low-orbiting satellites were launched, Motorola spun Iridium off as a separate company and continued to fund the development of the concept. By 1996, Motorola had sunk over $500 million in cash and guaranteed over $750 million in loans on Iridium’s behalf; exceeding Motorola’s entire profit for the same year. However, Iridium still wasn’t ready for commercial use and would need significantly more capital in order to launch the 60 plus satellites required for service. At the same time, the business case for Iridium had changed dramatically. In the 1980s cell coverage was sparse, at best, but by the mid-1990s traditional cell service blanketed much of the globe, including many rural areas in developing nations. There was mounting empirical evidence against moving forward with the venture but Iridium, at the direction of its largest shareholder, Motorola, decided to move forward, and in 1998 Iridium went live for new customers. The very next year Iridium filed for bankruptcy and defaulted on more than $1.5 billion in loans. Motorola was forced to write-off more than $2 billion in losses related to Iridium, helping to push Motorola to the next stage of decline. Motorola needed to make a tough decision, cut bait and walk away from the $500 million in cash they invested or hope for a big hit despite the fact the service was no longer relevant. Motorola rolled the dice and nearly lost it all. In contrast, by the late 1970s Texas Instruments (TI) had developed and sold a novel toy that spoke words to children to help them learn to spell. They called it Speak & Spell (I was a huge fan). While the end product was just a toy, the brain behind the device was the DSP chip. TI’s initial investment in the DSP chip was $150,000, a mere fraction of their revenues for the year. By 1986, TI had generated $6 million in revenues from DSP chips, which supported further investment in the technology. Over time customers began to find new uses for DSP in modems and in a variety of communication devices. In 1993, TI landed a contract with Nokia to create DSP chips for their digital cell phones. Four years later, DSP chips could be found in more than 22 million phones around the world. In a bold move, TI’s CEO decided to sell off TI’s defense and memory chip businesses in order to focus on the growing DSP market. But, contrary to how it sounds on paper, TI didn’t make a rash decision. They didn’t bet the farm on a new shiny object. Over the course of more than 15 years, TI made a series of small investments into DSP in order to slowly turn the flywheel and fully test out the business case, and only when the evidence supported the decision did they decided to move forward. TI didn’t bet big in 1982 when they were able to put DSP on a single chip, nor when they had generated $6 million in revenues in 1986. They waited until the decision was essentially made for them. Thankfully, the bold decision paid off and by 2004, TI controlled more than half of the $8 billion DSP market. Collins points to an interesting concept used by Bill Gore, founder of W.L. Gore & Associates, for decision making and risk taking, called the “waterline” principle. The concept is pretty simple; think about being on a ship at sea and any bad decision will blow a hole in the side of the ship. If you blow a hole above the waterline, there will be damage to the ship but you can still patch the hole (learn from your mistake) and move on. However, if you blow a hole below the waterline, the ship will immediately take on water and begin to sink. Can you still patch the hole? Yes, but it will be incredibly difficult and you will continue to sink until the ship has been fully repaired. Make a really bad decision and the hole may be too large to repair and the ship will quickly sink to bottom of the ocean. Again, businesses still can make big bets but they need to be prepared in the event they make the wrong decision. Collins suggests asking three questions when making risky bets and decisions in the event of ambiguous or conflicting data: 1) What’s the upside if events turn out well? 2) What’s the downside if events go very badly? 3) Can you live with the downside? In other words, would a bad decision blow a hole above or below the waterline, and can you survive in either case? The financial meltdown of 2008 shows what happens when you avoid these types of questions. As the housing market bubble grew at an unprecedented rate, so did the likelihood of a catastrophic real estate crash. Do you think anyone on Wall Street and abroad ever weighed the upside of dramatically increasing leverage and exposure to mortgage-backed securities against the downside of a housing market crash followed by a worldwide credit crisis? The stakeholders of Merrill Lynch, Fannie Mae, Bear Stearns and Lehman Brothers certainly bet big on the upside of the credit market but failed to consider what would happen if they were wrong. In the end, they either sold out or simply disappeared altogether. Remember, companies in and of themselves aren’t making the decisions, they are made by a team of executives. A successful company must have the “right” people in the “right” seats working towards the “right” goals. Leadership teams on the way down tend to exhibit similar dynamics: 1) Those in power are shielded from grim facts for fear of penalty. 2) Team members agree with strategic decisions yet do not unite to make the strategies a success. 3) Team members argue to “look smart” or to simply improve their own interests rather than argue to find the best answers. 4) Team members conduct a post-mortem of a bad decision in order to assign blame instead of learning from their painful experiences (this is one of my favorites). Bold decisions are ok and often lead to significant innovations and gains in the market. However, decline and, ultimately, demise can be self-inflicted if a company refuses to listen to its customers, the market, and, more importantly, its employees. No matter how big or small, the wrong decision can send any company to the bottom of the ocean. ~TJM ——————– |
| BABE OF THE MONTH “Desiree”
2005 Deere 800C Contact: Travis Mottet |
| BOOZE REVIEW An Unexpected Treat
Names have been changed to preserve the innocent, so for the sake of the story, let’s call him “Bob.” I flew out on very short notice to meet Bob at Wagner’s yard. I had only spoken with Bob on the phone over the prior two weeks and he claimed to be working with a major player and would be buying dozens of machines in the coming months. I figured anyone who would spend the money to fly out to inspect a machine was serious, so I plunked down $700 on Southwest and flew out to meet him the next day. Bob picked me up at the hotel and we drove out to Wagner’s yard. The drive was about 15 minutes so we had a little time to get to know each other. Bob was from Texas and had the accent and boots to prove it. We were about the same age and were both fairly new to the industry. He seemed like a straight shooter and was very easy to get along with. We arrived at the yard and spent the next 10 minutes looking over the scraper. It was a clean unit with good tires, no blow-by, good chains, and best of all, was priced right. Bob hoped out of the cab and said, “You got yourself a deal!” and we shook hands. Neither of us had flights until the next morning, so I suggested that we grab a drink and a bite to eat to celebrate our first deal. We headed back into town and ended up at some Hooters knock-off aptly named “Twin Peaks.” Get it? I wasn’t in the mood for a beer and it seemed too early in the evening for a scotch so I asked the girl what she could suggest. Her repertoire of beverages was fairly limited, so she could only suggest a few drinks that were “on special” and said the Tennessee Honey with ginger ale was pretty good. I ordered one and hoped for the best but expected the worst. I was quite surprised at how good my first sip tasted. It wasn’t too sweet as you would expect from a liqueur and the ginger ale gave it a little zing to the aftertaste. I’m really not one for cutting my drinks with mixers, so the next order was for Tennessee Honey on the rocks, which was perfect. The ice really opened up the whiskey as it melted, while the honey masked most of the typical alcohol bite. The next drink turned into a few more and I was officially hooked. Bob and I wrapped up dinner and made a slight detour to the local casino before retiring to our respective hotels. We both had early flights and Bob assured me the money for the scraper would be in my account by the following week. I wish the trip to Albuquerque had produced two new friends but sadly I was left with just the drink as Bob dragged the deal on for another 3 weeks and then dropped off the face of the earth. Oh well, at least I can always count on Jack. ~TJM |
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