by Jacob Taylor
“Are you saying when a customer refers a friend, they’re almost referring themselves all over again?” I asked.
“You said it better than I did… first time for everything,” he said. “Here’s that other advertising joke I promised. It’s more of a pithy observation. When you stop to think about it, a flower is nothing more than a weed with an advertising budget.”
“Huh, I guess that’s true,” I said. “Humans go to great lengths to plant flowers. But we pull weeds out of the ground because we don’t like their advertising. But is there really much of a difference? They’re both just plants trying to survive and propagate.”
“There’s a very profound idea buried in that joke,” he said. “Remember back to our Iron Rule of Economic Survival. What does successful advertising do to our triangles?”
“There’s obviously a cost involved. You have to buy ad space or pay the skywriting pilot,” I said.
“True,” he nodded. “Keep going--think of a great ad you saw. How did it make you feel inside?”
After a bit of reminiscing, I said, “I remember when I was a kid the Gatorade commercials with Michael Jordan. I was never that into sports, but my best friend loved watching him play basketball. He used to say that drinking Gatorade was his chance to ‘Be Like Mike.’ He told me he was drinking the same lemon-lime flavor that Jordan drank during his games.”
“That’s a great example,” he said. “So Gatorade was able to take yellow-colored sugar water and make him feel he could be Michael Jordan. How much more do you think he enjoyed Gatorade because of that commercial?”
“He told me he made sure to have it at every game, as part of a good luck routine,” I said. “I was never like Mike. I was a foot shorter than everyone else and could barely dribble.”
“I’m sure you brought other skills?” he said in a fatherly way.
“Yeah, I kept the bench warm for all the other players.”
“Every experience makes us who we are,” he said tenderly. “Back to our lesson. Advertising has two functions: make people aware of the product, and shift out that V straw and increase the perceived value a customer experiences. If you can nudge V out farther than the cost required, I’d consider that to be a sound strategic expense. At Cootie we happen to focus on quality ingredients and a great customer experience, but that doesn’t mean it’s the only way. Gatorade dramatically increased the perceived value of their drinks in your friend’s mind through their association with Michael Jordan.”
“I guess there are a lot more ways to shift the Value straw than I realized,” I said.
“Indeed, and if your business focuses on discovering and expanding on those ways through imagining Eleven-Star Experiences, you have a good shot at making your customers feel great--which is the whole point of business.” Ugh, there was that feeling discomfort again in the pit of my chest. I was definitely warming up to the whole concept of business when it was explained by my Midwest Miyagi. It seemed unthinkable: the idea that capitalism actually served the little people instead of taking advantage of them? Che would not approve. Talk about cognitive dissonance.
Mr. X sat quietly while I pushed him along in his chair. He instructed me to turn onto a small paved path that lead away from the river. We went over a few small hills and came to the gate of a cemetery. Mr. X said to go inside. OK...
We wound our way through the grey and black headstones that popped from the verdant grass. Life and death in stark relief. I did the math on how long the deceased had lived as we meandered by the headstones. I tried to imagine what their lives had been like based on the dates. All those thoughts, hopes, and dreams that make up a person, distilled to a slab of rock with some etchings on it. Dust in the wind...
Mr. X navigated via monosyllabic instructions as we walked deeper into the graveyard. “I want to tell you a very personal story.” Have I finally broken through to him?
“OK, Mr. X,” I said. He was staring off into the distance as we glided along the weaving path.
“I mentioned before that I have…” he paused as the words stuck in his throat. “... had an amazing wife and daughter. I also had a son. His name was Edward, but we called him Eddie. He was a special kid. Smart, precocious, though a bit of a showoff. When Eddie was nine years old, he came down with a cough. Nothing out of the ordinary for a healthy kid, but after awhile, it wouldn’t go away.”
Mr. X pointed to an offshoot of the main path and we followed a capillary into a section of headstones. He held up his hand, signaling to stop. I followed his eyes to a smaller stone with a handsome placard. Reading it grabbed my soul with a wrench.
Edward Richard Xavier
1961-1971
“We took Eddie in to see the doctor. After a battery of tests, we discovered he had a tumor in his chest cavity. The doctor scheduled a surgery to remove it...” He trailed off, staring out at the rolling hills. The thick blanket of clouds fit the somber mood. “We knew the surgery carried risks...” His eyes were moist, the wound torn open again for probably the millionth time. His voice was gravel, “Eddie didn’t survive the surgery.”
“I’m sorry, Mr. X,” I whispered and squeezed his shoulder.
“I remember wandering the streets of Wichita, lost, alone with my grief, crying uncontrollably. My wife and daughter were at home, but I just couldn’t bear seeing them at that point. I stumbled down the street saying Eddie’s name over and over again out loud as my mind played highlights of our short time with him.” Tears were now streaming down his crinkled face. “Even more painful was imagining the moments that would never come to be. I’m sure I looked like a lunatic…” He took time to recompose himself.
“Don’t forget,” he said. “You never know the fight someone else is struggling with. You don’t know their circumstances, so be careful with your judgments. To people going about their lives in Wichita in 1971, I looked like I should be in an asylum.”
“I can only imagine…” I said. I was having trouble finding any words. Poor Mr. X.
“The other point of this story is that life can be damned unfair. I’ve never gotten over losing Eddie. And I never will. That’s all I have to say right now. Please take me back.”
The old man had dealt with a lot in his life. Maybe everyone who reaches a certain age has their portion of sad stories. I’d later learn that I didn’t know the half of Mr. X’s.
CHAPTER 31
It was time for my midterm presentation on Zero-Based Budgeting (ZBB) for my Budgets and Controls class. It served as a nice dress rehearsal for my pitch at Big Rock. I had been practicing for weeks in a vain attempt to overcome my shoddy public-speaking skills.
I was nervous before I started my talk at school. Glancing around the room, I realized that my indifferent classmates were busy surfing the web and couldn’t have cared less about what I was saying. That made it a little easier. I focused on my professor and ran through my presentation as if we were the only two in the room. It went off without a hitch and I got a good grade. Yeah! I felt ready for my big chance at Big Rock later that week.
“Cost is the variable that managers have the most control over in a business,” I began to a room full of Big Rock bigwigs. Not exactly, “It was the best of times, it was the worst of times,” but how exciting can budgeting be?
I explained the basics of ZBB. The analysis of strategic versus non-strategic costs, determined by the delight of customers. The problem of hoarding resources and use-it-or-lose-it budget inertia. You couldn’t just spend the same amount as last year. The burden of proof was to justify every expense. If it wasn’t an effective use of capital, then it had to go.
I wanted to give the higher-ups something more tangible. I explained the studies which found that when properly implemented, ZBB could reduce costs by ten to twenty percent, often within six months. I picked out a specific company that Big Rock had recently acquired and showed them projections of a fifteen percent savings in the operating budget within four months of the adoption of ZBB.
I
explained that ZBB was a way to cut out bogus spending and make resources available for the most-promising strategies. If a company reinvests in profitable growth, it will eventually show up as increased earnings, available for more intelligent reinvestment. Your goal is a compounding of business value in a virtuous cycle. I sprinkled in liberal doses of Mr. X’s favorite Warren Buffett quotes.
As I wrapped up, a lively conversation broke out among the upper brass at Big Rock. They had apparently only heard half my presentation. Specifically, the half about cutting costs. This was the academic equivalent of telling the wolf it was OK to enter the henhouse. ZBB would be the cover for them to squeeze budgets as close to zero as possible and cut everything to the bone.
They missed the second half of my message about reinvesting back into strategic expenses to delight customers. Cutting non-strategic fat in order to build strategic muscle. Reinvestment and the compounding of value creation that propels humanity forward.
It was bittersweet when management later announced I had won the competition and the trip for two to Catalina Island. A pyrrhic victory if there ever was one. I learned a stark lesson in how hard it is to create change in a big organization.
CHAPTER 32
I couldn’t wait to tell Mr. X about my win and the Catalina trip. The next visit to Wichita rolled around and I received my customary note.
“I made an even worse mistake when I said 'yes' to Dexter, a shoe business I bought in 1993 for $433 million in Berkshire stock (25,203 shares of A). What I had assessed as durable competitive advantage vanished within a few years. But that’s just the beginning: By using Berkshire stock, I compounded this error hugely. That move made the cost to Berkshire shareholders not $400 million, but rather $3.5 billion. In essence, I gave away 1.6% of a wonderful business – one now valued at $220 billion – to buy a worthless business.” -- Warren Buffett
Cathy had instructed me to wait at curbside pickup at the airport. Mr. X would be fetching me in a town car. Look at me now. When the sleek black car pulled up, a driver I didn’t recognize hopped out and opened the rear door for me. Mr. X was waiting in the back seat. He looked frail, almost childlike from the weight he’d been shedding. His clothes hung on him like a human coat hanger. He gave me a brave smile and motioned to get in.
“Hi, Mr. X,” I said while putting on my seatbelt. “Where are we headed?”
“You’ll see,” he said. His voice was as thin as his body.
“I wanted to tell you in person,” I said. “I won a competition at work by giving a presentation on zero-based budgeting. I wanted to say thank you for turning me on to the concept. The prize for winning is a trip for two to Catalina Island. I can’t wait to take Stephanie there!”
“Oh, good,” Mr. X replied. “That’s terrific news, Nicky. Although I’m surprised that a place like Big Rock would adopt something like ZBB.” Nicky? I’d never liked it when people called me that. But from Mr. X, it was endearing.
“Yeah, I was very excited to win. Who knows if they’ll actually use it,” I said. I knew the answer, but didn’t want to admit defeat to Mr. X. “And there’s more. I’m a junior analyst right now, but there’s an opening for an analyst position that I’m gunning for. It would be a sizeable pay raise, and my family sure could use the extra income.” Desperately, I didn’t add. “Big Rock is big on competitions, so they’re giving the position to whoever presents the best big idea to the higher-ups. I have about a month to come up with something that will blow their socks off. Any ideas?”
“Well, knowing what I do about your current employer, you have two choices. You can pick an idea that would actually help them, and know you’ll lose the promotion. Or you could choose an idea that is flashy and gives you a chance to win, but won’t be of much use to anyone. It’s an interesting philosophical question: would you rather win their game, or would you rather be useful? That’s as much as I can tell you, but I’ll think about it a little more.” Ugh, Vance was the clear front runner for the promotion. If he ended up as my boss, there’d be a pink slip in my future. I needed something bigger than cryptic philosophy from Mr. X.
I was feeling pouty all of a sudden and wanted to change the subject. “So I assume from this week’s Buffett quote that we’re going to be talking about mergers and acquisitions?”
“That’s correct,” Mr. X said, lighting up in a way that betrayed his feeble body. Our business lessons were a frequency that always resonated with him.
“Have you ever done a merger or acquisition at Cootie?” I asked. I knew the answer from our previous conversations, but let’s tee up a softball for the old man. And maybe if we cover enough ground, he’ll have a bright idea for my presentation.
“Yes, several actually,” he replied. “There’s a lot of nuisance that goes into that decision.”
“Can you walk me through it?” I asked.
“The first thing you have to examine is your own motivations for wanting to do a deal. Be truly honest with yourself about why you want to do it.”
“That’s probably easier said than done,” I said.
“Indeed. Let me first give you the wrong reasons for doing a deal. And unfortunately, these are what drive a lot of the behavior I see. First is just the thrill of action--to be in the game, to make something happen, even if it’s stupid. Humans have a tendency to follow leaders who are bold. It must have been a survival mechanism of some kind.” I loved how Mr. X could weave a tapestry from the threads of business, psychology, and biology.
“The second wrong reason is size, status, and ego. You can’t discount the BBQ factor.”
“What’s the BBQ factor?” I asked.
“Being able to brag to your friends and family at the BBQ,” he said.
“Oh, I see.”
“Telling them how you’re a big shot who runs a large company with more revenue, more employees, more assets, more complexity. Prestige is an awfully stupid reason for M&A. Like a bad king, you create a larger empire but with poorer citizens,” he said.
“Is there a third wrong reason?” I said, keeping him rolling.
“I’ll classify the third as general overconfidence,” he continued. “If you’ve had some recent success, you might think you’re on a hot streak. Many don’t appreciate the dynamics of luck and skill in complex systems. Your hot streak may have a lot less to do with your abilities than you think.”
“Can you explain that a little more?” I asked.
“Well, overconfidence can show up in something as simple as lofty expectations about what the two companies will look like when combined into one. It’s called ‘synergy,’ assuming that two plus two will later equal five. There are generally two types of synergies. Can you guess what they are?”
The M&A note a few days before had prompted me to do some research in hopes of impressing Mr. X. “Revenue and cost synergies?” I said.
“Very good!” he said. Hey, why was he so surprised? His small outburst of excitement triggered a coughing fit that had me genuinely worried it would never stop. After a time, Mr. X regained himself. “You’ve really come along way since our first meeting.” I just smiled. “You can basically forget about revenue synergies where two businesses sell more just because they’re combined. It hardly ever happens, and never to the degree that’s projected. Businesses are rarely complimentary in that way.”
“What about cost synergies due to sharing expenses between two businesses?” I asked.
“Those can be real, especially in the back office. It depends on how well each of the companies are run in their strategic versus non-strategic expenses before the merger. But even real cost synergies will come up short against overconfident projections. Deals fail in practice, but they never fail in projections.”
“So I guess my takeaway for synergies should be that you shouldn’t go into any M&A deal expecting miracles?” I said.
“That’s right,” he said. “Hail Marys are for church and the football field.”
We pulled up in front of a competito
r’s burger joint. It had less curb appeal than the Cootie Burgers I had visited, but this chain did have a reputation for standout fries. “What are we doing here?” I asked Mr. X.
“Just doing a little research,” he said cryptically as he motioned to exit the car. The driver hopped out and pulled out a wheelchair from the trunk. He helped Mr. X get settled into the chair and told us that he’d wait in the parking lot. I pushed Mr. X up the ramp and into the restaurant, out of the cold.
“What should I order?” I asked Mr. X as we stood in line. I wanted to help with the research.
“Whatever sounds good,” he instructed. “Make sure you get fries; they’re quite good.”
“OK, what would you like?” I asked.
“I’m not hungry--thank you though,” he said. “And as usual, please let me pay as a small thank you for all the traveling you do to come see me.” I really didn’t mind. It rivaled my hikes with Steph as the favorite thing on my calendar.
We ordered and I rolled Mr. X to a table that accommodated his chair. I saw Mr. X looking around in evaluation, no doubt sliding straws around in his head. It was a habit I had picked up from my unlikely mentor whenever I interacted with a business. Simply unthinkable to the Nick from a year ago. We continued our lesson.
“Let’s discuss how a deal gets financed,” Mr. X said. “It’s a critical part of the merger and acquisition calculus.”
“OK, like what?” I asked.
“The first choice is to use cash you have in the bank. The second is usually to issue debt to fund your acquisition. Remember back to our conversations about pine cones and 1980s junk bonds?”