The Rebel Allocator

by Jacob Taylor

  “Thank you,” I said. “He made a big impression on me. I’m just happy I got to see him one last time before he passed.”

  “It’s a good thing you left when you did then. I’m sorry I was being so dramatic. I just felt so disconnected from you. I wanted to know what you were feeling. Plus my parents were in my head. I had a hunch that you might propose that weekend. And when I realized it wasn’t going to happen, I didn’t do a very good job hiding my disappointment. I wasn’t the best version of myself. I’m really sorry.”

  “How was the rest of Catalina?” I asked.

  “Not good without you there,” she said.

  I smiled. “I have something to show you. It’s just up the river a bit. I made you something.”

  “You did?” she said with a smile. “I do love surprises.”

  We hiked upstream for a few minutes. I took her hand as she stepped over a small tree that had fallen across the trail. It felt good to touch her again, even in that small way.

  “I need you to put this blindfold on now.”

  “What?”

  “Just trust me,” I said.

  I tied a scarf around her face to cover her eyes. I took her hand and lead her around the bend. I guided her up the side of a boulder that was nestled near the trail. When we got to the top, I stood behind her and removed the blindfold. She blinked her eyes and looked out.

  “Oh my god, Nick.” Tears started to streamed down her face. From our elevated position on the boulder, she could see at least two dozen places where I’d stenciled in red paint “Will you marry me?” on the exposed rock faces. She turned to find me bent down on one knee.

  “Stephanie... I know things have been difficult. But I’ve come to some realizations.”

  “You have?” she said.

  “Yes, Mr. X told me after he met you that I’d be a fool to let you get away,” I said. “And he was right.”

  “I knew I liked him for some reason,” she said.

  “Steph, I’ve changed in ways I’m not sure I can describe. I quit my job at Big Rock.”

  “What?!”

  “I had to,” I said. “I wasn’t happy there--I didn’t fit in. If I stayed, I would have become a shell of myself. But I have a new path I’m excited to walk down. Like, crazy excited. I can’t wait to tell you all about it. And I want to walk this new path with you. Only you.” I paused, for dramatic effect and mostly because of the enormous lump in my throat. “Stephanie, will you marry me?” I opened a small box to reveal an exceptionally modest ring. Even then I’d be making payments on it for eternity. Yet I knew it was the best capital allocation decision I’d ever make.

  “Yes, Nick. Of course I will,” she said through tears.

  I stood up and we kissed. I soaked in the moment, imagining how I’d tell our grandchildren about it. I’m still working on that whole “being present” thing.

  As we exited off the big boulder, I grabbed a bag I’d tucked into the bushes earlier.

  “Being married to me will probably never be easy,” I said. “I’ll make a big mess, but my heart will always be in the right place. And that starts right now, even while we’re engaged.” I handed her a brush and a wad of steel wool and smiled. “We’ve got my first mess to clean up.”

  It took us three hours of intense scrubbing to remove the red paint from all of the rocks. Welcome to betrothed bliss, Steph.

  EPILOGUE

  Last I heard, Vance had been fired from BR. The story was he had been accused of sexual harassment by a coworker. Not a shocker. The first to step forward broke the seal and a dozen others came forward. Even Vance’s rich father couldn’t hold back that avalanche. It came to light that Vance had been falsifying numbers on practically every assignment he’d worked on, including his miraculous presentation that wowed the higher-ups.

  Not long after, I visited the coffee shop where Steph used to sling caffeine, for old time’s sake. My eyes widened when I recognized the barista—it was Vance! I kept it classy, not wanting to gloat at his shift in fortune. I did ask him for some extra straws though; I was working on an important business problem.

  I’m happy to report my father landed a series of important (non-pro-bono) cases and my mom took a position at a charitable foundation focusing on the environment. They still tilted at windmills, but their financial struggles were soon behind them. For now. I hope they learned an important lesson about saving when they can, not when they have to.

  Relations with Steph’s parents improved after it became apparent I had set a decisive course in life. It’s amazing what a little confidence will do. I can’t blame them for worrying about their daughter becoming stranded in the doldrums of the old version of myself. Her father shoots me words of encouragement now instead of icy daggers.

  ◆◆◆

  I got a note from Mr. X in the mail. I was shocked and confused at first, until I noticed it had been postmarked weeks ago. He had sent it before my last trip out to Wichita. It must have gotten lost in the mail and just resurfaced. A tear streamed down as I opened it. It warmed my heart to see one last Warren Buffett quote from Mr. X:

  “The heads of many companies are not skilled in capital allocation. Their inadequacy is not surprising. Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration or, sometimes, institutional politics.

  Once they become CEOs, they face new responsibilities. They now must make capital allocation decisions, a critical job that they may have never tackled and that is not easily mastered. To stretch the point, it's as if the final step for a highly-talented musician was not to perform at Carnegie Hall but, instead, to be named Chairman of the Federal Reserve. In the end, plenty of unintelligent capital allocation takes place in corporate America.”

  Do what you can to make your dent, son.

  -- Mr. X

  I will, Mr. X. You have my word.

  ◆◆◆

  A few months after the lost note surfaced, I received a call from Cathy:

  “Hi, Nick. How are you?”

  “I’m doing well, thanks. And you?”

  “It’s been a little rough around here after losing Mr. X, but his successor is a wonderful leader, so the business is in good hands. Mr. X thought it might run better without him. I won’t say that’s true, but we’re doing just fine.”

  “That’s good to hear.”

  “How’s Stephanie?”

  “She’s great. We’re actually engaged now.”

  “Oh, that’s terrific news! I’m so happy-- you two are a good match.”

  “I tried to screw it up, but we’ve figured things out. You’re definitely on our wedding invite list.”

  “I wouldn’t miss it!”

  “Did I tell you that I left Big Rock?”

  “No, is leaving a good thing or a bad thing?”

  “It’s a good thing. Mostly. I didn’t fit in there and although the paycheck was desperately needed, I was selling my soul to earn it. I had to get out, even though it means a financial struggle for the foreseeable future. I’m actually starting my own thing instead, if you can believe that. I know, it’s a crazy thought: Mr. Socialism starts his own business.”

  “No, I love it. That’s so great. It’s funny, I thought we’d be having this conversation years from now.”

  “What?”

  “Let me explain. In Mr. X’s will, he left you a sum of money that was only available if you started your own business. He said specifically that he wanted to leave you enough where you could afford to do anything, but not so much that you could afford to do nothing.” I started to tear up. That specific language meant Mr. X thought of me as his son. It took me a few moments to gain my composure. Cathy understood the implication and waited patiently.

  “How did he know I’d ever want to start my own business?” I finally said.

  “He was very wise and knew you were destined to be your own boss at some point. Plus, he knew you didn’t fit in at Big Rock. It was just a matter
of time.”

  “He was very wise. I miss him.”

  “We all do.”

  “I feel like we didn’t get a chance to finish our lessons. Like our time was cut short.”

  “I think Mr. X would say you learned everything you needed to learn.”

  “That does sound like him.”

  “Well, I should probably get back to work here. I’ll have Mr. X’s lawyer contact you regarding the details of the inheritance soon.”

  “OK, thank you, Cathy. I should get back to work also. And Cathy…”

  “Yes, Nick?”

  “You have my word that the book I write about Mr. X will be worthy of the original source. It will be something he’d be proud of.”

  “I know you will, Nick.”

  THE REBEL ALLOCATOR’S CHECKLIST

  ____ Respect the Iron Law of Economic Survival: Cost < Price < Value.

  ____ Value is perceived by the customer, focus on what doesn’t change for them, engineering doesn’t always have the right answer because of the customer’s subjective perception.

  ____ mall, incremental improvements really add up.

  ____ Push decision-making down as close to the customer as possible.

  ____ Choose your strategy: differentiated product or lowest-cost producer?

  ____ Appreciate the tradeoffs between profit and brand. Are you storing fat or glucose?

  ____ Practice zero-based budgeting.

  ____ Strategic costs delight the customer and build a moat around your business. Invest in them.

  ____ Non-strategic costs sap your resources and should be eliminated.

  ____ Don’t “paint the fourth wall.”

  ____ Cash is the oxygen of business. Don’t cut it close.

  ____ Fund strategies, not individual projects.

  ____ Returns on invested capital tell you if you’re providing value. It’s your weight-lifting form. Only add the plates of growth when you can maintain good form.

  ____ Growth isn’t necessarily good or bad, it’s just “more.”

  ____ Be patient like the pine cone. Everything moves in cycles.

  ____ Be confident to zig when everyone else is zagging.

  ____ Lay out all of your capital allocation options into a single menu before you decide.

  ____ Keep your balance sheet conservative. One of your responsibilities is to serve as an economic shock absorber and protect various stakeholders.

  ____ Imagine all the different ways to “put a roof over your head.”

  ____ Perform the 11-Star Experience exercise to push the boundaries of what’s possible to delight customers.

  ____ Don’t do mergers and acquisitions for the BBQ Factor, don’t expect synergy miracles.

  ____ Using shares for M&A is like selling part of your business.

  ____ Get back at least as much value as you’re giving up. Chances are, you’re overpaying.

  ____ The dumbest activity occurs late in the cycle. Tread carefully.

  ____ Be conservative with healthy margins of safety on all projections.

  ____ If you can’t create value by reinvesting in operations, M&A, or creating a new business line, you should return capital to shareholders.

  ____ You have a fiduciary responsibility to your shareholders to keep your stock trading as close to intrinsic value as possible. This helps prevent incoming and outgoing shareholders from taking advantage of each other.

  ____ Having publicly traded shares are like having your own currency. Respect them as such.

  ____ Use share buybacks to put a floor under your stock. You never know why a partner needs liquidity.

  ____ Tell your partners/shareholders everything you’d want to know if your roles were reversed so they can arrive at their own fair value of the company.

  ____ Paying a dividend should be a last resort.

  ____ Never forget you are a fiduciary for your shareholders. Treat them like partners.

  ____ Thoughtful allocation of resources is one of the most important societal functions entrusted to you. It’s important for customers, employees, boards, management, and the environment. Give it your best effort.

  For more Rebel Allocator resources, please visit :

  www.fivegoodquestions.co/rebel-resources.

  There you’ll find a printable versions of The Rebel Allocator’s Checklist, Capital Allocation Base Rates, an extensive bibliography and relevant white papers.

  You can also sign up to receive occasional email updates on rebellious capital allocation, if you're weird like me and love this stuff.

  CAPITAL ALLOCATION BASE RATES

  If you’re going to be a rebel allocator, it doesn’t hurt to know what businesses have historically done as your starting point. Always remember you can deviate when logical reasoning says you should; the crowd isn’t necessarily right. Trust your judgment.

  Sources and Uses of Cash for Large Cap US Companies 1990-2018**

  Sources of Cash

  Operating Cash Flow 59%

  Debt Issuance 23%

  Equity Issuance 5%

  Other 5%

  Working Capital Changes 4%

  Investment Sales 3%

  Sale of Property, Plant, and Equipment 1%

  Uses of Cash

  Capital Expenditures 25%

  Debt Paydown 20%

  Buybacks 12%

  Research and Development 9%

  Acquisitions 8%

  Dividends 8%

  Working Capital Changes 7%

  Investments 6%

  Other 5%

  ** Data used with permission from O’Shaughnessey Asset Management

  ACKNOWLEDGEMENTS

  First, I recognize there are thousands of great books that come out every year. It means a lot to me that you chose to spend time with mine. If you found this story worthwhile, I have two favors to ask, both with the goal of getting the book’s lessons into more hands and closing the capital allocation gap Mr. Buffett describes.

  The first favor would be to leave a review on amazon (or goodreads). Stars are the currency of books these days and the ratings impact the algorithms. More votes lead to more recommendations and exposure. Your review, good or bad, is welcome. The second favor would be to get a copy of the book into the hands of any CEOs or boards of directors you think could benefit. Capital allocation occurs throughout the org chart, so leadership at any level would likely get something useful from the story you just read.

  You won’t find an original idea of mine in this book. (Well, except for Nick’s proposal to Stephanie—I pulled that one off in real life.) Everything intelligent is borrowed from people smarter than myself. First and foremost, I want to thank Warren Buffett for the intellectual generosity of his writing and speaking. As a first-year MBA, I had the opportunity to travel to Omaha for a Q&A session and lunch with Mr. Buffett. Talk about a game-changer! Charlie Munger is also one of my heroes and I’ve been lucky to enough to catch the Warren and Charlie Show in person for more than a dozen years during the Berkshire weekend in Omaha. Both of their fingerprints are all over this book; it simply doesn’t exist without them. I avoided direct attributions to keep from breaking the flow of the story, but Mr. X’s most sage quotes are often directly cribbed from Warren and Charlie. They deserve all the credit.

  I also have thank yous for specific ideas: James Clear on the power of one percent improvements. Yvon Chouinard for the concept of yarak. Gary Keller for the importance of focusing on ONE thing. 3G Capital for zero-based budgeting. Bob Fifer for strategic versus non-strategic expenses and differentiated product versus lowest cost producer. Tom Murphy for the story of painting only three walls. Nick Gogerty for inspiring the Iron Law of Economic Survival. Various Austrian economists throughout history for the theory of subjective value and non-homogenous capital accumulation. Al Ries and Jack Trout for the Law of Duality. Jeff Bezos for focusing on delighting customers with things that are unlikely to change. Rory Sutherland for the six billion dollar London to Paris train example and the
flower-weed advertising joke. Noted Air Force pilot John Boyd for the German concept of auftragstaktik. Nassim Taleb for the Lindy effect. Peter Thiel for thoughts on monopoly. Jason Fung for inspiring the comparison to insulin in the body with profit versus brand tradeoffs. Sardar Biglari for operational leverage in the restaurant industry, the economics of franchising, and buying back your own restaurant roofs. Elliot Noss for net promoter score and for more generally being a top-flight capital allocator. Michael Mauboussin for clearing up the concepts of return on invested capital, research on mergers and acquisitions, strategies vs. projects, and seminal white papers on capital allocation (he’s the best). Mark Spitznagel for the roundabout strategy of the pinecone. Edward Chancellor for capital cycle theory. John Tobin for the Q ratio and the buy versus build calculus. Brian Chesky for the eleven-star customer experience. Barry Schwartz for the paradox of choice. McKinsey for their various articles on zero-based budgeting. Andrew Lawrence and Mark Thornton for the skyscraper index. Ben Graham for thoughts on treating shareholders with respect. David Foster Wallace for the two fishes in water joke. James Montier for his clever writing and research on simple models versus experts. O’Shaughnessey Asset Management for the data on sources and uses of corporate cash.