He told us he was a technology consultant for years before achieving his dream of stock-picking for a living. “I lived and breathed stocks,” he said, staring at me goggle-eyed. “That’s the only way to do this. I read every book I could. I learned about every company I could. I didn’t go to business school. There were no short-cuts for me. I ran my own portfolio while I was working and kept on applying for these jobs until finally I got this one.” He asked us how many of the cases we read in preparation for class. All of them, I told him. Two Indian men at the table said they read only one in three or one in five at the most. I could not tell if they were joking, but they said that they had better things to do with their time at HBS than read sloppy marketing and LEAD cases. For example, they liked to play poker five nights a week. The fund manager seemed to like this. With dessert came a shuffling of places and another of the executives came and sat at our table. He and his colleague began to trade war stories while sloshing back more wine. “Did you see Howie just played Pebble Beach? Howie runs our media fund. He’s the guy who bumped off the CEO of AOL. Brilliant guy. Legend. Beats the market every year. Never misses. Twenty years straight. Rupert Murdoch calls him for advice. I mean, the guy’s a legend. He bought Viacom at ten!”
Away from home with nothing to do but interview students, they were wallowing in their fully expensed trip, ordering more wine, more chocolate ganache with raspberry sauce, swapping more war stories. “So Bill was reading the financial statements—Bill’s our head retail analyst, guys—and he noticed that inventory had just gone through the roof and same-store sales were lagging. They were just piling up crap in the stores and no one was buying, but it was still seen as this hot company, right? So he started unloading the thing. No one else had seen it and he got out before the stock tanked thirty percent. Unbelievable.”
I left as soon as I could. The freezing air in Harvard Square was sharp and refreshing. I was happy to be out of there.
I arrived in Spangler at 8:30 A.M. to find my two interviewers, an older man and a woman who had graduated from HBS just a couple of years earlier, gingerly peeling back the plastic tabs on their Styrofoam coffee cups. They had had a long night. The first question they put to me was this: In fifteen minutes, you have to make a realistic bid to purchase Harvard Business School. How much do you bid?
They were trying to see how I went about the process of valuation.
“Who’s buying?” I asked.
“You are,” said the man.
“But am I a private company planning to turn HBS into an executive retreat or an educational business or a real estate developer or what?” They shrugged. I began building a balance sheet for HBS, listing its assets, liabilities, and equity. First there was the real estate on the banks of the Charles River, close to Boston, populated by office buildings, apartment blocks, classrooms, a gym, an auditorium, and a library. I took a wild stab. I had read that the new Spangler building, by far the largest building on campus, had cost around $100 million to build. I reckoned Spangler made up perhaps one tenth of all the real estate on campus. I also assumed that if the campus was forty-four acres in size and that each acre in this area of Boston cost around $1 million, then you had at least $44 million of raw land underneath all of these buildings. So how about a billion dollars for the real estate?
Then there was the endowment, $1.5 billion or so sitting in various accounts. I did not think this could be considered in any purchase, since the money would be tied to the specific mission of Harvard Business School and not be available to some new acquirer. It would probably have to be returned to the donors or credited to the general university endowment. The school had no debt to speak of, and its sole equity holder was itself. As to revenue and costs, our section had recently had a visit from the school’s management department and I seemed to recall that tuition from MBA students made up around one third of HBS’s total income. The rest came from executive education and publishing books and cases. So, if there were 1,800 students each paying $38,000 per year for tuition, that came to around $68 million; multiply that by three, comes to just over $200 million in total revenue. Since the school does not run for profit, all of that is spent each year in various ways, from paying professors to manicuring the grounds. If you wanted to run HBS for profit, you could probably do so handsomely at first, though over time, I wondered, the loss of not-for-profit tax advantages and the official links to Harvard University might shrink your margins. But assuming you could make 20 percent before interest and tax, and a valuation multiple of fifteen times earnings, HBS might be valued at $600 million.
Time was running out, so I tried to ask some more questions. Could the school still call itself HBS? Would it retain its links to Harvard? If not, what would this mean for one of the school’s key assets, its professors? Would they decamp to a more traditional university? If there was no way to retain them, this would drastically lower the value of the asset. My interviewers refused to give me any hard answers. There seemed to be so many variables, and by now the piece of paper in front of me was a mess of numbers, squiggles, and arrows leading nowhere.
“So what number are you going to write on the check?” the woman asked.
“I read recently that the New York Yankees were worth around six hundred million,” I said. “So given the unique uses for the real estate, and stripping out the endowment, and with all the uncertainty about this new institution’s ability to use the Harvard name, how about a little more than the Yankees, around seven hundred million.” It was a deranged muddle, and they gave me this strange stare before jotting something down on their notepads. They were probably writing “half-wit.”
The next morning, I interviewed with a Boston-based mutual fund firm. True to its thrifty reputation, there was no dinner beforehand, just a conference room, two white men in white shirts and dark ties, and me.
“You have an interesting résumé,” the older of the two began. “But what makes you think you could evaluate and pick companies to invest in?” I had developed a spiel about how journalism and investment research required similar skills, principally the ability to discover and weigh up many different kinds of information, from quantifiable facts to softer judgments about the character of individuals. I told them how I had been through a number of very tough situations, from earthquakes to terrorist attacks, where I had to gather information quickly and write clearly under strict deadlines. They nodded and noted and asked me what I thought about buying Apple stock.
This was February 2005. The iPod was already a runaway hit, and Apple was hoping its PC business would be able to piggyback on its success. So I said that I thought Apple was a great company but that its historic difficulty in achieving sustained success made me hesitant. It had always been an innovator but it was inconsistent. I wondered how long the iPod would continue to make money and whether consumers would really choose Apple computers simply because of their experience with the iPod. As an investor, I might wait to see what else Apple had in its pipeline and also wait for some heat to come out of the stock. And I would also like to find out who beside Steve Jobs could run the company. Having such a dominant CEO had advantages, but the great risk was succession. My interviewers nodded to each other and jotted something down.
Next, they asked, what makes a stock price move? This was one of those questions where you think you have an answer, until you have to give it. All kinds of things, I said. Fundamentally, the price moves according to changing expectations of future earnings, but what influences those changing expectations remains a mystery. Some say the markets are so well informed that all changes are rational, based on accurate forecasts of future earnings. Others believe a herd mentality can set in and that prices end up being set by the most basic human emotions: greed, fear, envy, lust. I do remember my hand seeming to take on a life of its own as I offered my explanation, moving up and down and round and round as if on an invisible roller-coaster. I tried to read my interviewers’ reaction. But their faces were expressionless.
&n
bsp; That evening I learned that neither company wanted me for a second interview. I thought I wouldn’t care, but I did. I wanted to adhere to the HBS culture because it seemed to promise so much, but then again I didn’t, because it seemed so formulaic. I wanted to be a part of this thing, but did I really? It was turning out to be more of a struggle than I had ever imagined.
Fortunately, I was not alone. Luis cornered me one day to ask about my plans for the summer. He was carrying his soccer boots and heading off for a game.
“This pressure, man, it’s insane,” he said. “When I got here, I knew I wanted to pursue the entrepreneurial path. But now, with this interview thing—and you see all these big famous companies coming to campus like Google and Skype—I’m thinking maybe I should go and work for one of them.”
“I know,” I told him. “I nearly convinced myself I could be an investment banker. I realize I’m comparing myself to the other people here and it’s killing me. I’ve got to stop.”
“You’ve got to have a super strong conviction about what you want to do here,” he said, resting one soccer boot on my shoulder. “You know what finally stopped me chasing these things? It was hearing about the grilling people were getting for these stupid summer jobs. For people like you and me, the old guys, it’s too undignified.” Luis had decided he would go home to Madrid and spend the summer helping an American online travel company that was seeking to crack the European market. “I’ll be able to do it on my own time,” he said. “No boss.”
Justin applied to the investment banks and got a job. “It’s going to be great,” he told me, waving his offer letter at me.
“No it isn’t.”
“I can’t listen to you anymore,” he said, plugging his ears. “You’re a corrupting influence. La, la, la, la, I love investment banking, investment banking’s what I love.”
Annette, also from the section, had performed the most stunning volte-face. She had arrived at HBS with a scholarship from a top investment bank, which was paying for her tuition and had guaranteed her a summer job and a job when she graduated. But the prospect of returning to Wall Street tortured her.
“I knew that if I went back, that was it,” she told me. “I would be there for the rest of my career. The money and status are very addictive.” Instead, she wanted to get out of financial services and into a company with a real, physical product to sell. She had received an offer from a fashion house to work in their marketing department over the summer. The money was half of what the bank was offering. And if she took the fashion job, she would forfeit her scholarship and more than sixty thousand dollars in tuition grants. “I did what I always do when I face a dilemma,” she said. “I locked myself away and just forced myself to make a decision. I had to leave finance.”
All her life up to then, she said, she had been following a formula for success, and doing so very effectively. What was unnerving about choosing the fashion house was the reaction of those closest to her. They were baffled, and their bafflement stoked her insecurity. It was as though she had dropped the veil on a hitherto secret part of her soul. Was she crazy? Or self-indulgent? How many people would kill for the opportunity she had to succeed on Wall Street? Why would she have made all these decisions to get to this point and then make this one? It was exactly what I had felt when I left my job in Paris. People asked what was wrong with me. How could I leave such a great job? Why had I even bothered getting to that point in my career only to walk away and start afresh? But as Annette had just found out, when you know, you know.
Chapter Ten
ETHICAL JIHADISTS
Business is the activity of making things to sell at a profit—decently.
—EDWIN GAY,
SECOND DEAN OF
HARVARD BUSINESS SCHOOL
Despite the onslaught of recruitment, there was still a course of academic study to pursue. Besides more finance, the second semester would introduce us to strategy, negotiations, entrepreneurship macroeconomics, and business ethics. Strategy was taught by a Swiss professor, Felix Oberholzer-Gee. He looked like the quintessential academic, with round glasses, hair brushed forward, and an absentminded gaze when he walked across campus. But he had spent five years in the injection-molding business in Switzerland and then another five in the economics department of an investment bank. He brought a wry worldliness to the classroom and quickly became a favorite of the section.
Harvard prided itself on its strategy department, not least because it was the core of the general management program. Establishing and executing a strategy was precisely what a general manager did. We were not being trained to be excellent financiers or operations managers but rather good generals. We were learning how to marshal disparate forces and resources to pursue the goals of creating and capturing as much value as possible. Strategy was not about filing the right accounts or making sure the machinery worked. It dealt with the big picture: building and managing a business to make superior returns over the long term.
The first thing to understand about strategy, we learned, is that it is not operational efficiency. You could run the best laundry in the world, but if what you were doing was quite simple and thousands of others could do it, you were not going to make any money. You lacked, as Felix liked to say, “a great strategy.” A beautifully run restaurant with the greatest chef in the world could be an economic disaster, while owning a few grubby fast-food franchises could make you a millionaire. Being very good at doing something was absolutely no guarantee of financial success. I recalled Steenburgh in marketing telling us, “A good product alone won’t get you there.” So the first challenge for the strategist was picking the right thing to do.
Felix showed us a graph of the distribution of returns on equity of major American companies over the past twenty years. Most returned between 10 and 15 percent a year. But a few had returns on equity over 20 percent. What were they doing that enabled them to do this? The most profitable companies year after year tended to be in a few sectors: pharmaceuticals, high-technology, financial services, discount department stores, and oil. The worst major industry to be in was airlines. There were exceptions, such as Southwest, which had done phenomenally well. But even Southwest, we had to assume, would eventually struggle to escape the broader trends of its industry. Picking the right industry, one with a sound structure, where your chances of making a profit were highest, was where good strategy began.
In 1980, a Harvard Business School professor called Michael Porter published an article, “What Is Strategy?,” that laid out the five forces he believed determined a company’s ability to capture value. They are: barriers to entry, supplier power, customer power, substitutes, and rivalry. Understanding the five forces allowed you to see why the well-run laundry or the wonderful restaurant floundered, while a shoddily run muffler store flourished. The five forces are the cornerstone of modern strategic thinking.
Take the laundry. The barriers to entry are relatively low. It does not require highly skilled labor, and almost anyone could buy a small Laundromat with a bank loan. This is why so many immigrants run laundries. When you are new to the country, laundries are simple businesses to acquire and run. If you speak little English, have a little money, and are prepared to work hard, laundries make sense as a first entrepreneurial endeavor. But you must expect a lot of competition from people with the same idea and the same access to the opportunity.
The suppliers to the laundry are the companies that make laundry machines and cleaning products. There are plenty of both, which keeps down prices and provides you with options should you decide to change. The bad news is your customers. In big cities, there tend to be laundries on almost every street corner, offering identical services and prices. If one laundry wrecks your shirts, you can easily go to another. The only cost of switching from one to the other might be a slightly longer walk. The main substitute for a laundry service is the washer-dryer at home. In Manhattan, many apartment buildings do not allow people to have washer-dryers in their homes, which forces t
hem out to laundries. If that rule were to change and everyone were permitted a washer-dryer, the laundries would be in deep trouble. The degree of competitive rivalry among laundries is stoked by all of these forces—low barriers to entry, weak suppliers, powerful customers, and substitutes in the market where the business is located.
Since Porter came up with his five forces, a couple more have been added. Complements are those products that might enhance your own. In the computer business, complements to a PC include software and printers. Better software or printers make the PC more desirable. Beautiful shirts and ties are the complement to well-made suits. Nurturing these complementary businesses can have a positive effect on your own business. For some businesses, especially those that are highly regulated, government is the seventh force. No major media company, for example, can ignore the workings of the Federal Communications Commission.
The five-forces analysis provides a good idea of a firm’s competitive advantage over its rivals, and hence its chances of relative success. But first we had to understand the notion of competitive advantage. It came in two flavors: either you had a cost advantage, whereby you made things cheaper and sold them cheaper, or you differentiated your product somehow, either by making it better than your rivals or by designing it differently to appeal to a different group of people. These two forms of differentiation were known as vertical or horizontal: vertical meant better or worse; horizontal meant different. If you had two cars and one had a better engine, brakes, and interior than the other, they were vertically differentiated; one was simply better than the other. But if you had two identical cars, but one was pink and one black, they were horizontally differentiated, appealing to different kinds of customer. One nightmare for a business is to have no advantage, to be neither the cheapest to produce nor clearly differentiated. This was to be “stuck in the middle.”
Ahead of the Curve Page 16