Business Book Review

Saturday, November 04, 2006


While rockets and broadband will revolutionize movement and communications, they will not fundamentally alter the economy or the notions of exchange that underlie the economy.
“When CEOs ask, ‘What’s the secret to venture capital?’ I say, ‘Not running out of money.’ Don’t get cute with capital. Presume that you’ll never raise another dime, and run your business accordingly.”
--Robert H. Lessin
The basic rules for business-building, the rules that form the operating framework that Cheyfitz calls “The Box,” do not change much, not in weeks or months, not even in years, and not significantly over decades or centuries, or even over millennia. These basic rules as outlined by the author are 1) Know the difference between what will change and what will not, and pay attention to the former; 2) The first business of business is making money; 3) If cash is not managed, there will not be anything to manage; 4) It is far better (and more certain) to cut expenses than to pray for sales; 5) Give customers what they want, not what the business wants to give them; 6) Sell all the time; 7) Businesses should follow the example of virtually every big company in history and buy their way to “bigness” (at reasonable prices); 8) When it comes to people, managers can hire smart and get out of the way, or they can run themselves ragged micromanaging; 9) Businesses need to find their real assets (the ones that generate the profits) and exploit them for all they are worth; 10) Remember that the end result is what really matters; 11) Business should always be ready to renew their basic business; and 12) Make a plan to get money out of a business, and keep the plan updated and handy.

The “new economy” of the 1990s (a bit of historical research reveals that supposed “new economies” have surfaced periodically over the course of centuries) was much touted by the press, by Wall Street, and even by Alan Greenspan, to explain what was then viewed as an unprecedented, fundamental change in economic reality. The result of the belief that economics had been fundamentally altered by massive technological growth was the dot-com disaster of the 1990s and, close on its heels, the disastrous collapse of the telecommunications industry in 2000 and 2001.

These disasters occurred because absolutely nothing had changed about the economy; indeed, it cannot change, a lesson that history and social science teaches. Although technology is important, and shapes the way business is conducted at any given time, technology does not fundamentally alter the way economics works. Therefore, it is critical to know which things will change, and which will not—and to know the difference between what is coming next, and what it will always be. This is the essence of the author’s first plank—“the basic Box”—understanding the unchanging nature of the fundamental rules that make business work, while appreciating the constantly changing nature of the factors that influence all businesses. Businesses should, then, focus their efforts on how their customers’ lives are changing and how they can serve their emerging needs with new products and services, delivered using tried-and-true business models.

The primary rule of economic activity is that making a profit is what it is all about—a rule forgotten, and even derided, in the 1990s. The business of business is making money. In the 1990s, in the white-hot frenzy of the “new economy,” many of the new high tech start-ups took the position that while profit was thought to be an important future objective, its necessity in the near-term was not absolutely necessary and that other metrics, such market share or penetration of ‘new markets’ or undercutting competitors, were more important. Fred Smith, the founder of FedEx, undeniably one of the great success stories of twentieth century American business, has always been an advocate of the measurements that all business plans must include: revenue, expenses, projected profits.

One of the more notorious examples of a business that did not follow Smith’s counsel is the ill-fated, the Web-based pet supply retailer. Following the conventional wisdom of the day—establish the brand and profits will follow— chose the high-cost strategy of heavy ad spending to establish the brand across America with its Sock Puppet. The puppet raced around in a delivery van, explaining that delivered “because pets can’t drive.” The Sock Puppet was a nationally recognized and loved character, and it did establish a brand personality. While was building its brand, however, it was also losing phenomenal amounts of money. In mid-1999, the online retailer was losing money on every sale, without counting other expenses, because it was selling merchandise for about one-third of what it cost to buy the goods, and it had failed to calculate the high shipping costs for delivery of heavy, low-margin items. The company also spent nineteen times its total revenue on marketing. The traditional wisdom that “you can’t lose money on every customer and make it back on volume” is exactly what tried to do—with predictable results. As the author notes, was not just a failure of execution, it was a failure of thinking—a failure that could only be achieved by ignoring the fundamental idea that profit always matters.

At FedEx, on the other hand, Fred Smith had focused on reaching the necessary critical mass for profitability. He had a disciplined approach; he researched the market for overnight air freight, validated his financial assumptions, and came up with a business plan to achieve profitability. Profits are the product and the progenitor of all corporate creativity, and they have to be achieved as quickly as possible, or the possibility of achieving them goes away forever. By disregarding profit, the author notes, took roughly $300 million and turned it into nothing—no jobs, no assets, and no productivity. On the other hand, by executing a profit-focused business plan, Fred Smith took roughly the same amount of capital [adjusted for inflation], and turned it into $16.4 billion in market capitalization and more than 200,000 jobs.

As critical as profit is to a business, it is, theoretically at least, of no concern whatsoever as long as the business has access to an infinite supply of cash. Profit is paramount because it is the sole supply of cash in any business. Thinking inside the box is about sticking to fundamentals, and next to profit, there is nothing more fundamental than cash. Surviving in business is not simply arranging things so that more money comes in than goes out, it’s making sure that the money coming in arrives in the right quantities and at the right times to cover all operating expenses on time.

Cash flow problems can be the result of several different causes: lack of profitability, as well as a profitable company that is growing very fast, or businesses with large investment needs (such as technology or machinery). Also, companies that have borrowed heavily in the past, perhaps at a time when credit was easy to obtain, and that now face big loan payments, are also especially vulnerable to cash shortages. Once a company finds itself in a cash crisis, the number of options are few: borrowing money or selling stock (or finding some new source of capital); speeding up collecting money that’s owed to the company (reducing receivables); slowing down bill payment (increasing payables); postponing spending on capital projects; cutting operating expenses; and selling all nonessential assets. As business history shows—particularly very recent business history—companies can make up stories about profits, but they can’t make up cash. The most famous recent debacle, of course, is Enron. The lesson of Enron, and many before it, according to the author, is “don’t lie (to yourself, at least) about profits and don’t plan on being rescued by new financing, because it might not materialize.”


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