Sunday, February 6, 2022

Losing Our Edge

No one has to tell you you’ve come to the right place. The look of merchandising authority is complete and unmistakable.’’

That’s how the New York Times described Sears in 1983.

'‘In the markets we enter, we’ll be dominant,” said its head of retail. Few doubted it.

After dominating American retail over the previous century, Sears in 1983 was pushing into banking. Few doubted it would win there, too. “On a scale of 10, not to be flip about it, I’ve got us at about 10.5,” its chairman told the Times.

That wasn’t hyperbole. Sears was the largest retailer in the world housed in the tallest building in the world spreading its operational expertise into new businesses. Its catalog was the Amazon of its day.

Then everything fell apart.

Sears made more profit in 1954 than its market cap is worth today.

There’s one story about what Sears did wrong, which is well known.

There’s another story about how common these declines are. More than 40% of all public companies go on to lose effectively all their value.

The only thing harder than gaining a competitive edge is not losing that advantage when you have one. That’s as true for careers and investment strategies as it is for business. And since people are naturally optimistic, there’s a tendency to put more thought into finding an edge than not losing it once you find one.

Competition and incompetence are usually blamed when a competitive advantage dies. But here are other factors I’ve seen pull winners off the podium.

“Being right is the enemy of staying right because it leads you to forget the way the world works.” – Jason Zweig. Buddhism has a concept called beginner’s mind, which is an active openness to trying new things and studying new ideas, unburdened by past preconceptions, like a beginner would. Knowing you have a competitive advantage is often the enemy of beginner’s mind, because doing well reduces the incentive to explore other ideas, especially when those ideas conflict with your proven strategy. Which is dangerous. Being locked into a single view is fatal in an economy where reversion to the mean and competition constantly dismantles old strategies.

Maintaining financial success takes precedence over traits that were vital to building the initial idea. Nothing to lose is a wonderful thing to have. You focus all your energy on building something great. Having a quarterly dividend to maintain is what happens after you build something great. But it can come at the expense of what made you successful in the first place. Deutsche Bank once asked large companies how they prioritize cash flow in a crunch. I’ll let them explain:

After cutting deferrable investment, firms would borrow money to pay the dividend, as long as they do not lose their credit rating. Next, they would sell assets at fair value and cut strategic investment. Only if all these actions are insufficient, would they resort to a dividend cut.

They cut strategic investment to maintain the dividend. This is Christmas to scrappy newcomers.

Mistaking a temporary trend for a competitive advantage. Serendipity often masquerades as skill. Take monetary policy. The top three investing skills are patience, temperament, and having your career coincide with a 30-year uninterrupted decline in interest rates. Or sales: Orange County circa 2006 convinced many subprime mortgage companies that they had a leg up on traditional lenders. Sure, exploit opportunity when the wind is at your back. But don’t be surprised when an outgoing tide reveals the limits of sustained individual greatness.

Scaling a product requires scaling HR, which is monstrously complex and usually unrelated to your original skill. Designing a device or discovering an investment strategy is a million miles separated from managing 500 or 1,000 people. Managing one-hundred thousand people is a different universe. Even when responsibilities are delegated, creating a culture that promotes trust, creativity, and growth is likely a totally different skill than was required to build your product in the first place.

The decline of paranoia that made you successful to begin with. I like the idea that systems are better than goals, because once you reach a goal you tend to stop doing the thing that made achieving the goal possible. “I’m going to work out every day” is better than “I’m going to lose 10 pounds” because once you lose 10 pounds you’ll probably stop working out. Same thing happens when a successful business or career hits a big goal. Paranoia is a trait newcomers use to combat how deeply the odds are stacked against them. But it tends to die once a goal is hit. Few things sap the paranoiac drive to do better than stable cash flow and high profit margins. Michael Moritz of Sequoia was once asked why his firm had thrived for 40 years. “We’ve always been afraid of going out of business,” was his answer. That is an exceedingly rare response in a world where most people step back, see all they’ve achieved, and assume they can breathe a sigh of relief.

Reputational momentum is vicious and unforgiving on the way down. The more successful you are the more people want to be associated with you – which is great. But that’s equally powerful in reverse. Someone early in their career can screw up and recover quickly, moving onto the next company. A successful person or company has each flaw blared across the news, saturating the gossip channels of their network. Lehman Brothers’ 2008 struggles made front-page national news; a small community bank could have been at its wits end with hardly a soul aware. Sears fits this bucket: Everyone is aware how strained it is, so no one – customers, employees, investors, vendors – wants to be associated with it.

Brands are hard to build and even harder to span across generations. You can do everything right and still fail because customers don’t want to be associated with products of their parents’ generation. Morgan Stanley could make the indisputably best robo advisor in the world and millennials would still prefer Betterment. That’s how Charles Schwab blossomed in the 1980s and 1990s; with a brand baby boomers felt was theirs, not their parents’. One of my goals as a writer is to bow out the moment I realize I’m too old to understand how the game is played anymore. Companies, with indefinite time horizons, have to keep trying. A few of them pull it off; more often it’s painful to watch.

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