When is Enough Enough?

As I read about the return of Howard Schultz to the helm of Starbucks, I am reminded of the journey of almost every company as it moves from doing for customers to doing to customers. One of the reasons that I prefer company founders as CEOs of our portfolio companies is their non-MBA characteristics. In business schools, students are taught concepts, some of which are constructive and some of which are destructive. I view the most destructive concepts lie in the "profit maximization" area.

One portfolio manager describes the journey of companies as in three stages. Stage One is the Wow! stage - where companies seek to delight customers and, as a by-product, disrupt and change industries. Herein lies the reason why Jeff Bezos focused Amazon on everyday is Day One. Stage One is marked by rapid growth and often prohibitively high stock market prices. 

Most of the time I simply watch these Stage One companies enviously. Starbucks in its early years was in this category. It was the place you could actually get a high quality espresso in the US. I actually chose my Dallas house location based on the fact that I could walk to four Starbucks stores.Tesla has always been in Stage One because its admirable CEO refuses to bureaucratize in his anti-social and probably anti-MBA style. When viewing Stage One companies, I find myself filled with love and admiration for capitalism and creativity.

Stage Two is the maturation stage - where markets get saturated and the companies seek to cross-sell products into their mature markets. Often, there are delightful customer improvements as the Stage One purism settles down. These Stage Two companies have attractive financials as the capex requirements settle down and business practices stabilize. The companies become quantifiably investable, because at this stage, companies are finally profitable. Without profits, ideas are unsustainable. However, this is also the stage in which companies start to wander out of doing for the customer into doing to the customer. The add-on services are usually chosen based on increased profitability, higher operating leverage and all those MBA concepts. The speed at which the company moves from doing for to doing to is a function of leadership and founder leadership is more likely to slow this inexorable journey.

For example, Starbucks finally started to get food products and juices in its stores. But because these cross-selling opportunities are not focal, they are usually inferior to the core offering. It's hard to believe that Howard Schultz could've spent time in Italian espresso shops with their fresh orange juice making and then sell the god-awful juices they put in their coolers. I've never had a Wow! moment in any of their cross-selling attempts - because I believe these attempts are directed financially. When Tesla starts to expand to more accessories, I will probably feel the same about their choices. When viewing Stage Two companies, I find myself filled with admiration for the efficiency and effectiveness of the large scale of services provided - in contrast to government services.

Finally, Stage Three is repugnant stage of screwing the trapped customer, utilizing every trick in the "profit maximization" catalogue. At this point, companies have managed to hold off competition or dominate it in such a way that taking advantage of the customer is a viable business model. Think Jack Welch and the culture he spawned. At this stage, the companies continue to increase profitability and are investable. I believe that owning Comcast today might be one such company. Investors become focused strictly on the "delta" as analysts cheer every clever trick and bemoan every attempt to reinvest in the business. Since the successes at the earlier two stages were strong, this allows flourishing as a Stage Three company. But the end is near as these dynamics set the stage for another Stage One founder to disrupt.

When Howard Schultz left leadership in 2017, the focal point was to reintroduce its premium branding and differentiate itself from a McDonald's-type drive through experience. Yet, his successor with a gaggle of spreadsheet running supporters managed to shut down such directives and scale into schemes to sell more stuff more quickly. Schultz's return may portend a return to at least Stage Two levels. Such changes do occur but require exceptional ability. That type of change occurred at Microsoft when Satya Nadella replaced Steve Ballmer. Steve Ballmer had been continuing to forcefully implement Bill Gates' Windows-centric model on the world. Satya Nadella did the unthinkable - reset the company on a cloud-based journey to meet the needs of its corporate customers. 

When I view Stage Three companies, they fill me with a sense of disgust and even shame. Since all companies end up here, why not support other socio-economic models? My support for capitalism lies in its ability to renew. Much as older generations attempt to hold on to the past legislatively and culturally, they are inevitably replaced by a new generation. Mother Nature knows best. Capitalism and its profit-seeking behavior seems to best imitate Mother Nature's ability to effect the death of the old and the birth of the new.

Big Pharma Big Expectations

When speaking with clients about their pharmaceutical holdings, I consistently hear dissatisfaction concerning the cost and structure of drug development. First, there is dismay over the astonishing cost of some newly developed drugs. Second, there is dismay over the seemingly automatic utilization of more and more drugs as wellness solutions are rarely offered or implemented. Third, there is dismay over the inability to generate better drug outcomes with less side effects. 

In a sense, all of this disappointment is rooted in the pharmaceutical industry's outsize success in treating certain problems, particularly within infectious diseases. As a result of this success, the general public was willing to try more treatments, the medical community was willing to prescribe more treatments and the investment community was willing to fund more treatments. 

The unintended consequence has been to lose sight of what gains are likely to make against various forms of disease. For example, Alzheimer's is a truly awful disease and affects almost everyone by debilitating someone they know. Yet, my reluctance to grant that brain science is even close to solving this problem has prevented some monetary and reputational losses (so far).

My broad takeaways after years of investing within this sector are: 1) the body is much more complex than any of us imagine, 2) wellness practices will continue to generate the best ROI, 3) specific areas of pharmaceutical success are knowable when the mechanism is clearly understood and 4) a diverse pipeline of consumer-like but medically proven drugs is the most investable approach.

"Digital" Real Estate as Legal, as Collective Mind?

As I study the dominant companies in the "digital real estate" world, I am increasingly impressed by how different these companies are than those I have studied for the past decades. Much has been written recently about the hazards of investing in companies with such sizeable market caps. The price declines in Alibaba (BABA) are sometimes used as a warning. Yet my studies of BABA reveal the same powerful difference at work. The key here is how I might characterize this difference.

My first attempt was to call it "digital real estate." As the "metaverse" develops, an effort is being generated so that a seamless transition works between analog and digital, but that model has some difficulties. The analog world is clearly limited and finite, while the "digital" repurposes and can expand as necessary. In this sense, there is an analogy of the mind-body problem in which the body is finite and limited and moves forward through time while the mind is changeable, unlimited and moves backwards and forwards through time. 

If there is an analogy here for the "mind," what then is a way of thinking about a collective "mind"? It seems to me that one real useful reference is our legal system. The legal system is a mental and collective construct that allows for and dictates the allocation of analog assets. If this analogy is true, and I think it is, then the question would logically follow - what is the investment price that I would pay for a piece of our legal system? In that sense, I think it also follows why buying the Western greats such as GOOG, FB, MSFT and AMZN works compatibly with owning the Eastern greats. It also points out the necessity for regulatory action which simply enfranchises and functionalizes these "digital real estate" companies.

More Debt, More Inflation: Japan's Counterexample

Japan has just announced a $490 billion support package to families and small businesses. This sizeable support structure is funded by more Japanese debt. While a few economists issue cries of concern about the size of the debt and the prospect of inflation, most economists and the Japanese lawmakers are unconcerned. With interest rates at 0% for 30 years, who could blame them? 

Yet the interesting part is that Japan's relative debt to GDP dwarfs that of the US. If more debt creates more inflation, why are these stimulus packages in Japan not creating more inflation? Yes, it is true that less immigration occurs in Japan and yes, it is also true that birthrates are lower. However, these factors do not seem capable of driving such an extraordinary difference in the mantra "more debt, more inflation."

Of course, no one truly knows the answer. That's part of the fun in opining on this process as opposed to advances in quantum computing or genetic engineering. However, for my part, I continue to see that more debt at some high level - such at 100% debt to GDP - slows the economy. In the famous equation that inflation equals money times velocity, it appears that increased money is thwarted by the slowing effects of massive debt on velocity numbers. The only chance of offset would be to use debt to fund productivity improvements, but increased productivity is incredibly unpopular - as we are seeing in India.

Is India the next China? The "Sacred" Productivity Problem

I have been spending more time thinking about India as a result of Modi's governance, investment observations of Indian leadership of American companies and personal interactions with Indians. As a friend of mine noted, "don't try to out trade people who invented numbers."

With that said, last weeks announcement that Prime Minister Nodi was abandoning the attempt to deregulate the agricultural sector. By bowing to the pressure of farmers, Modi has allowed incalculable damage to a people's ability to raise their standards of living. He complained that he "couldn't explain such a sacred thing to some farmers."

The phrase "sacred thing" is delightful. The truth is that gains in productivity fund increases in our standards of living. At the root of these increases are gains in agricultural productivity. While the US economy allowed the Great Depression to painfully shift employment into towns, Argentina stopped the transition. The result is that the US has gone on to gains, while Argentina has the most default-ridden of developed economies.

In the 2015 BRK annual report, Chairman Buffett writes (edited for brevity), "In 1900, America’s work force numbered 28 million. Of these, 40% worked in farming. The leading crop was corn. About 90 million acres were devoted to it and the yield was 30 bushels per acre. Then came the tractor. Today, we devote about 85 million acres to corn,but the yield is more than 150 bushels per acre - a five-fold gain. This is only half the story: The huge increases in output have been accompanied by a dramatic reduction in farmers. Today a tiny 2% of our 158-million-person work force farm - a twenty-fold gain." If farmers had been allowed to dictate (by democratic protests) this process, it is impossible to see how our standards of living would have improved without a basis in this 100-fold gain.

Interestingly, Modi was able to improve and simplify the tax system. Unlike the US which got rolled by the accounting profession into retaining nonsensical complexity, India now has a dramatically simplified system. However, without agricultural gains, India with its democracy seems a far less attractive investment space than China with its autocracy.

China Vs. US: Education

As China emphasizes "common prosperity," the leadership has cracked down on tutoring companies that provide educational advantages at great expense. The Chinese reaction to tutoring is that such education provides advantages available only to the wealthy. For such tutoring costs, families generally spend 20% of their income. 

It is interesting to see the same implicit "crackdown" occurring in the US. From the scandals around bought admissions to the removal of standardized tests, the leadership in the US is attempting to "level the playing field." Of course, admissions processes have long held a heavy hand in granting favor to those perceived to be operating at a disadvantage. 

But in China, ironically, the crackdown has impacted the private investor in tutoring companies while the changes occurring in US higher education has not affected private investment. The reason for this is that higher education has been purified of the private sector interests. 

It is clear to me that both systems are trying to emphasize a "meritocracy" approach and that the conviction of a system's worth has become a moral one - an increasingly murky distinction where self-rationalization and justification may be leading the way. Despite the structural weakness of the "meritocracy" thesis, its appeal is a potent force for investors and politicians. In this way, I am finding China and the US more common than different.

The "Real World" - more Meta?

For the past year, I have been emphasizing a movement from "physical" real estate to "digital" real estate. When I originally studied and valued Home Depot stock, I spent time studying the locations, the structures and the private valuations of those. This "physical" real estate anchored my understanding, valuation and analysis.

Since then, I have moved to the value of "digital" real estate, preferring digital real estate because of its scalability. Physical real estate became valuable due to its toll road nature, but that limitation also became a limitation in value. Digital real estate is expandable with little limitation on scale. This scalability creates an amazing "winner take all" characteristic powerful network effects drive a financially virtuous cycle of growth.

All of this converges with a growing sense that the "real world" is made up of an interplay between the two. This convergence has hit me as recently I have been considering the sale of my home. I received a beautifully written note from a realtor expressing interest in my "stunning, magical and picturesque" property and, based on her poetically stated interest, agreed to meet. 

I originally selected the property because of its connectivity in an active and busy area of town. However, as I watch the development of the digital world from Zoom to Instagram to LinkedIn to emails, I find that my main connectivity, especially during Covid-19, to be through the digital venue and my physical location was less significant. Perhaps the flight path of the jets of Love Field as well as my neighbor's daily obsession with gas-powered leaf dampened my ardor. Now I grapple with what is my best life?

I'm not sure yet, but I believe that physical real estate patterns will be affected on individual basis in the same way as retail space has been disrupted by Amazon. It seems as if the primary shift in residential will be a greater sprawl when suburban concepts are appealing. For those who are attracted to inner cities, the metrics are altered to an increase in space as office dedicated space is important. But it looks like the grind of daily suburban commutes are likely to be reduced.

A capstone of this trend is Facebook's recent pivot to the metaverse. As the physical and the digital converge, it seems clear to me that the metaverse will play a multidimensional approach like the facetime dynamic. The convenience factor will be important. Over time, there are signs that zoom, google meeting and skype are tiresome and awkward. Why not simply write a lovely note like this realtor? However, if the newly named Meta can drive interactions as easy as those between iPhone owners, then physical reality may become even less relevant and allow for an expanded suburbia.