Warren Buffett is getting a lot of flack this week from my colleagues here at Forbes for his tax policy positions. But don’t let the hot air around Buffett's sensible tax positions obscure the fact that he is called the “Sage of Omaha” for a different reason, namely that he is one of the most successful investors and executives in the history of capitalism.
The more important guidance for corporate executives to take from Warren Buffett right now is this principle:
Be fearful when others are greedy and greedy when others are fearful.
There’s certainly plenty of fear out there, given the debt crisis in Europe and deep-seated issues around unemployment, housing, deficits and political paralysis in the US. That means there must be plenty of opportunities to get greedy, too. It is time to start taking advantage of them.
Companies have been notching strong results but have been too hesitant to invest. The Associated Press recently reported that, for the 460 companies in the S&P 500 that have reported second-quarter results, earnings were up 12 percent from a year ago. Yet the 500 companies in the S&P index were hoarding a total of $963.3 billion in cash at the end of March. Citing JPMorganChase, the NY Times reported this morning that American multinational corporations had $1.375 trillion parked outside the United States.
Signs are finally appearing that companies might start deploying the enormous cash reserves that have accumulated since the recession ended. Just this Monday, Google, Time Warner Cable, Cargill and Transocean each announced major acquisitions that totaled more than $19 billion.
But, as executives shift from fear to greed mode, they need to be as cleared-eye as Buffett in the strategies that they pursue. In particular, they need to watch out for seven common mistakes that plague aggressive acquisition and growth strategies.*
1. Mistaking marketing for market research. Too often, in the case of testing a product idea, companies get carried away in highlighting the vision while glossing over the known limits of the actual offering. As a result, research overestimates demand. One of the most infamous examples of this occurred in the early days of the market research for Motorola’s Iridium satellite phone, launched in 1998 (and bankrupt nine months later). Researchers asked:
There will soon be a new personal telephone service which at a reasonable cost will provide you with the capability to be reached or to place calls anywhere in the world using satellite technology, which is not limited in coverage like a cellular phone. To access the service you would have a small handset that fits in your pocket...
Respondents were quite positive, and Motorola enthusiastically used the survey results to raise billions in investment. Unfortunately, the responses had little bearing on the actual offering because “reasonable cost” meant $3,000 per handset plus $3 per minute plus monthly fees, because “anywhere” meant a line-of-sight view to satellites, and because “fits in your pocket” meant you needed a pocket that could hold a brick.
2. Underestimating the complexity that comes with scale. It is easy to rationalize that expansion will allow you to spread fixed costs over more revenue, and that overhead expenses will drop as a percentage of revenue. Don’t forget that as you double in size, you likely won’t be doing precisely the same thing, twice as many times. You might be dealing with different markets, customers, sales channels, and so on. Car and computer makers, for example, are famous for saying they’ll share parts across product lines and then “optimize” those parts for a particular model. Once that happens, the benefits of commonality quickly disappear.
3. Overestimating the increased negotiating power that comes with size. Be wary anytime you see the term “critical mass” as justification for a strategic move. Doubling or tripling in size feels like a real achievement to those inside a company, but the outside world may not notice. If you remain a small part of the industry, doubling or tripling won’t get you much purchasing, pricing, or other negotiating power.
4. Overestimating your hold on customers. Companies sometimes talk themselves into truly strange ideas about their tight relations with customers—like the Florida utility that decided that people would buy insurance from it just because they bought its electricity. Customers do have loyalties to certain brands and products. But if you put a new name on the door, change the pricing strategy, or alter the product mix, customers may well head next door.
5. Playing semantic games. Any strategy that depends on a clever turn of phrase—such as saying “we’re not in the airline business, we’re in the travel business”—should be looked upon with suspicion. It is true that travelers use airlines, but that doesn’t mean that they want to rely on airlines to rent them cars or operate their hotels. And it certainly doesn’t mean that airline companies have any particular competency for doing so.
6. Not considering all options. Companies all live under the imperative to grow. The survivors are the ones who are remembered, and rewarded. Sometimes, however, it is best to forgo certain attempts at growth because they’d just be a waste of money. Even harder, it is sometimes better to sell the business early. It is better to collect a high valuation rather than hang on and fritter away value.
7. Overpaying for acquisitions. But, of course, you didn’t need me to tell you that. There’s already a wealth of information about the fact that businesses often overpay when buying other companies. Remember that two-thirds of large takeovers reduce the value of the acquiring company. How are you going to buck that trend?
To quote another management legend, Andy Grove, the former chief executive of Intel:
Bad companies are destroyed by crisis. Good companies survive them. Great companies are improved by them.
Now is the time for companies that aspire to greatness to step forward. If they avoid these seven pitfalls, they’ll drastically increase their chances of success.
Can you point out other common strategy mistakes, and companies that are making them? Please share your comments below.
Follow me on Twitter @ChunkaMui
---
