During a decade of low interest rates and abundant capital, companies greenlighted many projects that make little sense now that the economic environment has changed. To avoid experiencing these regrets in the future, companies should add more value thinkers to the teams that decide which projects to pursue. Although value thinkers are sometimes derided as worriers who lack imagination, in fact their careful, rational approach to analysis can be an important counterbalance to the reckless optimism that has become prevalent in recent years.
For the past decade, interest rates have been close to zero, capital has flowed freely, and business executives have lined up to finance dream projects. Financial markets can’t seem to get enough of this action: rewarding the “dreamiest” leaders, businesses, and concepts to an almost unfathomable degree.
But times have changed. Interest rates, the gravity that anchors capital allocation to reality, are now back with a vengeance. Markets have weakened. And the leaders of many companies, looking back on their capital commitments, think: “What have we done!”
In fact, the quick distribution of capital can have painful consequences: business failures, bankruptcy, layoffs, dismissals, etc. Once mistakes are made, the road to recovery is often difficult. But there is one idea that can help, not only in the recovery process but also in avoiding future regrets: consider adding more value-centered thinking to capital allocation decisions.
Most famously associated with investors from Benjamin Graham school, this way of thinking is very applicable to business managers in a corporate setting. It provides a comprehensive, rational, disciplined framework for all capital allocation – a framework that is especially useful in times like the present. Yet it’s also a tough one to find in today’s businesses, reeling from a decade of unrestrained risk-taking. Sidelined, as it were, by the recent dominance of what I’ll call the “moonshot” approach.
Here are five defining characteristics of bought oriented capital allocation and, for contrast, equal characteristics of take the moon procedure:
Risk versus Return
- bought – First risk: The #1 question is always “how can things be unique false?” Followed closely by “are we protected against irreversible, game-changing losses if that happens?”
- Moon shot – Return first: Question #1 is “how can things be made better TRUE?” Followed closely by “are we positioned to win big if that happens?”
Beware of Vision
- bought – Margin of safety: Provide capital only when reasonable and verifiable analysis makes a clear case for it – with little room for error, and don’t rely on heroic assumptions. As Warren Buffet said: “When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 pound trucks across it.”
- Moon shot — Power of vision: Commitment to a game-changing, futuristic vision with huge untapped potential. Today’s assumptions and analysis are of little importance if one can act against such a vision.
Wisdom of the Crowd
- bought — Ignore the crowd: Avoid the temptation to join any business trend that may be fashionable at any point in time. Have the courage to run against the crowd and, if necessary, do the opposite of what everyone else seems to be doing.
- Moon shot — Evangelism the multitude: Drive passion, belief, and the “fear of missing out” to get others to buy into the big vision. Encourage the crowd to follow our lead and run alongside.
Reality vs. DREAM
- bought — Separate dreams from reality: Focus on dispassionate, rational analysis of unit economics and capital efficiency. Does the math show that the return on capital invested comfortably exceeds the cost of capital required? Only then focus on growth and size.
- Moon shot — Make dreams come true: Focus on figuring out what it takes to overcome obstacles and quickly grow and dominate the market. Trust that unit economics and capital efficiency will fall into place, although we don’t yet know how.
- bought — Patience: Avoid the urge to always “do something.” Be comfortable operating on relatively low intensity level for a long period of time while waiting for the right opportunities to arise.
- Moon shot — Now or never: Every moment is precious, and there is no time to waste sitting around waiting. Achieving a dream requires constant action, experimentation, and relentless, energetic effort.
It’s fair to look at the moonshot characteristics above and ask: But isn’t it? GOOD characteristics? Income items want for our organization to see? Absolutely. I am not suggesting otherwise. In fact, such thinking has helped create some of the most exciting, world-changing businesses today: Amazon, Tesla, Netflix, Zoom, Uber, and more. And the leaders behind these extraordinary success stories have become household names, capturing the imaginations of managers around the world.
But this moonshot way of thinking seems to be coming to an end again successful. Over the past decade it has come to dominate corporate capital allocation to such a degree that such decisions have become more untethered from reality. Proposals previously dismissed as outlandish are rationalized using compelling arguments from the moonshot template. And even companies with perfectly sound, solid business models have convinced themselves that they will somehow be left behind unless they urgently go “all-in” on some disruptive futuristic venture. -see (for example, involving AI, crypto blockchain, virtual world, cloud, space exploration, etc.). All of this has created a desperate competitive scramble to build and/or buy assets, resources, and talent in those areas – as if to whatever cost.
In contrast, value oriented thinkers – contrarian voices at the best of times – are labeled as worrywarts, timid, short-sighted, or worse. The case studies they want to cite — like Teledyne’s focus on capital efficiency (in the 1970s and 80s), Danaher’s leadership development through his disciplined business system, Alleghany Corporation’s 90-plus years of flexible yet smart value creation through multiple market cycles, and Places called Berkshire Hathaway in the United States famous model of efficient capital allocation – as largely thought of as ancient relics of a bygone era. As a result, many naturally “hard wired” value thinkers seem to have fallen into silent acceptance as the all-out spirit surrounding risk-taking over the last decade continues to prove them “wrong. “
But time (and the end of easy money) now shows that maybe they weren’t so wrong after all. And that perhaps the checks-and-balances that their voices can provide are actually sorely missed. Importantly, such checks-and-balances should not mean abandoning big, bold, futuristic bets on growth. But they should help ensure that these bets are the real value of betting valuable capital. As the economist Daniel Kahneman said: “Courage is the willingness to take risks when you know the possibilities. Optimistic overconfidence means you take risks because you don’t know the possibilities.” possibility. Big difference.”
So it’s worth considering: Does your organization need to get more value-based thinkers back into the rooms where capital allocation decisions are made? Should there be more of these in your analysis groups, due diligence task forces, management committees, and boards? These people should be intentionally found, appreciated, nurtured, and listened to, especially if they offer a reasonable objection to some tempting and fashionable, but dangerously dangerous idea. Why? Because they provide a necessary balance – a test of health – that helps keep your organization’s capital commitments grounded in reality. And in doing so, they can not only help your organization deal with the pressing economic realities of today but also prevent the mistakes of the past from being repeated in the future.