Do financial services companies provide value? There is an interesting Forbes article by John Bogle in the November 17 issue.

To summarize, Bogle determined that in a recent year, the "financial services" industry effectively took $620 billion off the top for a 7% fee on $9.5 trillion value of stocks, or 2% of a $30 trillion value of bonds, or 1.5% of $40 trillion value of US securities. Now we're not sure who Bogle has included in his definition of the "financial services industry as the "croupiers," "the money shufflers and middlemen." It doesn't really matter because his point is not about the specific cost but the role of those folks in the market.

Bogle refers to Warren Buffett's letter (PDF) in the 2005 annual report for Berkshire Hathaway. In his extended analogy, Buffett makes the general point that if one family owns all the shares of all the companies, some family members paying advisors to get a net larger slice of the pie vis-a-vis other family members is unwise because the total FCF for distribution is the same and the advisors will take away from the distributions to the family. Of course, the question of whether the family as a whole is better off is, perhaps, the right question but not the one actually being presented. Each family member in the hypothetical is trying to increase that person's FCF without regard to the FCF of the rest of the family. (OPEC & the difficulty in keeping cartel members from cheating or the more basic prisoner's dilemma are obvious parallels.)

Once the option exists to choose individual investments, as opposed to market-wide index funds, advice to optimize the portfolio becomes a rational alternative to consider, with the rationality of the choice a separate issue that is more complicated. Buffett, and now Bogle, seems to say that seeking advice does not make sense.

Do portfolio-pickers and brokers (and that's the category with which Bogle seems most concerned) cost too much? Maybe. Some do, some don't. Doesn't the performance of the pick matter? Consider a relatively simple question of choosing a traditional market-cap weighted index fund vs. a dollar-weighted index fund or equally weighted index fund. Those returns are different. Is the investment advice that points you to the right one worth more? At least worth something?

What this article sparked for us was the recognition that companies are in fact much like Buffett's fictional family and yet also very different. On the one hand, a company consists of a portfolio of products, services, customers, and assets. Each company would be hard pressed to justify internal competition that doesn't have the effect of improving firm FCF. So advice doesn't make sense.

At the same time, cannibalization is a growing in acceptance as a part of corporate strategy. So each company is like an individual family member looking to improve its poosition as against its competition. Certainly, advice then makes sense.

So, while TSC can be described as a financial services company, we don't really operate in the same market that troubles Bogle. We help companies determine how to improve their free cash flow by analyzing the datastream of their business portfolio. Our insights may revolve around the acquisition of capital, the growth of revenue, the control over costs, and the reinvestment in the business, but in many ways they're fundamentally different from pure stock market advice. Of course, we have considered the application of our algorithms and equations to private wealth portfolio management, the selection of pairs of securities appropriate for hedged opportunities, synthetic M&A trading strategies, and portfolio optimization -- so maybe we are more of a financial services company than we think.

Labels: execution, IDM, performance, tips

Saturday, December 06, 2008 :: posted by Rick Colosimo @ 1:32 PM

Why raw data alone is insufficient for making decisions The WSj recently published an article regarding the prospects of asking/demanding that political candidates or prospective CEOs release DNA sequence information.

For us, even though data-driven analysis is the first phase in our business leadership process (Data-Driven Analytics (DDA), Informed Decision-Making (IDM), and Intentions-Based Guidance (IBG)), it is important to understand that data alone is meaningless. While the connections between sales data and pricing strategies or marketing campaigns is at least intuitively in the ballpark for most managers, the connections between DNA sequences, genetic predispositions, health risks, and actual health problems are far more attenuated. Geneticists and doctors (since the intersection is the important issue) know that only certain DNA sequences lead to definite health problems, and that only some health problems are tied primarily to purely genetic factors. For example, Huntington's Chorea, a genetic disorder, is caused precisely by a specific gene and regularly occurs when the mutation is present. Alternatively, even if I don't have a genetic predisposition to lung cancer, if I smoke a pack a day, I'm very likely to end up in trouble.

From a business perspective, it is clear to all (well, most, since we've found some of the exceptions) that if your sales price doesn't cover your costs, you're either in for a serious economic catastrophe or an antitrust investigation. But that single accounting snapshot is not a good description of how business happens. Businesses are continually making sale after sale, at varying prices, to different customers of different products and services. Tracking the change, rate of change, and source of change across those variables can point you in the right direction. Financial snapshots are like DNA; it's possible for them to point to problems all by themselves, but most of the time, you have to analyze the system dynamically because it's a dynamic system. In science, it's called experimentation; in medicine, it's called treatment; in business, it's called management.

Labels: DDA, execution, leadership

Saturday, November 01, 2008 :: posted by Rick Colosimo @ 1:32 PM

Too much data? Be decisive. This article & discussion from Lifehacker.com includes an excerpt from a new book, CrazyBusy. The author, in that excerpt, talks about how we often get entangled today by a desire to have all the data before we make a decision.

In our experience, this is not a side effect of the modern world, of the increasing availability of data. It is human nature to try to make good decisions, and the goal for certainty is underscored not by data but by poor management and worse leadership. Good leaders understand that people make mistakes and that data paralysis is to be avoided. Good managers help train people to understand what data is important and what is required to make a good decision (not necessarily the right decision). We can all look back at decisions we made that turned out to be right or wrong. That set isn't the same when we divide them by well-made vs. poorly made decisions.

Where do people learn about decisiveness? I know where we learned: the Army. As a young lieutenant, at the same time as we were teaching this concept to NCOs and junior enlisted soldiers, senior officers were teaching us. We left the Army with a well-tuned ability to figure out what kinds of information were required to choose among alternatives, how much information we needed to choose, how uncertainties in one area could be compensated by good information in another: actually making that choice, in an imperfect environment, we called decisiveness.

As junior officers, we were corrected more often for failing to make a decision than for choosing an alternative that turned out to be incorrect. We all had the opportunity to do plenty of pushups in places like West Point, Officer Candidate School, or Ranger School in the course of learning that lesson. That is one reason former junior military officers have often a bias for action, as we term it.

So, when you're faced with a data glut, do what your average 2LT would: figure out what you need to absolutely make the decision, assess how much information you have and how reliable it is, determine what the failure modes are based on incorrect or missing information; then, mash all that up in the supercomputer we call a brain and spit out an answer. After all, you're not just going to sit there, right? You *might* be wrong, but without intervention, the world *will* go to hell in a handbasket: it's Newton's Second Law.

Labels: execution, leadership, military

Tuesday, March 11, 2008 :: posted by Rick Colosimo @ 3:49 PM