Coyote Blog

Here are Coyote's first three rules of business strategy:

1. If people are entering the business for personal, passionate, non-monetary reasons then the business is likely going to suck.  When I say "suck", I mean there may be revenues and customers and even some profits, but that the returns on investment are going to be bad**.  Typically, the supply of products and services and the competitive intensity in an industry will equilibrate over time -- if profits are bad, some competitors exit and the supply glut eases.  But if people really love the industry and do not want to work anywhere else and get emotional benefits from working there, there always tends to be an oversupply problem.  For decades, maybe its whole history, the airline industry was like this.  The restaurant industry is this way as well.  The brew pub industry is really, really like this -- go to any city and check the list of small businesses for sale, and an absurd number will be brew pubs.
2. If the business is frequently featured in the media as the up and coming place to be and the hot place to work, stay away.  Having the media advertising for new entrants is only going to increase the competitive intensity and exacerbate the oversupply problem that every fast-growing industry inevitably faces as it matures.
3. Beware the lottery effect -- One or two people who made fortunes in the business mask the thousands who lost money (Freakonics had an article on the drug trade positing that it works just this way -- while many of us assume the illegal drug trade makes everyone in it rich, in fact only a few really do so and the vast majority are and always will be grinders making little money for high risk).  Even those people who made tons of money in hot businesses sometimes just had good timing to get out at the right time before the reckoning came.  Mark Cuban is famous as an internet billionaire, but in fact Broadcast.com, which he sold for over $5 billion to Yahoo, only had revenues in its last independent quarter of about $14 million and was losing money (that's barely four times larger than my small company).

When I was at Harvard Business School, the first two cases in the first week of strategy class were a really cool high-tech semiconductor fab and a company that makes brass water meters that are sold to utilities.  After we had read the cases but before we discussed them, the professor asked us which company we would like to work for.  Everyone wanted the tech firm.  But as we worked through the cases, it became clear that the semiconductor firm had an almost impossible profitability problem, while Rockwell water meters minted money.  I never forgot that lesson - seemingly boring industries could be quite attractive, and this lesson was later hammered home for me as I later was VP of corporate strategy for Emerson Electric, a company that was built around making money from boring but profitable industrial products businesses.

Of course there are exceptions, but almost every one of these have built some sort of competitive advantage that allowed them to rise above the rivalry.  Google and Facebook are sexy and make money, but they have built scale and network effect advantages that make them hard now to challenge.   Apple makes money now because it has created switching costs (try switching from an iPhone to an Android and ever being able to text again with iPhone users) and a powerful brand.  The NFL owners have enormously sexy businesses but have created a brand and other competitive restrictions that protect their positions (not to mention have perfected the art of sucking money out of taxpayers for stadiums).  But even looking at these examples, the world is littered with folks who tried to be in the same business and failed.  Remember Nokia, Blackberry, Motorola, Lycos, Yahoo, AOL, Netscape, USFL, XFL, Myspace, etc.  I don't really know how strategy is being taught today, but I was schooled at HBS in Michael Porter's five forces.  I still find this framework useful, and probably about as much as any layman needs to know about business strategy.

But what about marijuana?  There are a lot of people very passionate about marijuana.  It is easy to grow (I remember an ex-girlfriend way back in the eighties whose mom grew it in the attic) and easy to sell (there is plenty of retail space nowadays going begging, or there is always the internet).  Every time there is some expansion opportunity in the business (e.g. a new state legalizing) the fact is advertised all over the media.  Overall, most folks are going to fail and most investment is not going to have very good returns for all the reasons listed above.   For most entrants, marijuana is gong to suck as a business for years to come.   And, some states seem to be developing onerous licensing regimes, and this may allow a few folks with the coveted licenses to make pretty good money.  Some day there could well be someone who consolidates the business and builds a powerful consumer brand and drives down costs and increases scale that makes money in marijuana.  But that is years away and typically the person who leads this is not among the initial entrants.  Remember, the vast vast majority of folks who traveled to California in the 1849 gold rush never made a cent.

You can already see this in California (my emphasis added). 

California's marijuana growers are producing far more pot than is consumed in-state — and will be forced to reduce crops under new regulations that ban exports, the Los Angeles Times reported.

"We are producing too much," Allen told the Sacramento Press Club during a panel discussion, the Times reported; he added that state-licensed growers "are going to have to scale back. We are on a painful downsizing curve."

Estimates vary for just how much surplus California produces — anywhere from five times to 12 times what is consumed in-state, the Times reported.

** You can tell I have classical training in business strategy because my goal is return on investment.  One can argue, perhaps snarkily but also somewhat accurately, that there is a new school of thought that does not care about profitability, revenues, or return on investment but on getting larger and larger valuations from private investors based on either user counts or just general buzz.  I am entirely unschooled in this modern form of strategy.  However, the general strategy of getting someone to overpay for something from you is as old as time.  I mentioned Mark Cuban but there are many other examples.  Donald Trump seems to have made a lot of money from a related strategy of fleecing his debt holders.

I would characterize long-term Japanese economic policy this way:

• Technocratically planned economy where the government chose winners and losers and directed capital to industries favored for development (e.g. MITI with steel, autos, electronics).
• Strong government favoritism for exports and exporters over the domestic economy -- export industries are heavily protected at the cost of raising costs for internal consumers and limiting competition in domestic markets.
• Enormous, near Herculean commitment to deficit spending as stimulus.  With deficits consistently running in the 8% of GP range and total government debt a stratospheric levels, Japan is the poster child for Krugman's anti-austerity

To these three I would add something that is seldom mentioned, that Japan has a near Scandinavian GINI index, with income inequality well under that of the US.  Oh yes, and they were an enthusiastic adopter of CO2 limits.

And the result of all this has been... 25 years of stagnation.

I remember when every one of these three planks was enthusiastically lauded by the US elite.  I was at Harvard Business School in the late 1980's and much of the discussion was about the US needing to adopt MITI-like government industrial planning and management.  If pressed at the time, people might kind of sort of acknowledge that life wasn't so good for Japanese consumers, but we were in a Michael Porter big picture competitiveness-of-nations phase, and no one seemed to care that their definition of national success did not turn out so well for the people actually living there.

To me, Japan is a giant case study in Austrian economics.  It's like they set out to run a quarter-century test: "let's see if mispricing of credit and forced misallocation of capital is really the cause of recessions."  So it is amazing that no one seems to want to acknowledge the results of this experiment.  Paul Krugman appears weekly in the New York Times to frequently advocate for exactly this same economic plan.