I met with an investor the other day who was talking about successful businesses, and he claimed that almost all of today’s big businesses started out with extremely humble beginnings – raising less than $10M. I wish I could quote where that research comes from, but I don’t know. But let’s assert that it is true for a moment.
His second idea had to do with investment funds. His claim was that you should never trust a fund manager that keeps significant portions of his fund in cash. The reason is because when an investor has extra cash to use, he can make lightweight decisions to invest in something new. If all cash is invested, then buying a new investment means selling another. Having to make that tradeoff forces the fund manager to scrutinize his decisions – does he want investment A or investment B? He has to decide. If he has the cash already in hand, he doesn’t have to decide – he can do both.
In business, the same may be true. When managers have too many resources, the decision to use those resources can be made easily. You’ll always get better decisions when you have to give up something before acquiring something else. Having extra money in the bank allows you to avoid this critical thought process.
If you’ve read this far, maybe this is making some sense. And, maybe it means that good managers (be it fund managers, people managers, software managers, etc) are those which are able to always make good decisions even if resources are available.
So, here is the catcher – inherently, people aren’t naturally good at being decision makers when there is no tradeoff. Without a tradeoff, we can make decisions based on emotional moods or whims. After all, the resource is available and ready to use, so today, I’ll make the decision “because I feel like it”. I guess this consistent with Warren Buffet’s description of “Mr Market”.
Could this account for why large companies often fail to successfully enter new businesses? Spinning up a new division from a successful one will have lots of resources and cash from the onset. Using those resources wisely is hard to do. Unless the business is inherently difficult with high capital expenditures where it’s obvious how to spend the money, it can be easy to make poor decisions.
Well, don’t get too caught up in this, because if you take this literally, you’d believe that the incumbent companies would never be able to enter new businesses without acquiring. Odd, though, there do seem to be a lot of acquisitions recently.