21 Rules for Young Professionals

You just broke into the workforce as a professional.  Your first real job in the real world.  It won’t always be easy to navigate, or obvious what to do.   This list of timeless rules can serve as a guide to anyone hoping to survive their first foray into the life of a young professional.

1.       Understand failure
It is a thing that will happen.  Be prepared for it, and be prepared to learn from it.

2.       Embrace criticism
There’s nothing worse than seeing a person pout after they receive negative feedback.  You’ve just been given an opportunity to get better, use it. 

3.       Live outside of your comfort zone
Hate public speaking? Look for opportunities to speak in public.  No good at writing? Start a blog. 

4.       Stay humble
Everything that you have achieved up to this point is great, but it means a whole lot less if you start to act entitled.  Let your results speak for themselves.

5.       Have confidence in your work
There may be times when you feel like you have no idea what you're doing, but you landed in your role because someone trusted your ability to figure it out.

6.       Be reliable
There's no substitute for being on time, and being prepared.  Whether it's a meeting, a presentation, or drinks after work, show up on time and be organized.

7.       Become an expert in your field
School's over, and the skills you need for your job won’t always come from your education in the classroom.  Taking the initiative to master your role  can be the difference between a job and a career.

8.       Invest in your appearance
A professional appearance means a lot more when you’re 25 and don’t have ten years of workplace performance to back you up.  Nice clothes, shoes, and a haircut are all good places to start.

9.       Keep your work area clean
Whether you are in an office, a cubicle, or working out of your apartment, people can see your workspace and it reflects directly on your professionalism.

10.   Under promise, over deliver
Doing what you say you will do is one of the straightest paths to credibility.  No amount of education or connections will be able to overcome the damage of failing to follow through.

11.   Use your network, and let it use you
Who you know can make a world of difference, especially when you’re starting out.  Ask for help, ask for introductions, and be prepared for people in your network to ask you for the same.

12.   Handle yourself appropriately in social situations
It’s ok to have drinks with colleagues, even a few, but people never forget the time you make a fool of yourself.  One rough night can be a career limiting move.

13.   Always maintain your integrity
Compromising yourself for any short term gain is not an option, it will be outweighed by the repercussions and become a permanent part of your reputation.

14.   Be a great teammate
Help, support, and encourage everyone that you work with.  Whether they are peers, superiors, or interns, everyone is working toward the same goal.

15.   Manage your online presence
One of the first things someone will do when they want to know about you is Google your name.  Clean up Facebook (or make it private), put some time into your LinkedIn, and be responsible on Twitter.

16.   If you don’t know the answer, admit you don’t know
Honesty defines credibility, ignorance will dig a hole you can’t crawl out of.  Telling someone that you will get back to them with an answer will be understood and appreciated.

17.   Get your hands dirty
If you’re asked to do something, do it.  Nothing is below you at this point in your career, and you will learn something from every task you complete.  If you’re stuck doing paperwork for a week, get really good at doing paperwork.

18.   It’s ok to start small
No matter where you start, it will be your persistence, patience, and consistent effort that will lead you to success.

19.   Learn from your mistakes
You will make mistakes, it is normal and acceptable. Mistakes only become problematic if you make the same ones multiple times.

20.   Own your mistakes
When something goes wrong, deflecting responsibility makes your trustworthiness and dependability evaporate.

21.   Be a good person
Everything else in this list is moot if you’re not a good person, and being a good person is the best networking you will ever do.  Help people, volunteer, say thank you, leave a tip, and hold the door open.  You never know who is watching.

Contributors to this post:

@theaearl (Shopify)

@simonwlove (Ernst & Young)

@Marius_Felix (Brentwood College)

@beesureman (CBRE)

@MaxLanePWL (PWL Capital Inc)

Insights of a First Year Mutual Fund Representative

I wrote this letter to my managers within my first four months of being an insurance and mutual fund representative.  In reflection, I find it interesting that almost exactly a year later I have found myself in a firm that recruits and trains advisors in the manner that I describe here.  In my opinion, this type of model will have to be the future of the financial advisory business, especially when the changing regulatory environment is considered.  When I wrote this, I was not aware of the fee based model.  The fee based model is far more conducive to operating in the manner that I describe below, which is likely one of the reasons why the embedded commission model is under so much fire today.

 

The letter:

 

The broad expectation that I have for my current position is that I am constantly learning and fuelled by activity.  I will go into more detail later in this document.  When I entered into the position I had a vision of it being similar to a high level law practice.  I will explain what this looks like in my mind and then draw parallels to show how it applies to a high level financial advisory practice.

After performing casual research by speaking with a corporate lawyer and two litigators (one in family law one in intellectual property law) I have learned that when entering into a firm as an associate, excess clients are passed from the partners to the associates to give the associates an opportunity to learn and build their practice.  Associates are allowed and encouraged to bring in their own clients, but the high level business from the partners is what allows them to gain the type of experience required to add value to the firm; clients passed on from the partners also allow the associates to build a client base that fits with the image and quality of the firm.  An analogy that I discussed with one of the lawyers that helped me understand how a high level law firm works compared the way that financial advisors currently enter the business to a lawyer opening up their own law firm on the street; they are starting a practice with no brand equity, no referral base, and no high level cases to work on to gain the experience needed to become a high level practitioner.  This model is not conducive to building an elite practice.  Partners have spent years, if not generations, building a name and a referral base that brings in clients.  This difference in the way that a lawyer enters the business compared to the way an advisor enters the business explain the disparity between the average level of recruit entering a law firm and the average level of recruit entering an advisory firm.  This model also increases the barriers to entry for an advisory practice.  The current model allows managers to maintain relatively low standards when they are hiring new recruits for multiple reasons: new recruits are difficult to find due to the nature of the business, and the high turnover rate is somewhat justified by the relatively low level of investment by the firm.  It is a vicious circle and a chicken before the egg type situation.  If a model representing a law firm were adopted then the quality of advisors coming into practice would increase.  In the event that advisors knew they would be getting clients upon beginning to practice the business would be far more enticing for compensation and experience purposes; referring to my previous analogy, lawyers are far more likely to join an existing firm than to start their own right out of law school.  The reasoning of a lawyer choosing not to start their own practice is similar to that of a high level professional considering financial advisory; it is necessary to start a business from the ground up.  The alternative law firm hybrid model also increases the investment from the firm which will inevitably result in higher risk, but also greater reward.  The risk of high turnover will be mitigated by replicating the hiring standards of a law firm with an articling process, and a progression into the business.  The reputations of advisors in our business are damaged by the lack of an articling period and the rapid succession into practice.  If lawyers were able to write one two hour exam and begin practicing, the public would be as skeptical of them as they are of advisors.

In our discussion yesterday we referred to the trials and tribulations that people will go through to be analysts for Fidelity.  We failed to discuss some key aspects that make this possible, and the ways that they can be applied to revolutionize our business.  The people putting themselves through hell to become analysts for Fidelity are the cream of the crop.  They are top students from top schools competing for a top position that, if achieved, is guaranteed to come with a large payout and huge opportunities for the future.  In contrast to this, financial advisors often enter into the business with little idea of what it is that they are getting into, high hopes for the potential of income, and unrealistic expectations for what the first few years will be like.  Financial advisors are often second career people looking for higher income, or university graduates that were unsure of what they would choose as a career.  It is very possible for advisors to go through their career never making one tenth of what an analyst at Fidelity will make, while continuing to scramble as if they were fighting for a spot.  It is a difficult expectation for the firm to hold that individuals with high income potential will walk into a business with such a high failure rate when they could be entering into fields with guaranteed income.  I understand the argument that the income potential in this business justifies the initial risk, but imagine the advisors that are being overlooked due to being averse to the risk.  Changing the broad business model to the law firm-like approach will make gaining a spot in this firm a cherished opportunity that graduates with high expectations for themselves and their careers will compete for.

The law firm business model sounds attractive and flashy, but is it feasible to apply this model to an advisory practice?  Lawyers are paid on a salary with an opportunity to earn a bonus based on their performance and the revenue that they are able to produce; billable hours are charged to the firm and used in analyzing the performance of associates.  In the event that associates are brought into cases with a partner their billable hours are combined with that of the partner.  The billing system records how files come in and associates are paid a bonus between .5 and 2% of the total bill for that case.   This occurs if the associate refers a case in, or if they are present in the initial meeting and throughout the case.  Associates are given “sales” targets that must be met using either billable hours or set block fees.  The cases handed to associates by partners count towards fulfilling these quotas; the same system could easily be applied to DSC sales and aum, using commissions and assets instead of billable hours.  From the samples that I took, it is common for first year associates to have to fulfill between 1200 and 1800 billable hours per year.  This does not include administrative work, so it is apparently very difficult to achieve these quotas.  Again, this system is very relatable to commissions.  Advisors would still be motivated to sell and gain clientele to meet their quotas, while having the safety of a salary.  When a lawyer is awarded a position in a firm they are required to go through a period of articling which lasts 10 months; they are paid a salary of approximately $40K during this time.  The next step is to become a first year associate, during which time they are compensated with a salary of approximately $65K and incentives based on activity.  A small percentage (.5-2%) of the business that a first year associate brings to the office is paid out to them.

I understood entering the business that it would not look like what I have described in this document, but I certainly did expect it to be somewhere between what I have described and what it is.  I believe that if we are able to build a model that operates in line with what I have described, we will be able to bring in higher level advisors and bigger clients, take advantage of the concept of functional specialists, and create young advisors that operate on a level that usually takes a life time to achieve.

Understanding that there is a small chance that any of this will actually happen, my expectation going forward is that I will be included on large cases, I will be compensated according to the level of work I am performing, which may not be directly related to premium submitted, and I will be given the type of guidance and structure that an articling lawyer would receive.  It is my preference that I am put on a salary as my current lifestyle cannot be maintained with my level of pay, and the clients that I am attracting to try and pay the bills are not conducive to building the type of practice that I envision.  A structure similar to a first year associate in a law firm, with bonus based on performance, is preferable.

A final note that I hope will make all of these ideas make sense when applied to our office:  There are a select few prestigious law firms that were built by charismatic people with affinities for both law and business.  They have built practices that bring the biggest law cases in the world to them because of the name they have built.  These firms employ massive amounts of highly intelligent and well respected lawyers which allow the firm to attract and handle even more business and bigger cases.  If every lawyer at Gowlings had opted to open their own practice instead of joining the firm, not only would they suffer from having to start from scratch, but the firm would suffer due to decreased capacity and an inability to grow.  Asking financial advisors to start from scratch every time they enter the business is inefficient.  A charismatic and talented advisor should be able to build a practice, and then continue to grow it by adding other advisors that he is able to pass his extra cases to and increase the capacity of his practice.  There is a huge difference between having people on a sales team and having people integrated fully into a practice.  Financial advisory fits so well into the model of a law firm; I believe that shifting to this model is the future of the business.

What Happened to lululemon athletica?

I don't pick stocks.  I don't really think that anyone can pick stocks.  A lot of analysis can be done to try and forecast stock prices, but it will never be possible to predict all new information (weather, wars, celebrities' actions...all new information).  Nobel Prize winner Gene Fama believes that all available information is reflected in the price of a security.  If we cannot predict all new information, and all new information is factored into the price of a security it is safe to say that success in forecasting will be as random as the development of new information. 

As much as I disagree with the fundamental concept of picking stocks, I do enjoy a good business case.  If I took one single thing away from my MBA (other than the people I met) it is that companies fail when they get away from their core competencies.  In attempts to keep pace with their past growth rates, poorly managed companies tend to stray from the strategy that brought them success in the first place.  I think that over the last few years lululemon has departed from their core strategy.  It is no surprise to me that they are faltering; the original shareholders cashed out, but is that the path to building long-term value?  Is it strategic for a company to create strong core competencies and maintain them just long enough for the original shareholders to cash out in the primary market only to leave the company to be ravaged by the demands of the secondary market?  Studies have been conducted on the willingness of executives to destroy long-term shareholder value in order to achieve short-term financial goals, and I think this is exactly what has happened at lululemon.  I don't blame them.  Chip Wilson is a business man.  Christine Day had analyst expectations to meet.

Dollar signs and ratios overcame the company's original vision; quality was traded for quantity and they began to diversify away from their core products.  I'd like to walk through how the industry environment has changed since the company began.

lululemon currently has multiple suppliers in a handful of developing countries; a far cry from back in 2004 when they first began outsourcing and had one single supplier in China which was merely a foreign extension of the original Vancouver manufacturer.  In 2004, the supplier had a significant amount of power over the price that they charged for the premium, exclusive, luon blend of 85% Nylon and 15% Lycra that Chip Wilson had created.  lululemon and their supplier had a mutually beneficial partnership that allowed both of them to become highly successful while creating high quality products.  It should not come as a surprise that as the company grew, margins and scale needed to increase and more suppliers were employed.  With the current number of suppliers that lululemon has, and the fact that luon can be easily replicated by other manufacturers, suppliers have been rendered powerless.

The power of buyers is also a far cry from 15 years ago when the company had just begun and the product was sought after as a status symbol and a fashion statement; women would pay $100 for a pair of Groove Pants without thinking twice, they were powerless against the draw of the brand.  As lululemon became obviously successful, multinational, diversified athletic apparel companies started manufacturing yoga equipment to keep pace with the developing market.  While this was happening, yoga went from being a craze, to a trend, to a mainstream form of exercise.  In the current market, yoga apparel is everywhere and buyers have a huge amount of power over the decision of where to buy.  Due to these developments, the market has become more price sensitive, and it is exceedingly difficult for lululemon to justify selling pants at a premium price point when their quality is no longer a differentiating factor.

Competition in the athletic apparel industry is extremely high.  The industry is fragmented and consists of both small private manufacturers like One Tooth, and huge companies like Nike, Adidas, and Roots.   In their 2013 10-K, lululemon acknowledges that the competitive landscape is not easy to operate in.  They actually explain the competitive rivalry in their industry much better than I can (I have paraphrased):

"We also face competition from wholesalers and direct retailers of traditional commodity athletic apparel, such as cotton T-shirts and sweatshirts. Many of our competitors are large apparel and sporting goods companies with strong worldwide brand recognition, such as Nike, Inc., adidas AG, which includes the adidas and Reebok brands, and The Gap, Inc, which includes the Athleta brand. Because of the fragmented nature of the industry, we also compete with other apparel sellers, including those specializing in yoga apparel. Many of our competitors have significant competitive advantages, including longer operating histories, larger and broader customer bases, more established relationships with a broader set of suppliers, greater brand recognition and greater financial, research and development, store development, marketing, distribution and other resources than we do. In addition, our technical athletic apparel is sold at a price premium to traditional athletic apparel.

Our competitors may be able to achieve and maintain brand awareness and market share more quickly and effectively than we can. In contrast to our “grassroots” marketing approach, many of our competitors promote their brands through traditional forms of advertising, such as print media and television commercials, and through celebrity endorsements, and have substantial resources to devote to such efforts. 

In addition, because we own no patents or exclusive intellectual property rights in the technology, fabrics or processes underlying our products, our current and future competitors are able to manufacture and sell products with performance characteristics, fabrication techniques and styling similar to our products."

If consumers choose not to buy yoga (or run, or dance) clothing at all, there are substitutes.  lululemon is much more than athletic clothing, it is casual wear and fashion; I think that from a strategic standpoint buying jeans or cotton sweatpants instead of lululemon clothing can be a logical substitute.  lululemon clothing has not fully lost its appeal as athletic apparel, but the brand had evolved into something not just sought after for use at the yoga studio or gym.  This clothing was trendy; it was fashionable and normal to wear the stretchy yoga pants out in public as if they were jeans.  Maybe I'm getting older and am not with the times any more, or maybe it's because it's winter, but it seems to me that wearing yoga pants is far less socially acceptable than it was a year ago.  The next time Ocean and Duke have a few bills to blow on clothes, it's my bet that they're looking for something that they can wear in public without looking like they just came from the gym... I remember when tear-away track pants were cool too.

For new competitors to appear, the cost of establishing production facilities would be a hurdle, but so many of the new entrants are existing companies that are diversifying into lululemon's market.  Smaller companies are also able to enter into the market to mop up the segment that wants Canadian made, high quality clothing for use in a yoga class; I think this is a segment that lulu left behind when they began their multinational outsourcing and reduced their quality standards.  New entrants can come from both huge companies that are diversifying, and also small players that cater to the traditional yogi market.

So, lululemon is in a market where suppliers are commodities, buyers have tremendous amounts of choice, competition is cumbersome, their product is becoming less fashionable, and new players can easily enter the market; how did they become so successful in the first place?  They leveraged their core competencies.  An extremely high quality product, and an extremely loyal, culture driven, cult-like customer base.   We all know what happens when you bite the hand that feeds you.  When the "scarcity model" shifted to mass production outsourced to inexpensive manufacturers in India, China, and Vietnam, the cult-like following that had previously felt so privileged to own one of the limited items produced in a particular style and colour started to feel just like everyone else on the street.  As the products became less and less exclusive, they also became lower in quality; it's a lot harder to justify buying a pair of stretchy pants for $100 when it may only last a season and everyone else at the gym has the same pair.  In the beginning, the design was meticulously functional and created with material that was carefully monitored for quality.  More recently, we have seen disastrous items like this:

Jacket.jpg

and had serious problems with the quality of the material.  Now that their loyal customers have been insulted with over-priced, unfashionable, poor quality garments it is no surprise that many of the women (and men) that once praised the company are becoming less interested in the culture, and the products.  With the entrance of a new CEO, lululemon could still change its direction and improve its image, but it will never go back to being the glowing superstar of the retail world that it once was, and the image of the wealthy, sporty, yogi, wearing her Astro Pants to yoga class before going straight to the organic market to pick up wheat grass and lentils is dead.  If it's not dead, it's at least out of style.  People will still buy lululemon clothing, it is still functional, and I'm sure the quality will improve to match the price point, but they had something very special that was thrown to the wayside in order to drive profits.  The way that this company fell from grace is attributable to the pressures that the financial markets put on short term performance rather than accepting periods of under performance in light of building out a long-term strategy.  All of this is interesting, and managers can learn from it, but for investors none of it matters.  The market has already priced in everything that I have discussed.

 

An academic classic, on the folly of rewarding A while hoping for B

In Kerr’s paper, An Academic Classic, On the Folly of Rewarding A While Hoping for B, he discusses how humans often set up systems that do not encourage the behaviour that is actually desired.  One of the examples that I found to be interesting was that of soldiers in Vietnam versus soldiers in World War Two.  The way that the soldiers were being rewarded in WWII was with the knowledge that if the war is won, they will go home; in Vietnam, the end of the war was not well defined and soldiers had to stay to fulfil their tour of duty no matter what was going on.  The difference in these rewards was the cause of the difference between the disciplined and obedient WWII soldier and the mutinous Vietnam soldiers.  In both of these cases, the Generals were hoping that their soldiers would be obedient, but only in one case were the goals of the soldiers in line with the goals of the Generals.    The same principles apply directly to agency issues where managers may be compensated in a way that rewards behavior that is really the opposite of what the company needs for sustained performance.   The errors in this area are summarized by Kerr; in business we hope for long-term growth and environmental responsibility while rewarding short term (quarterly) results.  It is expected that employees will employ teamwork, but they are rewarded for individual performance.  Employees and managers are expected to report bad news early and exercise candor, but they are rewarded for reporting good news and agreeing with their superiors.  In this same light, executive compensation can be a point of contention for managers and shareholders alike.  It is one of the greatest embodiments of agency issues as executives work extremely hard in order to increase the value of their company while also expecting to be rewarded for their performance.  If they are not paid enough they will take their skills to a competitor, and if their skills have been deemed worthwhile the shareholders will want to keep them.  In Rappaport’s article, New Thinking on how to link Executive Pay with Performance, he discusses some innovative ways to avoid compensating executives handsomely even when they are not delivering.  The idea of indexed stock options eliminates executive compensation being extremely high when the market is up and low when the market is down and instead requires the company’s stock to outperform the market (or a designated index of competitors) to make exercising options worthwhile.  This strategy has multiple effects on executives’ behaviour.  As Kerr says, when managers are not performing the way that they should be it may be time to evaluate the behaviors that are actually being rewarded; the company may not be rewarding what they think they are rewarding.  If managers were receiving options in a bull market, they would not necessarily need to be performing well to exercise their options and receive generous compensation.  In this situation they could easily become complacent while their pockets continued to be padded by the rising market.  Indexing stock option compensation also has the merit of being more valuable the longer those managers hold the options relative to a fixed price option; this also makes managers want to stay with the company longer.  Although this solves some problems for executive compensation, operating managers are not able to partake in this scheme.  Operating managers in charge of business units are less able to influence the price of the overall company’s stock and it would not make sense for them to be penalized for the poor performance of other departments if they have performed well.  Haspelagh, Noda, and Boulos go into these issues in further detail in their article It’s not Just About the Numbers, they refer to it as value based management (VBM).  This style of management focuses on people first, and expects the numbers to follow, and it does not only focus on senior executives.  Just as it was noted by Kaplan and Norton, it is vital for the entire organization to buy into this type of management for it to be successful.  Business units and their operational managers are structured into value centers with strategic goals in line with the VBM program that has been implemented by the overall company.  In order for this to be successful it is necessary to keep the accounting behind the VBM simple, clearly identify value drivers, integrate VBM budgets with the strategic goals of the company, and ensure that they are able to properly manage the performance data that is being produced.  With all of this being said, it is very important for corporate managers to communicate their actions not only across the company, but also to shareholders.  When everyone is used to having their eye on the stock price and short term metrics like EPS, it may be difficult for executives, operational managers, and employees to carry out truly value creating activities.  The example of PepsiCo’s CEO Indra Nooyi announcing restructuring that would reduce profits shows the current disconnect between perception, rewards, and actual value creation; she had fallen out of favor with the board of directors, and the financial media was predicting a meltdown.  Nooyi’s persistence in pursuing a value creating plan that she knew would work in the long term while appearing like a bad idea in the short term proved to be successful.  This is a true example of a CEO doing B despite being rewarded for A.  If executive compensation, and performance measurement at all management levels, is going to truly drive value for shareholders it has to take a long-term strategic approach.  This is not an easy task, but as the business community begins to realize that long term value destruction is caused by the short term performance measurement and compensation structures that are currently commonplace, there is a strong chance that new measures and a more strategic approach will continue be implemented.

What the Automotive Industry Can Teach Us About Mutual Funds

Up until General Motors (GM) went bankrupt in 2009, their business practices created a beautiful juxtaposition for the business practices of Toyota.  GM had been able to rely on their size, market share, and Japan's non-existence to remain profitable for many years.  This fostered an environment of complacency in their ability to perform their core activity...creating vehicles.  In 2006, GM's profitability was mostly derived from financing the sale of their vehicles while they lost an average of $2,300 on each sale; their core activity had become financing while they were still stuck with making cars.  They were using inefficient manufacturing techniques to create a wide array of uncompetitive vehicles.

In contrast, it's no secret that Japanese automotive manufacturers have absorbed the market share that GM was slowly giving up; in 1960 GM held 50% of the North American market, while they only held 19% in 2009.  There were some very clear factors that contributed to this shift in the market, and, strangely enough, I believe that the same principles can be applied to the current state of the mutual fund industry.  The principles are very basic; efficient manufacturing practices, and competitive products.

Efficient manufacturing practices were revolutionized by the Japanese with Just-in-Time manufacturing (JIT).  American manufacturing methods employed economies of scale to keep the cost of machine hours down; they would have a large production run of a single part and then change the machinery to produce the next part.  The problem with this was that the time and cost associated with changing the machinery was cumbersome.  In the event that a manager suddenly needed a small run of rear doors when the machines were set up for front doors, they would be paying a premium for those machine hours.  JIT made the manufacturing process flexible by implementing production machinery and a labour force that was interchangeable; managers no longer had to pay a premium for unexpected production runs because multiple machines could be quickly set up for a small production run of any part.  These interchangeable parts in the manufacturing process eliminated the high fixed costs of any single production run.  Parallels can be drawn between JIT in auto manufacturing and the trading done within a mutual fund.  

Active fund managers will conclude through research that it is the right time to purchase a certain amount of a given security.  When they fill this order, they will be paying a premium to obtain the specific amount of securities at a specific time due to the nature of bid-ask spreads; at a given time spreads will vary, and filling the kind of large market order that an active mutual fund would place will result in paying varying prices for different available lots.  In contrast, a portfolio designed with holding diversified across asset classes and geographies would not need to accept an undesirable bid-ask on any individual security because they would not be looking to purchase any particular security at any exact time.  A mandate may require a certain weighting of domestic small cap stocks, but the individual securities could be anything fitting that description.  This approach lowers overall trading costs; trading costs are not something to be overlooked either.  It would not be unusual to see an actively managed small cap fund with a trading expense ratio as high as 1%.

Lowering the costs associated with producing either a car or a mutual fund is beneficial to both the customer and the manufacturer, but if the product is not competitive, the cost savings do not drive any value.  In 2006, consumer surveys about vehicle value showed that people perceived Toyota vehicles as being better designed and built, costing less to own, and lasting longer than GM vehicles.  This higher perceived value combined with lower manufacturing costs allowed Toyota to grow its margins while GM’s margins became negative.  GM boasted a massive portfolio of brands and vehicles, each one with a wide array of available features.  This lack of focus and internal competition made it very difficult for GM to produce any single excellent product; in contrast, Toyota has only two brands (Toyota and Lexus), and the vehicles that each brand produces have fewer options.  Toyota’s focused approach to the continuous development of excellent products combined with their low costs allowed them to surpass GM as the number 1 auto manufacturer in the world.  As GM’s margins were squeezed by high manufacturing costs and competition with Toyota’s low prices, the quality of their products continued to suffer.  Near the end, and since their re-birth, GM has eliminated or sold many of the brands in their portfolio.

In the context of mutual funds, the industry is in a similar state as GM was before they went bankrupt.  Current funds in general are not of a high quality, they are costly to produce and costly to own.  Much like GM, fund companies are managing massive amounts of mutual funds.  On average, mutual fund companies manage 117 funds, a huge contrast to the average of 1.7 funds managed in 1951.  Just as GM had to eliminate many of their brands to pursue a more focused effort, mutual fund companies have been going through the same kind of consolidation.  Between 2001 and 2012 there was a 7% per year failure rate for mutual funds; failing funds would be absorbed into funds with strong records to mitigate the evidence of their poor performance.  If a mutual fund company were to take the same approach to their product portfolio that Toyota has taken in manufacturing vehicles, it would produce a few high quality, engineered, and focused products.

So, I have drawn a comparison between the automotive industry and the mutual fund industry.  Why do we care?  We care because those who cannot learn from history are doomed to repeat it.  If I went back in time and had a choice between investing in GM and investing in Toyota, I think it’s obvious where my money is going.  If I wanted to use this analogy to decide where to put my money today? Dimensional Fund Advisors would be my Toyota.

Advisors vs. Salesmen

Maxwell's.png

I was reading the brochure for a travelling tailor today and I came across a statement that made me think about how people enter the field of financial advisory.  The reason that this brochure piqued my interest was that the founding tailor of the company had "spent his early years learning the art of tailoring."  This man had started his business in 1961 equipped with the knowledge and skills that he had learned.  I started thinking about other people that I know who have started businesses.  A friend of mine owns his own engineering firm; he started it after working for a large employer for three years.  If he had tried to open his own firm right out of school he would not have had the applied skills or experience with clients to successfully operate a business.  I do know a lawyer that opened his own shop as soon as he had passed the bar, but lawyers are required to article before they can practice.  I have another friend that just finished medical school; after four years of classroom education, he has to complete another four years of residency before he is able to practice.  All of these people work in a capacity in which they hold themselves out as a professional whose advice should be taken due to their extensive expertise and training.  Financial advisors hold themselves out in the same way, but the level of training and expertise that is expected from a professional is not always present.  The 'best' financial advisors are not necessarily the people that are able to give the best financial advice, they might just be the best salespeople.  To be fair, everyone is selling something.  The difference between a lawyer and a mortgage broker is that one is selling their expertise, while the other is using their expertise to sell a product.  So what is your financial advisor selling?  This is becoming one of the most important questions to ask.

Sales.png

When a new advisor enters the business it is far more common for them to receive sales training than advisory training; new recruits are taught product knowledge and sales psychology.  Performance is not measured by the quality of financial plans being produced, but by the level of sales.  To the credit of many hard working people, it is possible to get through sales training, get a client base, and become a well educated financial professional that is truly able to help people.  The issue that I have is that it is left up to each individual advisor whether they want to be a true advisor or a salesman; both have the potential to build a rewarding career.  It is possible to gain some insight and clarity into what advisors are selling when the way that they are paid is examined.  There are three main ways that a financial advisor can be paid:

  1. Commissions - the advisor is paid commissions by a third party for selling their product.  The client does not directly pay the advisor.
  2. Fixed fee - the advisor and the client agree on a percent of the assets being managed that will be paid to the advisor for their service.  The client is in full agreement with how much the advisor is being paid.
  3. Hourly rate - the advisor will charge per hour of advice, much like a lawyer would charge for billable hours.   The client is paying a one time fee for the construction of a plan, but has to pay hourly each time they need further advice.

It is very clear that an advisor that is paid by commissions is selling products.  Issues quickly and readily arise when financial companies begin competing for the business of advisors by offering more attractive compensation.  Commissions are paid to the advisor by the financial company, but the money is coming from the management fee that the client is paying.  This form of compensation has a major problem because the advisor's compensation is not explicitly disclosed to the client.  This is issue has not gone unnoticed by regulators; fee disclosure to clients is a reality, and the future of embedded commissions is in question.  With embedded commissions, trailer fees in particular, clients are not always aware that they are paying a fee for ongoing service, and as such they do not demand the service that they deserve.

Both fixed fee and hourly rate financial advisors have an agreement with the client that determines how much the advisor is getting paid for their services; this type of arrangement ensures that the client is explicitly aware how much they are paying their advisor.

An advisor that is being paid directly for the advice and guidance that they offer is much more likely to need to spend time developing their knowledge and skills before they are able to begin offering their advice.  An advisor that is being pushed by their sales manager to sell financial products is less likely to develop the professional skills and knowledge that they should have to service their clients and more likely to look for their next sale.  The argument can be made that people need to be sold financial products because they are not motivated enough to buy them on their own, but to counter this argument I believe that when the goal of the advisor is not to sell financial products but rather to sell professional advice, clients will be knocking on the door.

If doctors had sales managers in their offices, and the sales managers compensation was tied to the amount of prescriptions the doctor wrote, it would be safe to say that there would be a lot more prescriptions being filled on a daily basis.  Financial advisors are a valuable asset in anyone's life; they fit in with accountants, lawyers, and doctors in their capacity to use their knowledge and skills to help people.  To truly operate as an advisor, however, takes a significant amount of dedication, time, and effort.  As this ageing industry begins to pass to the next generation, it is more important than ever for young advisors to find the mentorship that they need in order to maintain the level of professionalism and pride that should exist in this career.

Strategy Critique of Gordon Ramsey Holdings (GRH)

The high end restaurant industry is highly cyclical due to its discretionary nature.  In tough economic times the likelihood of consumers choosing to dine at a restaurant decreases dramatically; it is most likely less expensive to forgo the restaurant experience and instead cook at home for a fraction of the cost.  This is even more pronounced when we are looking at high end restaurants.  There are two possible ways that restaurants can increase sales; they can grow through increased same-store sales, or through opening new locations.  The profit margins in this industry are dependent on the restaurant’s ability to source their food at a lower price, and their ability to convince consumers that their product is worth a premium due to preparation and service.

Although the high end restaurant industry is highly discretionary and subject to strongly correlated movement with economic cycles, the environment of a particular location and culture can strongly affect the attractiveness of the industry.  Looking at the high end restaurant industry in London, England using the Porter’s Five Forces model will provide further insight into the industry attractiveness given the time and location being considered.

Supplier Power - Low

The power of suppliers in the industry in general is low due to there being multiple producers of food for restaurants to choose from, but the case is slightly different for high end restaurants; in order to stay competitive in a local area, restaurants need to cater to local tastes and local fare should be sourced as much as possible, subject to quality and logistical considerations (Jones, 2009).  In the case of local producers being able to offer their unique produce or organic meat there is some power with the supplier, but unless a restaurant is specialized in a very rare type of locally produced fare it is almost always possible to source food from elsewhere.  Food is not a unique product, and in London alone there were a minimum of twenty independent organic farms at the time that this case was written (Dunford, 2008).  Considering that food is a commodity, and in this case even specialty local organic food is a commodity, and the cost of switching is also low, the power of suppliers in the high end restaurant industry in London, England was low at the time this case was written.

Buyer Power - High

The buyers in the high end restaurant industry are in a position of power.  It is very easy for a customer to decide that they do not like what is being offered to them; due to the fact that high end customers are expecting an experience that incorporates many tangibles and intangibles delivered with consistency, quality, and creativity (Johnson, Surlemont, & Nicod, 2005) they are especially difficult to please.  If other restaurants are able to offer a comparable experience at a lower price, buyers may choose to eat elsewhere; this is especially true in a down economy that will likely benefit establishments at the middle and lower ends of the market (Jones, 2009).  The costs of switching are of no significance as consumers may choose different restaurants on a weekly basis for no other reason than their curiosity.  All of these factors are furthered by the fact that there are 45 Michelin-starred establishments in London alone.

Competitive Rivalry - High

The competitive landscape for high end restaurants in London is intense.  As previously mentioned, there were 45 Michelin-starred restaurants in the city of London at the time this case was written.  This indicates that there a many competitors offering quality food that is a potential competitive threat.  A decade of economic prosperity in the city had expanded the market (Jones, 2009), but the economic forecasts going forward were not as favorable.  It was expected that household spending would fall in 2008 and 2009 before growing slowly in 2010; contractions in employment were also expected in 2008 and 2009 with stabilization in 2010 (GLA Economics, 2008).  In this economic environment the competition will increase as there are less consumer dollars being spent across the industry.  The large amount of Michelin-starred restaurants and the contracting economy make this industry unattractive.  One important note in this case is that of the 45 restaurants with Michelin stars, only three of them had obtained the three star rating in London (Rogers, 2012), indicating that if obtaining a three star rating was feasible, the competition would decrease significantly, and the industry would become far more attractive.

Threat of Substitution - High

There are massive threats of substitution to the high end restaurant industry.  Rather than choosing to eat at a high end sit-down restaurant, consumers have the options of eating at a mid to low end sit down restaurant, getting fast food, or getting groceries and cooking at home.  At the time that this case was written, it was observed that there had been a rise in the consumption of fast foods as individuals downgraded from more expensive restaurant meals due to the economic downturn (Dominoes Pizza UK, 2008).  In 2009, it was observed that 32% of people were no longer eating out, but were instead opting to buy groceries and cook at home (Allegra Strategies, 2009).  The establishments that were hardest hit by the increase in in-home dining were those charging over £10 per head as consumers sought out greater affordability (Allegra Strategies, 2009).  Consumers are easily able to replace the eating aspect alone, and with the economy struggling consumers are less likely to choose the experience of high end dining for the experience due to the associated price.

Threat of New Entry - Low

For high end restaurants in London, the biggest challenge in entering the market is real estate.  This barrier to entry makes it very difficult for competitors to make their first move.  With an average price of $3,670 per square foot in 2009, London had the second most expensive real estate in the world (Toscano, 2009).  This barrier alone is enough to deter new entrants, but in the case of high end restaurants with Michelin stars, the process of gaining a star could be another barrier.  A Michelin star takes a minimum of six years to achieve.  Restaurants are visited once every eighteen months, and a one star candidate will receive four visits in the process of getting a star (The Independent, 2008).

The nature of the high end restaurant industry at the time of this case makes it a difficult environment for Gordon Ramsey to pursue his aggressive expansion strategy.  With a declining economy that extenuates an already high threat of substitution, and a market that is becoming more aware of the financial and health benefits of cooking at home, the structure of the industry is not conducive to the successful expansion of high end restaurants.  The biggest risk factors faced by Ramsey are the risks of slow economic recovery from the recession and the risk of changing consumer demands; the recession will leave a legacy in which consumers demand better value and an enhanced experience – but they won’t be willing to pay more for it (Allegra Strategies, 2009).

Considering Porter’s value chain and drawing upon the resource based view of the firm, Gordon Ramsay Holdings (GRH)’s core competencies lie in the bundle of valuable tangible and intangible resources consisting of Gordon Ramsay himself, the company’s ability to internally cultivate talent, and the company’s strategic partnership with Blackstone; this combination translates into a competitive advantage that is valuable, rare, in-imitable, and non-substitutable.  Gordon Ramsay’s presence is a primary activity that encompasses operations, marketing and sales, and service.  The company’s ability to cultivate talent is a secondary activity that can be classified as human resource management, and the strategic partnership with Blackstone provides support functions in the way of procurement, and infrastructure. 

Gordon Ramsay developed his name through his own talent and dedication to his trade.  He began his career by taking college classes in hotel management, and due to his evident talent he was given opportunities to train under multiple world renowned chefs (Gordonramsay.com, 2013).  Through continued good fortune Ramsay landed a job as a chef in London where he earned the establishment two Michelin stars; through this success he was able to open up his own restaurant and begin building his brand.  The reason for delving into the chef’s history is to paint a picture of the sweat equity that was required to gain the competitive advantage that his name now holds.  Ramsay’s brand is so widely known across the globe that it will continue to gain attention, but only for a finite period if it is not managed properly.  As with any brand, Ramsay’s activities will dictate whether or not his competitive advantage is sustainable; the competitive advantage that his name carries is due to his reputation for pursuing culinary perfection (Jones, 2009), but allowing GRH to stray from this goal will quickly eliminate any advantage associated with his name.  This capability is highly transferable for international expansion if the integrity of the brand can be maintained, and it is an excellent avenue to promote the other undertakings of GRH such as his cooking school, cookbooks, cookware, and television shows.  Using the brand to promote these things could, however, be a double edged sword.  While promoting these products the brand could stand to be devalued and cause a collapse of the value chain.

Just as the talented Ramsay was given the opportunity to study under famous chefs to propel his name to having desirable association, talent development is a major part of GRH’s competitive advantage.  With Ramsay’s aggressive growth across the globe it is necessary to have experienced staff that can be rotated to manage restaurant openings (Jones, 2009).  This support activity is absolutely necessary for GRH to maintain brand integrity by training chefs and managers that are able to operate at the level of perfection that Ramsay has built his name on; this is especially true as the brand spans the world and Ramsay himself can be directly involved in an increasingly lower percentage of his burgeoning business units.  One promising accolade associated with GRH’s ability to groom talent is that it is separable from Ramsay himself (Jones, 2009), and should therefore be highly transferrable, and in fact highly necessary, to international expansion.  This capability is not transferrable into other undertakings except for the cooking school where it is clearly a huge advantage.

GRH’s relationship with Blackstone cannot be separated from Ramsay’s name due to the fact that his pursuit of culinary perfection has been the key to their relationship.  Any prolonged dip in the quality of GRH establishments would put pressure on Blackstone and open the door for competitors (Jones, 2009).  The relationship with Blackstone is highly conducive to international expansion, but has far less to do with Ramsay’s other undertakings.

Overall, the value chain of GRH is highly transferable to international expansion, but not all of the capabilities are transferable to the other undertakings.  It is very important to understand that making sacrifices to any one of the three capabilities for a short term gain will have a drastic effect on the value chain.  GRH’s value chain is highly dependent on its bundle of resources being able to function together, and if the three of them are not working in unison, the competitive advantage is no longer sustainable.

Ramsay is the face of GRH.  The business is built on nothing more than his fierce desire to achieve culinary perfection; whether this is being done as he cooks food in one of his restaurants, meticulously trains a prodigal new chef, or screams at a contestant on a television show, he is maintaining the integrity of his brand and his name.  If the quality of any one of GRH’s establishments dips below the standard that people expect from Ramsay, the entire brand and Ramsay’s name lose value.  This does not mean that it is not possible for GRH to continue operations without Ramsay being present, but adjustments would need to be made to the company’s operations and a succession plan would need to be implemented. 

A plan for the continuation of GRH with Gordon Ramsay removed from the operation would be heavily reliant on the ability of the establishments to maintain his level of perfection.  Consumers expect to be treated to the Gordon Ramsay experience when they decide to eat at a GRH establishment; they do not necessarily expect to see Gordon Ramsay.  Ideally, due to this fact, GRH should be able to provide the Gordon Ramsay experience without the presence of Ramsay, but this has not been the case.  When Ramsay gave special attention to the opening of a Versailles restaurant, it was noted that the standards at other establishments decreased significantly enough to be noted by consumers (Jones, 2009).  The first consideration in creating a succession plan needs to be institutionalizing functions that could lower uncertainty, improve operational efficiency, and mitigate risk (Jones, 2009).  The construction of teams to carry out specific tasks such as restaurant openings around the world is an important consideration, but it may not be the solution in preparing the business to operate separate from Ramsay; instead of a single center, the company could establish core office hubs around the world in an effort to customize their products and services and unite the business units around a platform of proprietary knowledge and competencies (Prahalad & Bhattacharyya, 2011).  The next consideration in preparing for operations without Ramsay is the idea of a quality control function that is able to maintain Ramsay’s level of perfection throughout all establishments that bear the name.  The optimal way to accomplish this may not be with a strict manual that standardizes the operations across the globe; to take a lesson from McDonald’s globalization strategy, GRH could consider the idea of creating a single uniting platform on which the company could unite (Prahalad & Bhattacharyya, 2011).  Leveraging this platform would allow GRH to eliminate concerns about standardization under Chef Ramsay’s rule, and instead operate with the common goal of providing culinary perfection, an excellent experience, and customized offerings for different cultures while maintaining unity in the three things that have provided a competitive advantage to this point: Ramsay’s reputation for perfection, the internal cultivation of talent, and the strategic partnership with Blackstone.

When looking closer at the talent development portion of the sustainable competitive advantage, one of the major points made in the case is that GRH recognizes that the ultimate dream of any ambitious professional chef is to open an establishment of their own (Jones, 2009).  In an effort to maintain the talent they have helped to cultivate, the company will assist such chefs in opening their own establishments as subsidiaries of GRH.  This approach has both advantages and disadvantages from an RBV perspective of GRH.  The most notable advantage of this approach is that it maintains a key part of the resource bundle by allowing top talent and ambition to be retained within GRH.  If these chefs were driven out of the company due to their feeling suppressed, they would become competitors rather than revenue streams.  In line with this advantage is the fact that even if a chef opens their own branded restaurant as a subsidiary of GRH, they will still be able to contribute to the development of their own successors who can then participate in subsequent restaurant openings (Jones, 2009).  Allowing individuals to open their own restaurants is also advantageous because it fosters creativity and is more likely to incorporate local tastes and cultures due to a high level of involvement from the chef.  Gordon Ramsay is so busy with his multiple ventures that he is unable to personally oversee the opening of every new restaurant and, as previously mentioned, this may be a good thing.  Allowing individual chefs to create their own customized restaurants that meet local standards and cultural needs while remaining united under the ideals of the brand could be extremely effective for both the chef and for GRH.  The most notable disadvantage of this system is that there is the possibility of a subsidiary to damage the brand image by failing to maintain brand integrity.  A review on Yelp from one diner at Cielo, a GRH subsidiary created by Angela Hartnett, states that “Cielo is your typical fancy restaurant with BLAND food that is ridiculously expensive.  Gordon Ramsay needs to school this woman on how to use seasonings” (Yelp, 2010).  Something that ties directly into this, and could be a major problem considering the likely personality type of a chef with the ambition to open their own establishment, is the issue of GRH demanding that they follow their brand guidelines while running their own business.  In 2010 Angela Hartnett distanced herself from Ramsay and bought out his share in her restaurant, and another of Ramsay’s protégés who had been running a subsidiary also separated from GRH and went on to earn accolades that none of the GRH restaurants earned in the same year (Doward, 2010).  This clear evidence of disagreement with chefs of his subsidiaries has negative effects on the GRH brand, and it results in lost talent and burnt bridges.

In August of 2010 Ramsay and his business partner (and estranged father in law) Chris Hutcheson transferred all of their shareholdings into a new company called Kavalake Ltd. which is now the holding company for all of Ramsay’s interests (Doward, 2010).  If Ramsay is seeking investors for Kavalake Ltd. the primary concerns he needs to address are located in the financial statements.  Areas of concern include nearly $10M of liabilities in excess of assets and a quick ratio of just .29, current assets decreasing by 40% between 2010 and 2011, and losses of $4M in 2011 which is a 90% increase from the $450K loss reported in 2010.  Some of these numbers can be attributed to a large amount of capex and debt repayment which combine for $8.5M of negative cashflows.  The financial situation of Kavalake appears to be unstable, and the reported losses are a clear red flag.  Taking into consideration the significant increase in capex and debt repayment, however, it is possible that the posted losses on the income statement are the result of restructuring the financial position of the company.  Separate from the balance sheet, there are major concerns with the negative publicity that has surrounded Ramsay regarding both his personal and business activities.  In 2010 Ramsay had been criticized for unpaid suppliers, there were complaints from diners that Ramsay was too involved in TV, and American employees filed lawsuits for unpaid overtime work; all of this was occurring while interest payments for Kavalake had reached $557M.  With the interest payment reduced by more than half in 2011 the prospects of investing in Kavalake were improving, but the risk increased when the Claridge’s in London failed to renew the chef’s ten year lease when it expired that same year (Ryan, 2013).  Two years later, the Claridge’s contract was lost entirely by Ramsay; this occurrence was a hit to the high end Ramsay brand, but it is not majorly detrimental to the overarching strategy of culinary perfection that has brought success to Ramsay.  The cyclical nature of the dining industry inevitably results in changes and developments in the market; the opportunity that Ramsay had at Claridge’s propelled his career.  It is the end of an era and an indication of a slight shift in strategy toward serving culinary perfection to the middle market rather than pursuing high end dining.  Ramsay has guided Kavalake through a transformation, realizing that companies that seek leadership positions in their industries may have little choice but to pursue the global middle market (Tse, Russo, & Haddock, 2011).  Ramsay has indicated that ‘we took away the blasé-ness with ridiculous, overpriced ingredients [such as] Aberdeen Angus, how do you make a shin of beef just as tasty? How do you use an amazing, sustainable pollock or replace tuna with swordfish?'  This restructuring and shift in the way that Kavalake brings culinary perfection to consumers is an intelligent shift in strategy that will allow the company to maintain their sustainable competitive advantage while staying relevant in a changing market.  David Beckham recently made an investment in a restaurant with Ramsay; the Union Street Cafe will serve reasonably priced food in London (Burn-Callander, 2013).  Evidence of the successful restructuring and shift in strategy is clear in the £2M profit that Kavalake recently posted for the year to August 2012.