Hypothetical Management Question

[spartansaver]

Company A and B are the same company today. Company A and B are attractive businesses with long runways. The only difference is that company A has a great manager and company B has an average manager. Both managers are early in their careers.

 

What difference in price would you be willing to pay for company A vs. B?

[dwy000]

$1.46

[Jurgis]

Would not buy company B.

 

If you want a number, let's say 10x.

 

 

In reality though, this is a very difficult question. Is the comparison of Apple vs Nokia? Microsoft vs IBM? Tesla vs GM? Or is it more like BKNG vs EXPE vs TRIP? And what if Dara Khosrowshahi leaves for Uber? What about Uber vs Lyft after Dara Khosrowshahi came to Uber? Is he great manager enough to have Uber kill it? How about JPM vs BAC vs WFC? Is Jamie worth a lot? 10x? (No, he's not).

 

Edit: is the "great" manager Steve Jobs v1? Or Steve Jobs v2? Cause that matters too.

[Jurgis]

Let's take more hypotheticals:

 

Apple at iPod release: good manager handles iPod sales and ecosystem fine, never creates and releases iPhone. great manager does. 10x?

Amazon from beginning: good manager handles book sales and expands into selling everything online. great manager also adds third-party sales and AWS. 10x?

Microsoft at beginning: good manager works fine with MS DOS ecosystem. great manager also expands into MS Office, etc. 10x?

FB at beginning: good manager handles FB growth just fine; great manager also buys Instagram, WhatsApp. 10x?

 

OTOH, back to EXPE/BKNG/TRIP: good manager manages growth with tailwinds just fine, great manager - ??? not much more ??? - maybe not even 2x?

[spartansaver]

Let's take more hypotheticals:

 

Apple at iPod release: good manager handles iPod sales and ecosystem fine, never creates and releases iPhone. great manager does. 10x?

Amazon from beginning: good manager handles book sales and expands into selling everything online. great manager also adds third-party sales and AWS. 10x?

Microsoft at beginning: good manager works fine with MS DOS ecosystem. great manager also expands into MS Office, etc. 10x?

FB at beginning: good manager handles FB growth just fine; great manager also buys Instagram, WhatsApp. 10x?

 

OTOH, back to EXPE/BKNG/TRIP: good manager manages growth with tailwinds just fine, great manager - ??? not much more ??? - maybe not even 2x?

 

I think the most interesting part is that if you're certain that it is a great manager (almost impossible to be certain), the price differential becomes enormous. I think it really drills home the point when you look at certain examples (Tom Murphy (Great) vs. Bill Paley (Crappy)). For me the tough part is I don't know if I can recognize a great manager, so how much should I handicap my ability by (maybe a large amount). I think I can be more certain of who isn't a great manager, and simply pass on those.

[Jurgis]

I agree with you spartansaver. Recognizing great manager is tough. My examples make it look easy with 20/20 vision. But who knew that Ballmer will screw up while Satya will do great? (Yeah, I know the Monday morning quarterback Ballmer haters "knew".) Who knew that Rometty will fail while Satya will do great? And was Zuckerberg a great manager or just good one? How about Eric Schmidt? IIRC Novell failed under his leadership. I was definitely not impressed when Google made him CEO. Did he become a great manager or just good-enough one not to screw a great company? And how about Dara? Is he gonna make Uber great again? (Not even talking about Ron Johnson and JC Penney...). Is Larry Ellison great for building Oracle into juggernaut or is he a fail for recent Oracle mediocrity?

[Broeb22]

Jurgis’ points are good ones. I guess trying to generalize the examples he used, if an industry’s growth is more open-ended, a few key decisions early on can make all the difference in a company’s trajectory whereas in well-establishes industries, great managers can add a lot of value but that might pale in comparison to a Zuckerberg or Nadella.

 

I’m thinking of Fabrikant at Seacor ably trading oil and shipping assets. Has created value in a tough industry but the value created relative to a Zuckerberg (or name your own fave CEO) is in two different worlds.

 

So I guess the short answer in my mind is it depends, which is never satisfying.

 

 

[Nomad]

This is an incredibly important question, but an incredibly tough question to answer. Manager selection is one of the seemingly insoluble problems of investment that I would place in the "Important But Unknowable" category. Nevertheless, I'm going to attempt an answer simply to put my own thoughts on the matter in writing and to invite further discussion.

 

In a reductionist hypothetical, you could posit Companies A, B, and C, with equal financial statements, competitive positions, and margins. You could then assign a superior manager to Company A and a good manager to Company B. Company C you leave as the control, to which you could assign a superintelligent AI that ensures that Company C grows but generates no excess return. At this point, you could begin tinkering with the "alpha" you estimate for the managers of A and B.

 

Let's say that Company C delivers a post-tax real return of 5% per annum for 20 years, so your $100 invested at the outset becomes $265. Company B, led by the good manager, delivers an excess return of 4%, so you have $560 at the end. Company A, led by the superior manager, shows an alpha of 8%, leaving you with $1,152. The manager of company A has increased its value to over 4 times that of the benchmark, while the manager of Company B produces 2 times the value of the control company. Extending this scenario to 30 years, the control company gives you $432, the manager of Company B gives you $1,327, and the manager of Company A gives you $3,912. So, over a 20-year period, Manager A delivers twice the value of Manager B, but over 30 years, Manager A delivers treble the value of Manager B. The duration of outperformance also matters; letting Manager A run the show for a 30-year term produces double the value of keeping him at the helm for only 20 years.

 

Of course, the exercise above is so simplistic as to be ridiculous. The math tells you what you have at the end of each period, but it doesn't tell you what you should pay for Company A vs. Company B as a non-omniscient actor looking at the situation for the first time. Jurgis and spartansaver have already noted the difficulty of finding great managers ex ante. That's why Buffett and Munger "cheat" (in their own words) by only selecting great managers ex post. Compounding the problem is the fact that mediocre managers often become great managers over time. Mark Zuckerberg started off at Facebook with cartoonish antics ("I'm CEO, bitch") and ended up creating the dominant social networks of our time. He grew into his leadership role, and despite his arguably negative impact on society at large, there can be no doubt that he is a shrewd manager and capital allocator par excellence.

 

There are examples of this outside business too - just look at Bill Belichick. He went 36-44 with the Cleveland Browns and was considered maybe slightly above average as a football coach before joining the Patriots and winning six Super Bowl titles. There were plenty of other coaches who worked just as hard and who had similar schemes, but who did not become great. Who could have seen in 2000 that Belichick would become one of the best-ever NFL coaches? Could anyone have predicted in 2005 that Zuckerberg would become the John D. Rockefeller of the age? Maybe. But if you're in that camp, you have what is likely a five standard deviation ability to recognize rising talent, and you are probably enjoying the spoils produced by that ability on your yacht rather than posting on the Corner of Berkshire and Fairfax.

 

Broeb22 also brings up the industry variable, which has a massive impact. A great manager at a hypothetical pager or fax machine company in the late 1990s may have been able to reduce the exponential decay factor to 3% per annum, where a merely good manager would see 6% decay. The compound effect over a decade leaves you with about three-fourths of your value remaining with the great manager, but only slightly more than half of your value remaining with the merely good manager. But here the great manager, despite his evident talents, is still limited to finding clever ways to hold at bay the forces of decline, and he must either pivot to new business lines or gracefully return capital to owners. It's an interesting thought experiment, but the industry discussion raises more questions than it answers. What if the great manager's acumen allows him to steer clear of the fax and pager company in the first place? Alternatively, what if the great manager recognizes that the industry is in secular decline before anyone else and chooses to leave before he presides over the decline?

 

Meanwhile, a great manager in a great industry can easily do 100x or 1000x in a career. We see this process repeat in every business era, because every era presents different variables. Good managers recognize those variables and react, but great managers weaponize them. The Stanford historian Ian Morris has said that, eventually, "each age gets the thought it needs," and I would argue that this observation applies to business as well. The truly great manager in every domain of human experience is the one who recognizes the challenges and opportunities of the era and creates the paradigm that ultimately becomes the new normal.

 

Given all this, what do we do as investors? I think the best course of action is to simply copy the Buffett and Munger approach and select great managers ex post. Naturally, past performance does not equal future results, but it is not unreasonable to assume a decent probability of continued success with a captain who has astutely steered the ship already. But most of us are not that lucky, and we are stuck playing the game ex ante. In this case, as cliched as the term has become in the investing community, it's probably best to take the Jacobian approach and invert. Bad leaders can be spotted much more easily than good leaders, but I'll leave that discussion to another post since this one is already far too long.

[Spekulatius]

Yes, the issue is that some managers are good in some companies, but fail nomothetic. Actually Schmitt who ran Novell (leading it to its surmise) and Google (he developed the upstart into a mature powerhouse) is a great example.

This lead me to believe that many that are recognized as great managers aren’t really that great but rather lucky or perhaps great in one setting and mediocre in others.

[Gregmal]

Sounds like Joe MacMillan from Halt and Catch Fire. Great in one role, disaster in another.