Death By 1,000 Cuts - The Risk of Marginal Gains

The Massive Risk of Marginal Improvements in Business.

This business concept is in relation to a previous post about how MBA’s/Wall Street can f*ck up a company when coming in after a sale/acquisition, the full post is below for context.

The core idea is that when you come into a business, you don’t know why specific, usually inefficient processes were created, as a result it can be very easy to just come in, clean house, increase profit and not understand that over the long-term you are actually breaking the core value add of the business you acquired!

There’s a perfect example of this process that I previously read/listened to, although I cannot find the original source.

If memory serves me right, it was a concept from Warren Buffett but can’t find anything online that outlines the story, so if this is associated to anyone else, apologies.

Either way it does help outline this concept perfectly.

The example is in regards to a candy/chocolate bar that’s one of the leaders in it’s industry.

Great taste, great marketing, good margins, good brand and just all in all a good business, strong market share etc.

The bar itself has 17 ingredients, a mix of obvious things, cocoa, sugar and some other more rogue elements; binders, soy, cinnamon etc.

No one quite knows or remembers why things were added as the companies been working for 20+ years and the original founder passed this down to a son, who has now sold this company to a PE Firm, Wall street, MBA type, take your pick.

In short, the company sells to the highest bigger. I’ll just call this buyer “MBA group” for ease, but thinking about it like Wall St/corporate America will help too.

The MBA group comes in and looks for “synergy” and ways to increase profitability through cost cutting, marketing and their other items on their checklists.

They remove operational slack issues (full concept in the previous post) and awesomely profit goes up by 9%, wall street loves it and the share price increases by 15% in 1 quarter.

Life is good.

But wall street calls for more, even if not a public company, the execs call for the next increase.

So next they look into the product itself.

They hire a bunch of contract manufactures, consultants, external people…

And from that initial list of 17 ingredients, find out what actually matters most, what research groups like best and build a new recipe around just 16.

It’s actually pretty easy to do, add slightly more of one ingredient and cut one other one, easy.

Not even a change to manufacturing.

But they need to be sure, because this product is so good currently, don’t make mistakes.

So they run an almost scientific quality, blind taste test comparison of the original and the new 16 ingredient version.

And, great success.

No one can tell the difference.

So with this new production it’s actually 2% cheaper to make, so that goes directly onto the bottom line.

Wall Street is happy, MBAs get bonuses and life is good.

Next quarter rolls around.

Same thing happens, being extremely smart, they realise that playing with this formula and recipe

They find they can actually take out 2 ingredients now and replace it with a slightly different creation process that actually is even cheaper.

It works!

No one can tell the difference between this version and the current 16 ingredients one.

Bonuses and high fives.

And anyway this happens again and again until there’s only 11 ingredients, production is simplified and everyone is on cloud 9.

But then, as the story goes, sales start dropping.

And not just dropping but free falling, 2% a quarter, 5% the next, another 5% the next and suddenly the YoY Figure is down close to 20% to the year before.

This continues to happen, productions are tweaked, people try fix things, execs are fired and new people come in to try fix.

Nothing works.

The company decreases by 75% from its peak and is sold again, below the initial price it was brought 2 years later.

Then, as the story goes, someone finds a sealed box of original product, the ones from 2 years ago, right at the start, all perfectly sealed and good to eat still.

They sit around and taste test the original version vs the new one….

And you already know where the story goes.

The original is oceans different.

A completely different product in every way.

Creamy, crisp, lightweight, melt-in-your-mouth goodness.

Just a better product, magnitudes better.

But how could this be? - They were careful to taste each version with the previous one, and everytime no one could tell the difference!?

But the critical and obvious-now mistake, you are testing against the previous version, not the original.

Companies crumble bit by bit and then “all at once” as the saying goes.

The original product had not been over-optimised, it was optimised for the right thing. For taste, not profit.

It’s death by a thousand cuts…