The Most Important Lesson I Learned in B-School (Transcript)

By datatrekresearch in Blog

DataTrek co-founder Nick Colas goes back to his time at the University of Chicago and shares the most important lesson he learned while getting his MBA. It starts with a famous Harvard Business School case study about a greeting card company and ends with lessons for every trader and investor.

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Transcript:

Hi, Nick Colas from DataTrek here, and the topic of today's video is the most important lesson I learned in business school. To set the stage, I want to briefly discuss how business is taught at the university level here in the US. I went to the University of Chicago and graduated from there in 1991 with my MBA. And the approach then was very straightforward. At Chicago, you went to class, you read books, you took tests, you wrote essays, and it was very much a linear process. It was a very much based around academic approach to studying business as the university does with most other disciplines as well.

There is a different approach, though which Harvard Business School uses, because there's some things that can't be taught just out of the book. And Harvard uses case studies, which are basically stories about different business problems that the students go away and discuss, usually in groups, and then come back and present what they think the business should do in the case study, given the challenges that are described to the class, and they come up with a consensus about what the right approach for the business should be.

Chicago didn't use a lot of case studies, but they did use one, which is the one that we're going to talk about today, because there are some things that simply can't be taught out of the book, and I think this case study really shows it very well. The case study is called American Greetings, and the good news is, is that the scenario is, you've just become a CEO of a large and very successful greeting card company. The things you buy in supermarkets or drug stores to say happy birthday or happy anniversary. It's a pretty prosaic business, but at least for the CEO, and you realize quickly it's a very slow growth markets, and you already have a dominant market share, it's going to be tough to grow. On the plus side, the balance sheet is very clean, no debt, no operating leases.

And the question posed in the case study is, what do you do as the CEO of this company? The usual answers, and I've seen this case study taught a couple of different times, not just in Chicago, is that students come up with different ways to grow the business. Maybe you can create new demand by targeting different demographic groups. Women buy 80% of our greeting cards around the world. And so maybe there's an opportunity with men, or maybe an opportunity to expand in other ways, offering different kinds of new kinds of cards, different languages and so forth. Some other students come up with an idea of expanding internationally, because there are opportunities outside the US. There's large greeting card markets, for example, in Europe and Japan, and maybe you can grow organically by presenting more product to those markets, or maybe you can buy some local competition and grow your business that way. Of course, it's slow growth business. So the operating managers in the class like to talk about operating efficiencies to improve margins, a very valid approach as well. More recently, you'll hear people talk about digital opportunities, e cards, different things to do with even virtual currencies and virtual art as greeting cards, very innovative kinds of things, very clever. And lastly, you can also potentially not just sell greeting cards. You can sell small gift items, small paper items, wrapping paper because you have a lot of shelf space on your retailer's shelves, and you can leverage that to grow your business that way. These are the most common things. And look, they all make sense, all pretty sensible things to do, and what a traditional CEO would do. And what you hear from a lot of public companies CEOs is they pursue these same kind of strategies.

However, what actually happened is dramatically different. It's kind of crazy. Actually, American greeting, the case study was based on a real company called Gibson Greetings, and in January 1982 RCA, a big conglomerate that happened to own the asset, sold it to West Ray Corporation, a private equity firm, one of the first private equity firms in the country, actually, for $80 million so they sold it. The catch was that West Ray's two founders funded the entire acquisition with $330,000 of their own money a piece, and the rest of the capital came from debt financing and from sale and lease backs of the corporate assets. Remember that we told you that this business had no debt and no operating or capitalized leases at all, so they were able to basically take the free cash flow of the business, and along with the assets, be able to finance the entire company's purchase with a very small amount of their own capital. 18 months later, this would be like 1984 West Ray took Gibson public at a $290 million valuation. That's up from the $80 million they spent. So the two partners in 18 months made $70 million a piece.

And this was actually one of the first leveraged buyouts of the 1980s and you can credit a lot of the boom in the LBO cycle in the 80s, and even private equity today, huge firms that do private equity on this one transaction. It was really a landmark transaction in finance, because it showed what was possible by unlocking value from otherwise very sleepy, dormant, prosaic businesses. And the lesson that this case study teaches is to understand what is your goal, that is the most important question you can ask in business. So in the case of the Gibson Greetings case study, is your goal to sell more greeting cards? Fine, those first ideas we had were perfectly valid. But if your goal is to make as much money as possible, then obviously the LBO is the much better answer. There was a lot of untapped value in that asset. So very different outcome is based on the difference in what is your goal structure. What is your goal in a particular situation?

And this is why Harvard teaches business through case studies. In the real world, there are an infinite number of possibilities to use and in a given business challenge, but you have to decide on which one is the most important to you, and knowing your goal allows you to focus all your attention on the most important issues. And I think just expanding this out, what is your goal is the most important question in trading or investing, or, frankly, life itself.

You know, in trading, the goal, for example, that I was taught at the old SAC Capital was to make consistent profits on a daily or weekly basis. You generate good ideas, you size them appropriately, you manage risk, and that's the work of a trader. That's the goal of a trader making money consistently. And human psychology, your fears, your doubts, your worries about risk aversion are the primary impediment to reaching that goal.

Now in investing, it's very different, because there's kind of two or three goals. The first goal most investors think about is maximizing returns. Perfectly valid goal, right? But this has meant over the last 10 years, and I think for the next 10 years, only owning high performing US assets like US stocks and tech stocks, the goal of American capitalism. Just to expand this conversation out another level, is wealth creation. The goal of technology is disruption, and no other region in the world does this anywhere near as well as the US and US companies. That's just the way things go. That's the way the global economy has developed. US capitalism does wealth creation a lot better, because it makes it a primary goal of the society. Now, on the other hand, investing also means preserving wealth, and the challenge of investing is really combining those desires for wealth maximization with the goal of wealth preservation, and that's what every investor has to think about for themselves or with their advisor. But it's the tension between those two goals both perfectly valid, that create the right kind of portfolio structure for an individual investor or for an institution.

And then lastly, I'll tell you a little story. Whenever I interviewed people to work for me on Wall Street all through my career, one of the first questions I asked them is, how important is money in your life? Because no two people answer that exactly the same way, but it's a key question to ask, because in finance, we work very hard. We work very long hours, and money has to be a very important primary driving goal. And as you saw from the West Ray Gibson observation, if an investor has the goal of making a lot of money, it leads down very different channels, from perhaps selling more greeting cards or thinking things about more traditionally, so thinking about your goals is a really important part of life itself.

And with that, I hope that you found this video very useful. If you did, please hit like and subscribe at the bottom, and you can always check out datatrekresearch.com and get a two week free trial to our work. Thanks very much. Have a good day.