Your Customers
Success is a lousy teacher. It seduces smart people into thinking they can’t lose.
—Bill Gates
Treat your customers like they own you, because they do.
—Mark Cuban
One hot, sticky August evening during my first summer in Houston, my friend Bob Gaughan took me to a restaurant called the Atchafalaya River Cafe out on Westheimer Road. We sat down at a table outside, and he ordered me a bowl of something I had never heard of—gumbo.
I don’t think I would be exaggerating if I said that my first taste of gumbo changed my life. It was a revelation to me. The spices, the complex flavors of the roux mixing with the Andouille sausage and the okra and the shrimp, it all went off like a gunshot on my palate. I absolutely loved it. I could have sat there sweating in the humid Houston air all night long with Bob, drinking beer and eating that amazing food. And that’s exactly what we did. We went down the menu and I tried just about everything they had. I was so full by the time we left, I could barely walk to the car.
After I started making a little bit of money as a money manager, I went out to eat as often as I could. It was my way of decompressing. And Cajun food was my favorite cuisine. I went back to the Atchafalaya River Cafe regularly. There were plenty of other places to go in Houston. I also made the trip to New Orleans a number of times and tried all the famous spots there: K-Paul’s, Commander’s Palace, Antoine’s. But I have to say, overall, Houston probably has better Cajun food than New Orleans. It doesn’t get nearly as much press for it. But the food there is more authentic.
Then I moved back to the Bay Area to manage mutual funds for GT Capital. As far as Cajun food went, it was like moving to the moon. At the time, you couldn’t find a good bowl of gumbo within a thousand miles—and believe me, I tried. There was exactly one restaurant in the whole city of San Francisco that served it, a place on Fillmore Street called the Elite Cafe. It’s still there. The food wasn’t all that bad. It just wasn’t up to the standards I was used to. You have to understand, I was a fiend for that food. I craved it. And even though the rest of my life was going great, I was constantly wishing that I could jet back to the South for dinner.
Eventually, I decided to bring the South to me. That’s right—I used some of the money I was making by scouting out dead companies walking to go into one of the most failure-prone sectors in the business world—the restaurant game. Ironically (or maybe fittingly), my first attempt at being a restaurateur went down in flames. But that’s not the interesting part. Restaurants, especially first restaurants, fail all the time. What’s interesting about my experience is how blind I was to a very common mistake that I was making. As an investment manager, I’ve shorted dozens of businesses in all sorts of other sectors because they’ve made the exact same error. And yet, as often happens with business leaders, I was so caught up in my own passion and the work of bringing it to life, I couldn’t see that, just like those other failed companies, I had neglected to account for a relatively important factor in the success of any venture.
My customers.
I could write a whole book on the misadventures of that first restaurant. It would definitely be a comedy, even though it might make me cry to relive it all. Like how I signed the lease on a location in downtown Mill Valley, California, exactly one week after the 9/11 attacks (not exactly a propitious time to open an eatery). Or how I guaranteed a credit card for my first chef and wound up on the hook for $10,000 for what I later learned were hair plugs (even though, as far as I could remember, he had a healthy mane of hair!). Then there was the time another of the five different chefs I went through decided to get into a good old-fashioned fistfight with one of the five different general managers I hired and fired in the place’s three years of existence. Thankfully, the altercation took place after closing, but it didn’t do much for the staff’s already low morale or mine. Neither did the time the overnight cleaning crew set off the building’s sprinkler system. After being called by the fire department at 3 a.m., I watched the sun come up while standing in ankle-deep water in the middle of our dining room.
Of course, every restaurant has troubles. But if you’re losing between ten and twenty thousand dollars a month of your own money, like I was, those troubles are a lot harder to put up with. I was shelling out the equivalent of an all-expenses-paid vacation to Cancun every week to lose sleep and babysit my dysfunctional kitchen team, not to mention the twenty-something GM I fired after he put a dish on the menu called “Airline Chicken” without consulting me. As he argued, that was the technical term for the cut of chicken purchased from our supplier. But would you order something called “Airline Chicken”? I didn’t think so. Neither did anyone else.
The thing that hurt the most, though, and kept me believing that we could turn things around, was that the food itself was out of sight. The CEO of Il Fornaio, Mike Hislop—one of the finest restaurant operators in the Bay Area—told me that he had one of the best meals of his life at my restaurant. He said the flavors were “explosive.” That was my opinion, too, and by that point I’d spent almost twenty years trying every Cajun food place I could find. And yet, as good as the menu was, I might as well have been serving blackened hundred-dollar bills for all the money I was losing. And you know what? It was my own fault. In the end, it wasn’t goofballs like my pugnacious chef or the “Airline Chicken” GM who caused the place to fail. It was me. I was making a classic mistake. I was mixing up what I liked with what my customers wanted.
Let me say up front that Marin County is gorgeous. The weather is great, the scenery is breathtaking, the air is ocean fresh. I can drive ten minutes and be on top of a mountain overlooking the rugged Pacific Coast. Another ten minutes and I’m at the beach. If I go fifteen miles in the other direction, I’m in San Francisco, one of the best cities in the world. But let’s be frank: Marin County is not terribly exciting. Most of the people are old and getting older. Sure, a lot of them used to be hippies and flower children. Some of them did amazing, even revolutionary things several decades ago. But when you get down to it, they’re really not that much different than elderly people everywhere. They might drive Priuses with “Free Tibet” bumper stickers instead of Buicks with NRA decals, but they’re just as stuck in their ways as your average retiree in Florida and Arizona.
Put simply, opening a place in Mill Valley that specialized in white southern cuisine was like opening a California cuisine restaurant deep in the bayous of Louisiana. It was just a bad fit. Most people in town half-expected me to hang a Confederate flag in the window. That was pretty much what the food represented to them: southern, fried, and fattening. In other words, the exact opposite of what most Marin County diners want to spend their money on. But because I loved the food so much, and because I knew that all of those preconceptions about it are wrong, I believed I could change their minds and bring them over to my opinion. Over a million dollars later, I finally got the message: they weren’t going to change.
After my place closed, the next tenant opened a restaurant with a fairly generic menu—salmon, steak, garlic mashed potatoes, salads, some pasta dishes. Even though there are probably three dozen places serving almost identical fare in the vicinity, their dining room is jammed every night. Meanwhile, two years after I gave up on bringing southern food to Mill Valley, I opened another Cajun place across the bay in Berkeley, a college town with a younger, more diverse, and food-savvy population. On average, I’d say the food is no better than my first restaurant’s. But this new business is booming. We just leased the space next door and doubled our square footage to accommodate the crowds.
There’s no doubt in my mind that my first restaurant was doomed from the start by my own stubborn belief that I could convince people in Marin to love Cajun cuisine as much as I do. That stubbornness cost me a lot of money. In my experience, I actually got away fairly cheaply, though. I’ve seen lots of other people and companies lose a hell of a lot more trying to market something their target customers wanted nothing to do with.
The business media loves to laud idiosyncratic visionaries who disrupt their industries by introducing unconventional new products or services. Steve Jobs famously eschewed market research and claimed that he and his team built the first Mac computers for themselves, not their customers. Jobs was also famous for bragging that consumers didn’t know what they wanted until he showed it to them. This self-centered approach worked out for him and a few other uniquely gifted innovators. But for every Steve Jobs, there are countless corporate leaders who have lost everything trying to remake their customers’ habits.
In 2012, JCPenney’s (stock symbol: JCP) management team famously “fired its customers” by eliminating coupons and stocking more expensive brand-name merchandise. The problem was that the people who shopped at JCPenney liked using coupons. They enjoyed the feeling that they had discovered bargains, even on no-name or knockoff brands. For many of them, that experience was the main reason they went to JCPenney in the first place, and they stopped coming to the stores after it was taken away from them. These disastrous changes wound up losing the company more than a billion dollars in a single year. They also got the CEO who instituted them, Ron Johnson, unceremoniously canned after only eighteen months on the job. I’ll talk about Johnson’s absentee management style later on, but his doomed upscale strategy shows the dangers of confusing your own tastes with the tastes of your customers. Shortly after Johnson’s ouster, I visited the retailer’s offices in Plano, Texas. A longtime executive there gave a simple reason for his former CEO’s failure: “He wanted to make JCPenney into a place where he and his friends would shop.”
Johnson had previously overseen Apple’s retail stores, and just like I did with Cajun food in Marin County, he tried to foist his personal preference for luxury retail onto the people who patronized JCPenney. According to the executive I met with, not only did Johnson get rid of coupons and bring in more upscale brands, he also curtailed advertising in Spanish and reduced the company’s “Big and Tall” inventory, which had once accounted for a significant portion of JCPenney’s revenue. These actions practically hung a sign on the front of every JCPenney with Ron Johnson’s face on it and the caption, “If you aren’t a fit, affluent yuppie like me, don’t bother coming in here. We don’t want your money.”
Of course, there are plenty of profitable businesses that cater primarily to higher-earning customers. Johnson’s old employer Apple is a prime example. But JCPenney was never going to transform itself into a luxury brand like Apple or Saks or Lexus. Most of its thousand-plus locations are in middle- and working-class areas, and nearly one hundred of them are in its home state of Texas. You know who lives in Texas in huge numbers? People who speak Spanish! You know who else? People who could use a little extra room in the waistline of their pants. Both of these groups had been loyal JCPenney patrons. If Johnson had gotten past his own class biases, he would have recognized that both groups represented major future opportunities for the company too. Any demographer will tell you that Spanish speakers are one of the fastest-growing populations in the country, and lord knows Americans aren’t getting any skinnier. Yet Johnson was so eager to remake JCPenney in his own image, he purposely alienated these fast-growing customer bases, perhaps permanently.
Incredibly, getting rid of coupons, stocking prohibitively expensive brands, and turning off Hispanic and big and tall patrons might not have been the worst ways Johnson “fired” JCPenney’s core customers. He also removed most of the cash registers in the company’s stores and gave salespeople handheld iPads to conduct credit card–only transactions instead. Shoppers who wanted to use cash for their purchases had to schlep their items to special areas, often in remote parts of the stores. That’s right—JCPenney made cash-paying customers work to spend their money. And since a good number of those customers were “unbanked,” without traditional bank accounts or credit cards, this disastrous strategy only made them feel even more unwelcome. The executive I met with estimated that roughly a quarter of all transactions at JCPenney’s checkouts were in cash. Take a wild guess how much same-store sales dropped in Johnson’s first and only full year as CEO. That’s right—25 percent, or $4 billion.*
Not to pile on, but I can’t help but share one more of Johnson’s follies. The executive I spoke with also told me that Johnson personally disliked the look of antitheft sensors. He thought they made the clothing on sale look cheap—his kind of people would never shop in stores with ugly plastic sensors clipped to the merchandise!—so he ordered them removed. “Our ‘shrink’ doubled overnight,” the executive recounted with a sigh, using the retail industry term for the amount of items stolen or misplaced.
Ron Johnson might go down in history as the poster child of alienating a business’s core customers, but he was far from the first CEO to make this mistake. In the 1980s, Cadillac did the same thing as JCPenney, but in reverse. Instead of trying to sell upscale items to downscale buyers, Cadillac tried to market cheaper, more compact models like the Cimarron. But no one buys a Cadillac to demonstrate thrift or to save money on gas. People buy Cadillacs to show the world that they can afford to buy a Cadillac. They want them big, powerful, and as ostentatious as possible. They sure as hell don’t want something that looks like a glorified Chevy. This misreading of its customers almost brought the venerable brand to ruin. It took Cadillac decades to recover.
Of course, established companies shift strategies all the time. Many succeed in doing so. But just as many, if not more, forget the basic buying habits of their customers in the process. Sometimes managements get so emotionally attached to their creations, or so convinced that they’ve discovered a unique market need, that they wind up being the last people on Earth to realize that nobody else shares their opinion. Investors are also susceptible to this overconfidence. They buy into a company that they themselves patronize, or that they are convinced creates an indispensable product or service, and they often ignore very compelling evidence that the rest of the market does not share their tastes. It’s called confirmation bias—believing what you want to believe and discounting contrary information—and it has destroyed countless portfolios and businesses alike.
Fad on Wheels
You may remember that, for a little while, inline skates, known popularly as Rollerblades, were the must-have sporting goods item in this country. My son wanted some so badly, I couldn’t even get him to wait for Christmas to get them. He was about ten at the time, and every time he turned on the TV, he saw ads with ecstatic kids flying down the street. It drove him crazy. Finally, I broke down and took him to the store to get a pair.
The first letdown happened right after he took his new toys out of the box. They had so many straps and laces and hooks, it took the two of us fifteen minutes to get them on his feet. It was like donning moon boots or gearing up for a scuba dive. After we finally managed to get him in the things, he took off down the driveway, fell on his rear end, and promptly decided he wasn’t so thrilled with inline skates after all. He never wore them again.
Around that time, I was at a Hambrecht & Quist conference in San Francisco, and I saw the two guys running First Team Sports Inc. (stock symbol: FTSP), one of the biggest makers of inline skates, give a presentation. Their stock, like their product, was a hot item at the time. Now, most corporate presentations at stock conferences are absurdly optimistic, but this speech was downright silly. They had charts with sales projections literally turning vertical and flying up off the top of the page. I didn’t stay for the whole thing. But I did call an analyst handling the stock at Hambrecht & Quist a couple days later.
“Is this Rollerblade thing for real or is it going to go the way of the Slinky and the Hula Hoop?” I asked her.
“Oh, no,” she answered breathlessly. “Rollerblades are here to stay. They’re huge and they’re only going to get more popular as time goes on.”
After I expressed skepticism about this claim, she came back with the most preposterous prediction I have heard in thirty years of listening to preposterously optimistic predictions from analysts, executives, and entrepreneurs: “Mark my words, Scott,” she pronounced. “In ten years’ time, for every one bike you see in Golden Gate Park on a sunny day, you’re going to see ten people on Rollerblades.”
“Let me ask you a question,” I said. “Do you Rollerblade?”
“Absolutely!” she exclaimed. “So do all my friends. I do it every morning before work. It’s the best workout you can get!”
I thanked her for her time, hung up the phone, and promptly shorted the stock of First Team Sports. At the time, it was around $6, and to hear people in the business talk, it was quickly heading higher. But when sales stopped growing, the stock made a sharp U-turn. I didn’t wait for it to go all the way to zero. I covered my position when it hit $2, shortly before the company was bought out with its stock still clinging to life at $1 a share.
Betting against First Team Sports was not a sure thing. Shorting a company selling a fad product is a very tricky game. Even if you’re convinced that their popularity isn’t going to last, you still can’t tell when it’s going to fade. It could take years. But my conversation with the Hambrecht & Quist analyst convinced me that inline skates were going to wipe out sooner than later.
The average Wall Street analyst or institutional salesperson is three things: young, affluent, and hypercompetitive. In other words, people like that analyst I spoke with are the prime demographic for a fad fitness product like inline skates. But most Americans are not like your average person on Wall Street. Sure, for a couple years, the skates sold well, mainly because everybody’s kids harangued them into buying a pair. But I was pretty sure most of those buyers had the same letdown as my son did once they actually tried the things. They were simply too awkward to wear and too difficult to master.
First Team’s stock was trading at thirty times the company’s earnings when I shorted it. That big of a multiple is a major red flag. But the Hambrecht & Quist analyst and the rest of her Rollerblading friends in the industry failed to recognize that clear danger sign. All they knew was that they loved inline skating and so did everyone in their social circle, and they made the crucial error of assuming that the rest of the country would follow their lead.
In my opinion, the ultracompetitiveness that makes many money managers fall for fad fitness gear is a terrible trait for any investor. Yet most brokerage firms actively seek out competitive people to work for them. Montgomery Securities in San Francisco used to recruit, almost exclusively, former college athletes. They liked the fire and the discipline that the ex-jocks brought to the job. To be sure, those are good attributes for salespeople. But the real reason Montgomery coveted jocks was for their competitiveness, their obsession with winning at all costs. And that, in my opinion, is a very destructive quality. It’s actually the last thing you should want in someone handling your money. Why? Because quitting is very important when you’re buying and selling stocks.
I’m not perfect at what I do, by any stretch, but I am a very good quitter. I’d say I’m one of the better quitters I know. And that skill has helped me a lot over the years.
Take my experience with Advanced Marketing in chapter 2. I blew my chance to profit on that stock when it was still trading at its peak. And I was so enamored with my GARP formula that I exacerbated my mistake by waiting too long to get out. But as soon as I recognized my misreading of the company, I sold right away. I didn’t even wait to find out why the stock was going down. I just pulled the rip cord and parachuted out. And while I wound up losing all of the profits I would have made if I’d been more perceptive and sold earlier, I didn’t make excuses and hold on as the stock crashed. That’s usually the way it goes for me. I might sacrifice some profits, or miss out on chances to make more, but aside from running restaurants in Marin County, I rarely give up large sums of money. And there’s one reason for that: I’m a great quitter—and proud of it.
The fact that more companies fail than succeed means, as an investor, you’re going to have to deal with losing investments. Excessively competitive people have a hard time accepting this reality. They overestimate their own abilities and their own chances of success. Worst of all, they are reluctant to give up when things turn bad. That’s the real danger of competitiveness. Remember the old saying: “It’s okay to be wrong; it’s not okay to stay wrong.” Too often, investors break this rule. They think they can will their stocks to victory somehow, that things will come out well in the end if they just try hard enough. And that’s just not how it works.
Businesspeople make the mistake of thinking they can will their ventures to success as well, but in a slightly different way. Rather than getting too emotionally attached to their creations—as I did with my first restaurant—they take a more cerebral, but no less flawed, approach. Most entrepreneurs and corporate executives are, understandably, confident people. They have an unshakable faith in their instincts, their intelligence, and the products or services their companies offer. But, over the years, I’ve seen this self-assurance blind even the sharpest, most capable managers to a fatal problem: their target customers simply don’t want what they’re selling.
Clogged Thinking
One of the smartest people I have ever met said one of the dumbest things I have ever heard.
He was the CEO of Chemtrak (stock symbol: CMTR), which specialized in take-home medical tests. I drove down to visit the company’s headquarters in an office park outside of Palo Alto soon after Chemtrak went public. Chemtrak’s only product was an over-the-counter blood test for cholesterol levels. It had just received FDA approval, and Wall Street was all aflutter. CMTR had shot up from $10 to $20 on the news.
The company’s chief executive was a lean, dignified-looking man with a graying beard and a beautiful red silk turban wrapped around his head. To demonstrate the ease and usability of Chemtrak’s newly approved test, he had his secretary bring one into the office for me to try. She opened the packaging and removed a small plastic lancet, then showed me how to prick my finger with it. I don’t normally expect to shed blood at business meetings, but I went ahead and did as she directed.
“It is painless,” the CEO reassured me in his lilting Indian accent. “Just a little pinch.”
His secretary helped me squeeze a small drop of my blood into a plastic vial that contained a test strip.
“In twelve minutes we will have the results,” her boss announced with a proud smile. “It’s that easy.”
As I placed a small bandage on my finger, I told him that, as easy as the test was to administer, I was skeptical about the hype surrounding the product. It just didn’t seem like something American consumers would buy in big numbers. His response shocked me. After giving me a brief but authoritative report on the epidemic levels of heart disease in our country, and how lowering cholesterol levels was a crucial preventive measure, he delivered an astoundingly dense analogy: “Our research indicates that there are five million home pregnancy tests sold every year. Nearly all of those tests are purchased by women. But both men and women in America are concerned about heart health and cholesterol. Therefore, we are confident our sales will exceed five million units per year.”
I had to take a moment to process his words. I thought I must have misheard him. This man was not only an accomplished executive, he also had a PhD in, I believe, biochemistry. His IQ was almost certainly a few touchdowns higher than mine. And yet I couldn’t deny it: he was making the single most idiotic argument I had ever heard. People buy pregnancy kits because they absolutely have to know the results. They’re extremely invested in the outcome, to say the least. Somebody who just ate a Big Mac at McDonald’s or a Double-Double at In-N-Out Burger does not feel anywhere near that same sense of urgency when it comes to their cholesterol. If anything, cholesterol is the last thing on their mind. They don’t want to ruin the pleasure of the meal they’ve just had by thinking about how bad it was for them. That’s just not how American consumers behave. Throw in the fact that Chemtrak’s product was a blood test, and the comparison gets even more untenable. There’s no way someone’s going to rush off to Walgreens or CVS, plunk down twenty bucks, and then stab themselves in the finger just so they can feel guilty for overindulging.
The CEO looked a little mystified by my reaction. I’m sure he had delivered this speech to numerous potential investors, and apparently I was the first person to balk at it. Thankfully, my test results were ready by that point, so we could change the subject. As usual, despite my generally atrocious diet, my cholesterol was superbly low. (My wife is always shocked at this, and a little bit jealous.) The CEO congratulated me on my good health and I quickly departed his office.
I was inclined to short Chemtrak’s stock right away. I was fairly certain that its take-home cholesterol test would flop. But the fact that such an accomplished scientist and professional was so sure it would succeed scared me, so I decided to do a little more research before I made my decision. I sent a gofer who was working for me at the time to twenty drugstores around my office. I had him put a small nick on the packaging of the first five Chemtrak tests on the shelf at every location. He went back every other week for several months. At the end of this process, those first five tests in all the stores still had nicks on them. Not a single one had sold. That was all the proof I needed. I shorted Chemtrak’s stock. It quickly dropped below a dollar. But, as so often happens with failing companies, the company held out for way longer than I expected. Its stock didn’t go all the way to zero for another five years.
When I opened a Cajun restaurant in Marin County, I was too emotionally involved in my business. I was so excited to share my favorite food that I couldn’t see the plain fact that nobody else in Marin County wanted to eat it. Chemtrak’s management was much more cerebral in their approach. They had scientifically analyzed the health-care market and come up with a product they were convinced would fill an important need. The problem was, their analysis was just plain wrong. Even though heart disease is a major problem in this country, American consumers were simply not going to buy what Chemtrak was selling. Lots and lots of very smart people make this mistake. They fixate on some given set of data or analysis instead of the most important data set of all: how people in the real world behave. You can know everything there is to know about your industry—market trends, leading indicators, the latest technology—but if you don’t know your own customers, you might as well be trying to sell gumbo to gray-haired flower children.
Father Knows Best
My dad still lives in my hometown of Tempe, Arizona, but he comes out to visit regularly, especially in the summer months when the temperature in Arizona approaches the surface of your average white dwarf star. He’s a retired college professor, and he’s always been interested in investing, so sometimes when he’s in town, I’ll bring him along to meetings with corporate executives. It’s a fun way to spend some time together. And I appreciate the company while I’m on the road.
One morning in 1999, we drove across the Golden Gate Bridge and through San Francisco to a business park built on a spit of land, called Oyster Point, that sticks out into the bay. A company called PlanetRx (stock symbol: PLRX) had its headquarters there and I had an appointment with the CFO, a fellow named Steve.
This was during the heyday of the dotcom boom, when everybody and their brother was crowing about things like “the new economy” and predicting the end of brick-and-mortar retail. It was a crazy time, and it brought on the most irrational and inflated asset bubble in the history of capitalism. I’ll talk more about that later. For now, I’ll stick to my morning with my father and PlanetRx’s CFO. Steve invited us into his office overlooking the bay and told us all about how his company was going to remake the drug business the way Amazon.com had remade the book business. Instead of schlepping to the local drugstore, he explained, people would simply log on to PlanetRx’s website to order prescriptions and have them delivered straight to their door.
“It’s so easy,” he boasted as he demonstrated on his laptop. “You can do everything with a few clicks of the mouse.”
He then launched into a short presentation of the company’s projected earnings. Of course, it was wildly optimistic. PlanetRx was on the verge of “scaling,” he claimed, or rapidly growing its revenues. That was the big buzz word at the time. I didn’t interrupt him or question his figures. The dotcom mania had been flourishing for three years by then. I was used to those kinds of, shall we say, enhanced prognostications. The whole Bay Area economy had blown up bigger than Barry Bonds’s hat size. To my surprise, though, my father did clear his throat and chime in with a question.
“Excuse me, sir,” he said. “If I were to use your service, how long would it take for my medication to arrive?”
“It depends on where you live,” Steve replied. “In most of the country, it’ll get there in 24 to 48 hours. For more remote places like Alaska or a small town in South Dakota, it might be more like three days.”
“But I can drive down to the local drugstore and get my pills in fifteen minutes,” my father countered.
“Maybe so, but with our service, you don’t have to leave your house.”
“But with your service, I have to wait two days, maybe three!”
They went back and forth like this for a good five or ten minutes. I couldn’t believe what was happening. I just sat there with my mouth open and watched my father debate this executive. It was actually quite enjoyable. A lifelong academic, my dad has developed a very strong and finely calibrated BS detector. And as he was discovering in that office on Oyster Point, BS was the chief product of the dotcom industry in the late 1990s. He pointed out to the PlanetRx CFO that the majority of people who used prescription medications were senior citizens like himself.
“By and large, that population isn’t very comfortable using the computer to shop,” he explained. “Most people in their sixties and seventies don’t even know how to do it. How do you expect to make any money when your main customers can’t even figure out how to use your service?”
“Easy. We’ll teach them. People learned to use Amazon.”
“But Amazon sells books. You don’t need a book. You can wait a few days for it to show up. If you go days without your medicine, you get sick.”
“People just have to get used to ordering their refills a little earlier, that’s all.”
“So you’re going to teach your customers to do that, too?” my father pressed him.
Steve pulled at his tie and adjusted his weight in his chair. I decided to let him off the hook and ended the meeting. As my father and I walked through the parking lot to my car, he turned to me and said, “You should keep your eye on that company, son.”
“What do you mean?” I asked. “It sounded like you disliked everything about it.”
“I did,” he replied with a smile. “Except for one thing. The furniture in their offices was much nicer than the stuff in your office. I’ll bet you’ll be able to buy it for ten cents on the dollar when they go broke.”
I never shorted PlanetRx. In those heady days of the dotcom boom, shorting tech stocks was a scary proposition. Just about every company in the industry was enormously overvalued. I knew there was almost certainly a crash coming. It wasn’t a question of if, but when. But predicting when exactly when that would arrive was impossible.
I did, however, take my father’s advice and keep an eye on PLRX. At the time of our visit, the company had next to nothing in revenues, yet its stock had been flirting with $40 a share. But the high times didn’t last long. Even with the dotcom boom still going strong, the company’s poor sales started to scare investors. Its stock slowly inched down after our meeting. Then it cratered. In mid-2000, barely a year after my father debated the CFO, PlanetRx laid off a large portion of its staff and moved to Memphis. As we used to say in the business before stocks were listed decimally, the company’s stock went “hat-sized,” meaning it sold for a fraction of a dollar.
The reason for PlanetRx’s demise is quite simple. It only took my father a couple of minutes to spot it. The very consumers the company planned to serve had absolutely no interest in what they were offering. In some ways, PlanetRx failed for the same reason my first restaurant did—its founders confused their own tastes with the tastes of their target market. Like most tech companies, PlanetRx was launched by a bunch of techies who used the internet for just about everything they needed. They assumed that your average grandma and grandpa out in Middle America would share their love for the convenience of online shopping. But, as my dad so astutely pointed out, senior citizens aren’t exactly early adopters of technology. More important, the service PlanetRx was offering was actually less convenient than the method people were already using! In that regard, PlanetRx was very similar to Chemtrak. Its founders had analyzed their industry. They had come up with all sorts of impressive numbers and projections showing that their product would fill a profitable niche. But, as with Chemtrak’s management team, they hadn’t analyzed the thing that would make them money: the way people in the real world actually behave.
This failure to account for real-life human behavior also brought down the most overhyped company of the dotcom bubble (besides perhaps the still unbelievable Pets.com), Webvan. If you aren’t familiar with the story, Webvan delivered groceries. Despite that modest premise, it managed to raise and then blow hundreds of millions of dollars in a few short years. I was not dumb enough to invest in Webvan. I was even dumber. I invested $50,000 of my own money in a copycat business, a small start-up in Texas called Groceryworks. A buddy of mine pitched me on the company. His main selling point was the long distances between most homes in Texas and the nearest grocery stores. Having lived in Houston, I knew what he was talking about. Sometimes just going out for a gallon of milk felt like a sequel to On the Road. I thought people would be willing to pay to avoid that hassle.
I thought wrong.
The shoppers who buy the most groceries have families. They’re usually moms, though there are plenty of dads who shop now, too. And for parents, purchasing food is not like purchasing any other product. We’re talking about the stuff that sustains and nourishes your children. Making sure that you’re getting the best quality merchandise is not just important, it’s an instinctual drive. There’s no way you’re going to trust a website and some kid out in a warehouse somewhere to do it for you. Think about a mother who plans to serve fish for dinner. She has to see that tuna steak or that fillet of salmon. She has to pick it out herself so she can make sure it’s the right color and that it doesn’t smell like it’s been sitting in the display case for a week. If she doesn’t do that, she’s going to feel like a bad mother. That’s not an exaggeration. It’s how people are. You can’t get around human nature no matter how cool and easy-to-use your website is. We’re talking about parental instinct here. That’s a powerful force. And it completely trumped the benefits of shopping online for groceries.
As with a lot of the stories I share in this book, the flaws in Webvan’s and PlanetRx’s business models might seem obvious as I write about them. But they couldn’t have been that obvious at the time, because a lot of very smart people poured a whole bunch of money into the businesses. When it launched its website, PlanetRx had hundreds of millions in venture capital behind it. At one point, its market capitalization reached into the billions. Even after its stock started dropping, there were still plenty of analysts and other experts recommending it virtually up until the day the NASDAQ delisted it. Webvan’s early backers included the same people who had funded Apple, Google, and PayPal. And its executives were absolute all-stars. The founder started Borders Books. The CEO came over from Arthur Andersen. These were not dumb or inexperienced people. They were just so caught up in the mania of the dotcom boom and the almost cultlike conviction that the internet would remake every industry that they forgot to think about—or study—how actual people in the actual world behave. But this kind of mistake didn’t start or end with the tech boom in the 1990s. It happens all the time.
Indeed, failure is one business trend that never goes out of style.
Notes
*Matt Brownell, “JC Penney CEO Ron Johnson Out,” DailyFinance, April 8, 2013.