Isegoria

Handle has returned to discuss Average Is Over. Tyler Cowen’s book reminds him of a friend’s situation:

I know a Tesla mechanic and he really likes his job. He used to work for BMW, and said it had a truly toxic culture (not one that sounded very traditionally German) and the rats (i.e. other mechanics) were fleeing from a sinking ship. A former BMW maintenance manager was poached by Tesla, and he knew who the good guys were at BMW, and so was given the task of poaching them too.

Which really make you think.

One thing Tesla has is that anyone who can create a new car company from scratch will maintain a permanent advantage over all established car companies, in that it won’t be saddled with all those tremendous pension liabilities to former workers, and established super-powerful unions. Musk certainly has an incentive to get as far ahead on the automation curve as possible to avoid ever having to deal with those problems at anything like the magnitude of burden all the other companies must carry.

That makes it very hard for any established company to eat his lunch by copying simple and widely available tech, while also making it hard for any other new company to overcome the barrier to entry, especially if future subsidies are likely to be less generous than what Musk got to help him get started. That means there is a special, one-time opportunity to pick up this particular $100 bill off the sidewalk. He picked it up.

I admit I didn’t give this particular advantage enough consideration before, and now it seems to help account for Tesla’s unique ability to capitalize on electric cars with big batteries, which, after all, anyone can make. But his timing means that he’s the only one that can make them both with the most generous subsidies and before amassing manufacturing-era labor liabilities and before sclerosis infects his company.

It’s not necessarily regulatory arbitrage as it is also a kind of legacy sclerosis arbitrage. Indeed, this was and remains a considerably portion of the competitive advantage of East Asian automakers in the US market. All else being equal, the Big Three had to make an extra few thousand dollars per vehicle to pay for their liabilities. Tesla gets to start from scratch with a clean slate. That just having a clean slate is such a huge advantage these days is revealing in itself. Combined with ludicrously generous crony subsidies, it makes a strong case for his special, inimitable position.

Furthermore, in addition to not being saddled with the unions and all those pension liabilities to former workers, he’s got another advantage which accrues to any new company in an established sector, indeed one the big Silicon Valley companies have conspired among themselves to avoid by means of forming a labor-market demand-side cartel.

I’m guessing a lot of your work environments are a lot like mine, where compensation is fairly flat and compressed and bears little relation to ones marginal productivity in the short term, despite everyone knowing informally who is really pulling the weight. In the long term high performers are rewarded with promotions, but this suffers from Peter Principle problems, and anyway only works in tall hierarchies. There is a new employee where I work who is getting paid nearly as much as I am, but who is doing 20% of the work, because he is a moron, but he beats everybody in seniority, which is, alas, how the system works. He won’t get promoted, but in a way that’s almost worse, since the good performers will leave the job and people like him will stick around, lowering average productivity.

Everybody I know has lots stories like these.

So that creates another kind of obvious arbitrage opportunity. Maybe “Productivity Correlation Arbitrage.” If one could only pick one good manager in a unit or office, tell him he must fire 60% of people, and that he has unlimited authority to fire anyone he wants, and those he retains will get paid double so long as all the work gets done, then I have no doubt that the company and everyone left will be much better off.

Some seasonal companies actually do something like via over-hiring, automatic attrition, and selective rehiring. I had an uncle-in law who worked a job like this on the Alaskan oil fields and called it something like an “underbrush fire” that left all the big timbers standing.

But most mature organizations, especially those saddled with strong unions, can’t legally or practically manage anything remotely approaching this kind of ruthless culling.

But if a new company can poach a few good managers with the special inside knowledge needed to be future poachers of more good people, then your new company can start off with much better people producing much more value and for only a little more money. Is Tesla doing this too? That’s pretty smart, and it seems to borrow from some insights that may have been gained from Silicon Valley experiences.

Hmm… something to think about.

Gary Hoover takes us on a quick stroll through grocery-store history:

By 1912, America’s first great retail chain, the Great Atlantic and Pacific Tea Company (“The A&P”) had 480 stores spread across many states. The founder’s son John Augustine Hartford thought the highly successful company could do better if they lowered prices, but his father and conservative brother would not hear of it. Finally, he wore them down and they said, “Ok, you can open one of your cheap store ideas a few blocks from an A&P. But you cannot call it A&P and you can only have $3,000 with which to open the store.” They figured this would prove the stupidity of his “Economy Store” concept. Within months, the regular A&P around the corner had to close as customers loved the new concept. By 1927, only fifteen years later, A&P had opened 15,671 of these little stores, sometimes just a block apart in major urban centers. By 1929, the A&P had become one of America’s first companies to achieve $1 billion in annual revenue. The largest retailer in the land, these revenues were greater than those of #2 Sears, Roebuck and #3 FW Woolworth combined.

Despite this huge success, the A&P was not without competition. In 1929, Kroger of Cincinnati, Safeway of San Francisco, American Stores of Philadelphia, National Tea of Chicago, and First National of Boston operated an additional 14,188 stores. Grocery chains represented 4 of the 10 largest retail companies in America.

Then, on August 4, 1930, Michael J. Cullen opened his King Kullen store in Jamaica, Queens, New York, generally accepted as the first true supermarket. Cullen, a veteran of A&P and Kroger, had tried to convince the leaders of Kroger to try his new idea, described as “a new type of food store with a focus on low prices, cash sales, and without delivery service, in larger stores (at low rents) with ample parking.” These were to be “monstrous” stores, about forty feet wide and hundred and thirty to a hundred and sixty feet deep, located one to three blocks off the high rent district with plenty of parking space, to be operated as a semi-self-service store — twenty percent service and eighty percent self-service. Cullen suggested that this new type of store could achieve 10 times the volume and profits of the average Kroger or A&P. But his letter never even made it to the head of Kroger, as the chief’s lieutenants knew the idea was crazy.

But it wasn’t crazy. King Kullen and others around the nation added meat and produce to the standard mix of “dry groceries,” added parking, but most of all deep discounts. Others followed Cullen: two years later, Big Bear opened in New Jersey in the former Durant auto factory, its single store doing the revenue of 100 A&P’s.

Within a few years, the industry leaders woke up to the new concept. In 1937 A&P, ever ready to evolve under the same brilliant John Hartford, began closing its tiny stores and replacing them with the new “giant” supermarkets. In just thirteen years, by 1950 A&P had dropped from more than 14,000 stores to just over 4,000, but their revenues rose from $800 million to $3 billion. In 1955, 11 of the 25 largest American retailers were grocery store chains.

During the 1960s, the new concept of the discount store — general merchandise but no food — spread across America. Over time, many retailers attempted to integrate general merchandise with food: Walgreen’s and St. Louis’s Schnuck’s grocery chain, Skaggs/Albertson’s from the western US, Kmart and Detroit’s Allied Supermarkets, and others tried to make it work, with mixed success at best. Weekly “convenience goods” shopping for low margin groceries did not fit with the less frequent and more leisurely “shopping goods” trips for clothing, home furnishings, hardware, and other categories. The industry mentalities and restocking processes were radically different. A few regional firms made it work — Schwegmann’s in New Orleans, Meijer’s Thrifty Acres in Michigan, and Fred Meyer in Oregon. But none of the industry giants could figure it out.

Fast forward to 1987. Booming discount chain Walmart — still smaller than Sears or Kmart — opened an experimental store combining the general merchandise (non-food) that it knew well with groceries, a new category in an already fiercely competitive field. The store was called Hypermart USA, modeled on the “hypermarches” which were sweeping through Europe, led by France’s Carrefour. The store did not work and was soon closed.

Nevertheless, ever-experimenting Walmart opened its first “Supercenter” the next year (1988) in Washington, Missouri. This time it worked. For the next several years, the company gradually replaced most of its discount stores with the new food and general merchandise combination stores. As of January 31, 2017, there were 3,522 Walmart Supercenters in 49 of the 50 U.S. states, the District of Columbia, and Puerto Rico. Everywhere but Hawaii. Walmart is by far the largest food retailer in the world, with revenues almost twice those of runner-ups France’s Carrefour and Britain’s Tesco combined. Kroger remains the largest pure food chain in the US, and the only company to finish among America’s top ten retailers ever since 1929, a remarkable record in itself.

Yet another breakout of the 1970s and 1980s was the invention of the warehouse club with Sol Price’s Price Club in San Diego. Costco and Walmart’s Sam’s Club came along soon after. Costco later acquired the original Price Club organization. No retailer in American history has lived with such low profit margins as these stores, relying on membership fees for profitability (not unlike Amazon). Between 2000 and 2016, Amazon grew its North American revenue by $76 Billion, while Costco added $63 Billion.

Step ahead another 30 years to today. Convenience stores are getting a rising share of the food dollar, led by Sheetz, Wawa, 7-Eleven, and many smaller firms. Walgreen’s, in the 1970s a sleeping giant, and CVS, back then a small division of shoe giant Melville Corporation, are now adding more food on virtually every good street corner in America, often facing each other. Family Dollar, Dollar General, and DollarTree are adding stores and expanding in food. Aldi and Lidl are invading in spades. Those in the traditional supermarket industry in the “know” consider privately owned Publix, HEB, and Wegman’s as among the best in class — conclusions supported by surveys of customer loyalty and satisfaction.

According to Statista, in 2016 Walmart sold 17.3% of the food sold in America (excluding restaurants), followed by Kroger at 8.9%, Albertson’s/Safeway at 5.6%, Costco at 5.1%, Ahold Delhaize at 4.2%, Sam’s Club and Publix tied at 3.4%, HEB at 1.9%, Whole Foods and ShopRite at 1.7%, Target at 1.5%, Meijer at 1.4%, and Aldi at 1.3%. Further down the list were Trader Joe’s at 1.1%, and Wegman’s and Amazon tied at 0.8%. That is a LOT of upside for Amazon and the other tiny players, just as Whole Foods’ leaders realized 35 years ago.

Amazon is the most defensible company on earth — for not-so-obvious reasons:

It’s the fact that each piece of Amazon is being built with a service-oriented architecture, and Amazon is using that architecture to successively turn every single piece of the company into a separate platform — and thus opening each piece to outside competition.

I remember reading about the common pitfalls of vertically integrated companies when I was in school. While there are usually some compelling cost savings to be had from vertical integration (either through insourcing services or acquiring suppliers/customers), the increased margins typically evaporate over time as the “supplier” gets complacent with a captive, internal “customer.”

There are great examples of this in the automotive industry, where automakers have gone through alternating periods of supplier acquisitions and subsequent divestitures as component costs skyrocketed. Divisions get fat and inefficient without external competition. Attempts to mitigate this through competitive/external bid comparison, detailed cost accountings and quotas usually just lead to increased bureaucracy with little effect on actual cost structure.

The most obvious example of Amazon’s SOA structure is Amazon Web Services (Steve Yegge wrote a great rant about the beginnings of this back in 2011). Because of the timing of Amazon’s unparalleled scaling — hypergrowth in the early 2000s, before enterprise-class SaaS was widely available — Amazon had to build their own technology infrastructure. The financial genius of turning this infrastructure into an external product (AWS) has been well-covered — the windfalls have been enormous, to the tune of a $14 billion annual run rate. But the revenue bonanza is a footnote compared to the overlooked organizational insight that Amazon discovered: By carving out an operational piece of the company as a platform, they could future-proof the company against inefficiency and technological stagnation.

In the 10+ years since AWS’s debut, Amazon has been systematically rebuilding each of its internal tools as an externally consumable service. A recent example is AWS’s Amazon Connect — a self-service, cloud-based contact center platform that is based on the same technology used in Amazon’s own call centers. Again, the “extra revenue” here is great — but the real value is in honing Amazon’s internal tools.

If Amazon Connect is a complete commercial failure, Amazon’s management will have a quantifiable indicator (revenue, or lack thereof) that suggests their internal tools are significantly lagging behind the competition. Amazon has replaced useless, time-intensive bureaucracy like internal surveys and audits with a feedback loop that generates cash when it works — and quickly identifies problems when it doesn’t. They say that money earned is a reasonable approximation of the value you’re creating for the world, and Amazon has figured out a way to measure its own value in dozens of previously invisible areas.

But this much is obvious — we all know about AWS. The incredible thing here is that this strategy — in one of the most herculean displays of effort in the history of the modern corporation — has permeated Amazon at every level. Amazon has quietly rolled out external access in nooks and crannies across their entire ecosystem, and it is this long tail of external service availability that I think will be nearly impossible to replicate.