Tag Archives: contrarians

Notes – The Snowball, By Alice Schroeder: Part V, Chap. 43-52

The following are reading notes for The Snowball: Warren Buffett and the Business of Life, by Alice Schroeder (buy on Amazon.com). This post covers Part V: The King of Wall Street, Chap. 43-52

[These notes were never published on time. They may be incomplete as posted now.]

The modern Buffett

In Part V of the Snowball, we see Buffett’s transformation from the early, cigar butt-picking, Grahamian value-minded Buffett, through the filter of his Fisherite partner, Charlie Munger, into the mega cap conglomerator and franchise-buyer Buffett who is popularly known to investors and the public the world round.

It is in this part that we also see Buffett make one of his biggest missteps, a stumble which almost turns into a fall and which either way appears to shock and humble the maturing Buffett. It is in this era of his investing life that we see Buffett make some of his biggest rationalizations, become entangled in numerous scandals he never would’ve tolerated in his past and dive ever deeper into the world of “elephant bumping” and gross philanthropy, partly under the tutelage of his new best friend and Microsoft-founder, Bill Gates.

The lesson

Buffett made a series of poor investments but ultimately survived them all because of MoS. There will be challenges, struggles, and stress. But after the storm, comes the calm.

The keys to the fortress

From the late seventies until the late nineties, despite numerous economic and financial cycles Buffett’s fortune grew relentlessly under a seemingly unstoppable torrent of new capital:

Much of the money used for Buffett’s late seventies spending spree came from a bonanza of float from insurance and trading stamps

This “float” (negative working capital which was paid to Buffett’s companies in advance of services rendered, which he was able to invest at a profit in the meantime) was market agnostic, meaning that its volume was not much affected by the financial market booming or crashing. For example, if you owe premiums on your homeowner’s insurance, you don’t get to suspend payment on your coverage just because the Dow Jones has sold off or the economy is officially in a recession.

The growth in Buffett’s fortune, the wilting of his family

Between 1978 and the end of 1983, the Buffetts’ net worth had increased by a stunning amount, from $89 million to $680 million

Meanwhile Buffett proves he’s ever the worthless parent:

he handed the kids their Berkshire stock without stressing how important it might be to them someday, explaining compounding, or mentioning that they could borrow against the stock without selling it

Buffett had once written to a friend when his children were toddlers that he wanted to see “what the tree has produced” before deciding what to do about giving them money

(he didn’t actively parent though)

Buffett’s private equity shop

Another tool in Buffett’s investment arsenal was to purchase small private companies with dominant franchises and little need for capital reinvestment whose excess earnings could be siphoned off and used to make other investments in the public financial markets.

Continuing on with his success in acquiring the See’s Candy company, Buffett’s next private equity-style buyout involved the Nebraska Furniture Mart, run by a devoted Russian immigrant named Rose Blumkin and her family. And, much like the department store chain he once bought for a song from an emotionally-motivated seller, Buffett beat out a German group offering Rose Blumkin over $90M for her company, instead settling with Buffett on $55M for 90% of the company, quite a discount for a “fair valuation” of practically an entire business in the private market, especially considering the competing bid.

An audit of the company after purchase showed that the store was worth $85M. According to Rose Blumkin, the store earned $15M a year, meaning Buffett got it for 4x earnings. But Rose had buyers remorse and she eventually opened up a competing shop across the street from the one she had sold, waging war on the NFM until Buffett offered to buy her out for $5M, including the use of her name and her lease.

One secret to Buffett’s success in the private equity field? Personality:

“She really liked and trusted me. She would make up her mind about people and that was that.”

Buffett’s special priveleges

On hiding Rose Blumkin’s financial privacy: Buffet had no worries about getting a waiver from the SEC

Buffett got special dispensation from the SEC to not disclose his trades until the end of the year “to avoid moving markets”

The gorilla escapes its cage

Another theme of Buffett’s investing in the late 1980s and 1990s was his continual role as a “gorilla” investor who could protect potential LBO-targets from hostile takeover bids. The first of these was his $517M investment for 15% of Tom Murphy-controlled Cap Cities/ABC, a media conglomerate. Buffett left the board of the Washington Post to join the board of his latest investment.

Another white knight scenario involved Buffett’s investment in Ohio conglomerate Scott Fetzer, which Berkshire purchased for $410M.

Then Buffett got into Salomon Brothers, a Wall Street arbitrage shop that was being hunted by private equity boss Ron Perelman. Buffett bought $700M of preferred stock w/ a 9% coupon that was convertible into common stock at $38/share, for a total return potential of about 15%. It even came with a put option to return it to Salomon and get his money back.

But Buffett had stepped outside of his circle of competence:

He seemed to understand little of the details of how the business was run, and adjusting to a business that wasn’t literally made of bricks-and-mortar or run like an assembly line was not easy for him… he had made the investment in Salomon purely because of Gutfreund

Buffett’s disgusting ignorance and hypocrisy


I would force you to give back a huge chunk to society, so that hospitals get built and kids get educated too

Buffett decides to sell the assets of Berkshire’s textile mills– on the books for $50M, he gets $163,122 at the auction. He refused to face his workers and then had the gall to say

“The market isn’t perfect. You can’t rely on the market to give every single person a decent living.”

Buffett on John Gutfreund:

an outstanding, honorable man of integrity

Assorted quotes

Peter Kiewit, a wealthy businessman from Omaha, on reputation:

A reputation is like fine china: expensive to acquire, and easily broken… If you’re not sure if something is right or wrong, consider whether you’d want it reported in the morning paper

Buffett on Wall St:

Wall Street is the only place people ride to in a Rolls-Royce to get advice from people who take the subway

This Just Blew My Mind: The Moneyball Secret & Warren Buffett (#valueinvesting, #baseball, #success)

I read Michael Lewis’s Moneyball a few months ago after having seen the film. I would’ve preferred to do it in the other order (if I had ended up seeing the film at all) but I hadn’t gotten to the book yet on my reading list and an opportunity to see the movie presented itself that I decided not to turn down.

As I understood the story, the basic premise was the principles of Grahamite value investing in baseball– buy cheap things rather quality things and wait for reversion to the mean to kick in. These cheap things may not be worth much, but you can buy them at such a discount it doesn’t matter as they’d have to be truly worthless for you to have made a mistake in the aggregate.

Specifically, Billy Bean, the GM of the Oakland Athletics at the time, was recruiting players with no star power and no salary-negotiation power that could fill his roster with an above-average on base percentage. In contrast, all the big teams with the big budgets were buying the massive stars who were known for their RBIs and home run percentages. Billy Bean’s motto was “don’t make mistakes”, like a value investor who looks for a margin of safety. The other big teams with their massive budgets were operating with the motto “Aim for the stands, hit it out of the park”, like the huge mutual funds with their marketing machines and their reliance on investor expectations to add super fuel to the market.

That’s the story I thought I read, anyway, and it made a lot of sense. Inspiring stuff for a little value investor guy like me.

Today, I sat in a marketing presentation from a vendor who used Moneyball as a metaphor and he threw this image up on the projector during his slide show:

oakland_asThis is a picture of the Oakland A’s stadium. It is a shared stadium meaning it is not dedicated to the A’s but also serves as the Oakland Raiders football team home field. As a result, the baseball diamond has a lot of extra foul zone on the first and home base lines, which you might be able to see if you get real close to your monitor and squint.

I had never seen the A’s stadium before. I had no idea it had extra large foul zones. I didn’t realize that in a 160-odd game series the As would play around half, or nearly 80 games, at a stadium that had extra large foul zones.

I had no idea that a lot of players who had high on-base percentages got there because they hit balls that would normally end up in the stands at most other stadiums, but at the A’s home field it’d end up in the extra large foul zone. I had no idea that this meant those kinds of players would be extra valuable only on the Oakland A’s baseball team. I didn’t realize, as the demonstrator told us, Billy Bean was building a “pitching team”, not just a cheap on-base team (whatever that means).

This blew my mind. Maybe I just missed this in the book, and the movie. I am not a sports fan so maybe Lewis mentioned it and it wasn’t a detail that stuck out to me (which is actually another important lesson from all of this, but I digress…). Or maybe he didn’t. Maybe Lewis, the consummate story-teller, focused on the point he wanted to make from the story even though the reality, while related, was really determined by something else– the extra large foul zone at the Oakland A’s home stadium.

It reminded me of one of those situations with Warren Buffett. The first time you read Buffett’s biography and learn about his investments, you get the hokey “Just buy good businesses at fair prices!” schtick and you think, “Hey, that sounds simple, makes sense, that’s all there is to it!” Then you learn a few years later that what he was ACTUALLY doing was gaming the tax system, or creating synthetic leverage for himself, or whatever. You find the REAL angle, and it’s a bit more sophisticated and a bit harder for the average Joe to replicate by following the “invert, always invert” mantra of Charlie Munger.

What I took away from this is that people tell the stories they want to tell and you should never, ever take something at face value that involves a story of a person becoming wildly successful, wealthy, etc., just by figuring out some seemingly obvious, simple trick like buying cheap baseball stats.

There’s always an angle, like, he was buying cheap baseball stats that worked especially well in his home stadium.

That’s still genius, no doubt, but there’s less there that anyone operating outside that specific context can learn from it.


Review – The Outsiders (#management, #capital, #business, @HarvardBiz)

The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success (buy on Amazon.com)

by William N. Thorndike, Jr., published 2012

A “valueprax” review always serves two purposes: to inform the reader, and to remind the writer. Find more reviews by visiting the Virtual Library. Please note, I received a copy of this book for review from the publisher, Harvard Business Review Press, on a complimentary basis.

Capital allocation uber alles

“The Outsiders” rests on a premise, that the increase in a public company’s per share value is the best metric for measuring the success of a given CEO, which lends itself to the book’s major thesis: that superior capital allocation is what sets apart the best CEOs from the rest, and that most modern CEOs seem to be only partially aware, if at all, of its critical performance to their companies long-term business success.

Notice! This book is examining the efforts and measurements of CEOs of public companies, not all businesses (public and private), so as a result in comes up a bit short in the “universal application” department. Yes, capital allocation is still critical even in a private business, but you can not measure a private business’s per share value (because there isn’t a marketable security price to reference) and the CEO of a private company is missing one of the most powerful capital allocation tools available to public CEOs, the share buyback (because there is no free float for them to get their hands on at periodically irrational prices).

The CEO capital allocation toolkit

Thorndike describes five capital allocation choices CEOs have:

  1. invest in existing operations
  2. acquire other businesses
  3. issue dividends
  4. pay down debt
  5. repurchase stock

Along with this, they have three means of generating capital:

  1. internal/operational cash flow
  2. debt issuance
  3. equity issuance

With this framework, Thorndike proceeds to review the business decisions of 8 different “outsider” CEOs, so labeled because they tended to use these tools in a contrary fashion to the mainstream wisdom of their time and to much improved effect as per comparison to their benchmarks. Some of the CEOs are well known and oft mentioned and studied (Warren Buffett, John Malone, Kay Graham, Tom Murphy) and a few are known to the value cognoscenti but may have managed to escape notice of the wider public, academic or otherwise (Henry Singleton, Bill Anders, Bill Stirlitz and Dick Smith).

The author tries to tie together the various common threads, such as how,

All were first-time CEOs, most with very little prior management experience

and many of which (such as Singleton, Buffett and Graham) were large or majority equity holders in their companies, making them part of the vaunted owner-operator club with its resulting beneficial incentives.

Thorndike also tries to use the hedgehog vs. fox metaphor, claiming,

They had familiarity with other companies and industries and disciplines, and this ranginess translated into new perspectives, which in turn helped them to develop new approaches that eventually translated into exceptional results

Interestingly, the share buyback stands out as a particularly effective capital allocation tool for all and the author claims that during the difficult inflationary conditions and market depression of the 1974-1982 period,

every single one [emphasis in the original] was engaged in either a significant share repurchase program or a series of large acquisitions

In broad strokes, Thorndike’s efforts to paint these CEOs with a common brush works, but there are numerous times where his attempt to establish commonality  in genius comes across as forced and unworkable. Often, one of these CEOs will operate in a way inconsistent with Thorndike’s major thesis and yet he’ll end up praising the CEO anyway. In poker, we’d call this the “won, didn’t it?” fallacy– judging a process by the specific, short-term result accomplished rather than examining the long-term result of multiple iterations of the process over time.

Some quibbles

This is actually one of the things that rubbed me rather raw as I read the book. In every chapter, Thorndike manages to strike a rather breathless, hagiographic tone where these CEOs can do no wrong and everything they do is “great”, “fantastic,” etc. Unfortunately, this kind of hyperbolic language gets used over and over without any variety to the point it’s quite noticeable how lacking in detail and critical analysis Thorndike’s approach is at points.

Eventually, I reached a point where I almost wanted to set the book down, take a deep breath and say, “Okay… I get it, this guy is absolutely amazing… can we move on now?”

The editing seemed a bit sloppy, too. Thorndike is a graduate of Stanford and Harvard and runs his own financial advisory. He’s obviously an accomplished, intellectual person. Yet his prose often reads like an immature blog post. It’s too familiar and casual for the subject matter and the credentials of the author. I’m surprised they left those parts in during the editing process. I think it makes Thorndike’s thesis harder to take seriously when, in all likelihood, it’d probably be quite convincing if you happened to chat with the author on an airplane.

From vice to virtue

Something I liked about “The Outsiders” was the fact that there were 8 profiles, rather than one. It was reinforcing to see that the same principles and attitudes toward business and management were carried out by many different individuals who didn’t all know each other (though some did) and ALL had huge outperformance compared to their benchmark.

And I think for someone who is just jumping into the investing, management and agency problem literature, “The Outsiders” is a good place to start to get a broad outline of the major thesis which is that companies that are run by owner-operators, or by people who think like them, where the top management focuses on intelligently allocating capital to its highest use (which, oftentimes when the company’s stock remains stubbornly low compared to its estimated intrinsic value, makes buybacks in the public market the most intelligent option versus low margin growth) consistently outperform their peers and their benchmarks on a financial basis.

I think if this was one of the first books I had read on this theme, I would’ve found it quite illuminating and exciting, a real eye-opener experience. As it were, I read this book after reading a long train of other, often times significantly more comprehensive and detailed literature, so my personal experience was rather flat– I came away thinking I hadn’t learned much.

More to the story

There’s more to this story in two senses.

In the first sense, I actually highlighted many little comments or ideas throughout the book that are either helpful reminders or concepts I hadn’t fully considered myself yet, pertaining to best operational and management practices for businesses and the people who invest in them. In other words, the book is a little deeper than I bothered to share here. As a collection of anecdotes and principles for mastering the concept of capital allocation, it’s a good resource.

In the second sense, I think there’s a lot more to the success of the businessmen and their companies profiled (along with many others) than just good capital allocation. The text alludes to this with quotes from various figures about how they operated their businesses and managed people aside from the specific challenges of capital allocation. But it never goes into it because that isn’t in focus.

And as a business person myself, I know from my own reading, thinking and personal experience that capital allocation IS a critical factor in successfully managing and growing a business over the long-term — after all, if you can’t find good places to put your cash, you’ll inevitably end up wasting a lot of it — but you won’t have capital to allocate if you aren’t operating your business and managing your relationships with employees and customers well, in addition. The book just doesn’t do much in the way of explaining how it was that Ralston Purina, or General Dynamics or Teledyne or what have you, had so much capital to allocate in the first place.

Notes – Doing The Hugh Hendry (#debt, #diversification)

Below is some commentary from Hugh Hendry I found in an FT.com editorial I since can not access as I don’t have a login. But I thought it was interesting when I first read it awhile back and I still think it’s interesting now. I meant to post it earlier. Rectifying my mistake:

For the moment, let us forget the chances of a hard landing in China. Forget the drama of Europe’s circus of politically inspired economic incompetency. Forget that the good news of the US economy’s succession of positive economic surprises is really bad news as fixed income managers have sold copious amounts of too cheap volatility and because it has made equity investors turn bullish, sending stock market volatility back to 2007 levels. This is dangerous. Improved US data may represent a classic short-term cyclical upturn amid a profound global deleveraging cycle.

Such moves have been commonplace for the past three years and have yet to prove a harbinger of any structural upswing. I worry that the pathological course of the last several years will see volatility rise sharply once again. Even so, there exists, in terms of my parochial world of hedge fund investing, a bigger issue.

I fear that my no longer small community has been compromised. Last year was generally very tough for long/short strategies and I commiserate with all concerned. But last year world class funds lost more than 15 per cent in just two months. Today they are celebrated again for making double digit returns in the last quarter even though they still languish below high water marks and their reputation for risk management, at least to those clients who have poured over their copious due diligence statements, has been sorely compromised.

You can probably live with that if you are a pension scheme or a large, sophisticated fund-of-fund because you have a global macro sub-sector that can benefit from short-term shifts in volatility. But the unfortunate thing is that this group exercised its stop losses somewhere between the great stock market rallies of 2009 and 2010. That is to say, they honoured the pact they had with clients. They adhered to the terms of their risk budget: they lost money and they reduced their positions. I fear that owing to this nasty experience the financial world is in danger of harvesting a monoculture of fund returns that could prove less than robust should the global economy suffer another deflationary reversal.

To my mind the situation has parallels with the plight of the banana. Today the world eats predominately just one type of banana, the Cavendish, but it is being wiped out by a blight known as Tropical Race 4, which encourages the plant to kill itself. Scientists refer to it as programmed death cell destruction. In stressful situations bananas fortify themselves by dropping leaves, killing off weaker cells so that stronger ones may live to fight anew. They operate a stop-loss system.

But modern mass production of single type bananas has replaced jungle diversity with commercial monocultural fields that provide more hosts to harbour the blight. The economy keeps producing stressful volatility events. Good managers keep shedding risk and monetising losses and are duly fired, leaving us with a monoculture of brazen managers who will never stop loss because they are convinced central banks will print more money.

Diversification has proven the most robust survival mechanism against failures of judgment by any one society, hedge fund manager or style. But what if we are now a single global hedge fund community afraid to take stop losses and convinced of an inflationary outcome to be all short US Treasuries and long real assets?

This is pertinent as I have always been fascinated by that second rout in US Treasuries in 1984, long after the inflation of the 1970s was met head on by Paul Volcker’s monetary vice and a deep recession. How could 10-year Treasury yields have soared back to 14 per cent and how could so many investment veterans have been convinced that a second even more virulent inflation wave was to hit the global economy?

Psychologists tell us the explanation is embedded deep in the mind. They refer to the “availability heuristic”. Goaded by the proximity to the last dramatic event, investors overreacted to the news that the US economy was pulling out of recession in 1984. They saw high inflation where there was none.

With this in mind, I would contend that it may take several more years before the threat of debt and deflation can be successfully exorcised from investors’ minds, even if the global economy were not set on such a perilous course. Such is the potency and memory of 2008’s crash that anything remotely challenging to the economic consensus could be met by a sudden and severe reappraisal to the downside.

Should such an event send 30-year Treasury yields back to their 2008 low of 2.5 per cent, we believe enlightened investors might better be served by thinking the opposite. Only then might it prove rewarding to short the government bond market and embrace what may turn out to be a much promised once in a lifetime buying opportunity for risk assets.

Review – Nintendo Magic ($NTDOY, #videogames, #business)

Nintendo Magic: Winning the Videogame Wars (buy on Amazon.com)

by Osamu Inoue, published 2009, 2010 (translated from Japanese)

A “valueprax” review always serves two purposes: to inform the reader, and to remind the writer.

Two Nintendo legends no one seems to know about

The original Nintendo started out as a manufacturer of playing cards and other toys, games and trinkets near the end of the Shogunate era in Japan, but the modern company we know today which gave the world the Nintendo Entertainment System, the Game Boy, the Wii and characters like Mario & Luigi and Pokemon, was primarily shaped by four men: former president Hiroshi Yamauchi, lead designer Gunpei Yokoi, the firm’s first software designer Shigeru Miyamoto and the first “outside hire” executive and former software developer, Satoru Iwata.

A family member of the then privately-held Nintendo, Yamauchi took the presidency in 1949 when his grandfather passed away. He tried adding a number of different businesses (taxis, foodstuffs, copiers) to Nintendo in true conglomerate fashion, managing in one 12 year period to grow sales by a factor of 27 and operating profits by a factor of 37.

But his most influential mark on Nintendo’s business came with his fortuitous hiring of Gunpei Yokoi, an engineer, who would head up hardware development for Nintendo’s game division. It was this strategic decision to concentrate Nintendo’s efforts on game development that would lead to the modern purveyor of hardware and software known around the world today.

Hardware engineer Gunpei Yokoi is not a well-known name outside the world of hardcore Nintendo fandom, which is not altogether surprising because most Nintendo fans alive today were not users of some of his first toy gadgets such as the “Love Detector” and the “Game & Watch” handheld mini-game consoles. On the other hand, it’s a shock that the man’s reputation is not larger than it is because he essentially single-handedly created the company’s hardware development philosophy in the 1960s which has remained with it today and continues to influence Nintendo’s strategic vision within the video game industry.

That hardware philosophy was summed up by Nintendo’s first head of its hardware development section as “Lateral thinking with seasoned technology”. In concrete terms, it is the idea of using widely available, off-the-shelf technology that is unrelated to gaming in new and exciting ways of play, for example:

  • Yokoi’s “Love Detector” game, which used simple circuitry and electrical sensors to create an instrument that could supposedly detect romantic chemistry between two users when they held hands and held the machine
  • A blaster rifle toy that used common light-sensing equipment to deliver accuracy readings of the users target shots to the rifle, registering hits and points
  • More recently, the Nintendo “Wiimote” concept, which was simply the idea of repurposing the common household TV remote into a tool for play

Yokoi’s lasting impact on the hardware (and software) philosophy at Nintendo is best captured by current president Satoru Iwata who once said,

It’s not a matter of whether or not the tech is cutting egde, but whether or not people think it’s fun

Similarly, this focus on repurposing existing technology for fun rather than investing in brand new technology helps to explain why many of Nintendo’s systems have been knocked for their not-so-hardcore hardware (think non-HD Wii vs. HD-enabled Sony PS3 and Microsoft Xbox 360) but nonetheless became massive consumer hits– the focus was on fun, not flash.

The Wii particularly was the response to the failure of two systems which preceded it (Gamecube and N64), which were extremely technologically advanced for their era and which departed as swiftly from Yokoi’s philosophy as they posed monumental development challenges for software developers due to their complex, proprietary nature. Instead of creating yet another whizbang console, Nintendo decided that if Wii’s costs were kept down and developers were free to focus on things like a new, intuitive controller and built-in connectivity functions, fun and market success would follow.

Essentially, the game hardware is a commodity with zero barriers to entry. Anyone can have the latest, greatest technology if they’re willing to pay for it. There is no way to establish a competitive advantage on the basis for hardware sophistication alone. It must come from design, or, as Yokoi put it,

In videogames, these is always an easy way out if you don’t have any good ideas. That’s what the CPU competition and color competition are about

Nintendo’s two leading lights: Satoru Iwata and Shigeru Miyamoto

Rounding out the Fantastic Four are Satoru Iwata, the company’s current president, and Shigeru Miyamoto, the star software developer.

Iwata came from relative privilege and studied computer programming in school. He had a passion for making and playing games from an early age. He joined a software developer, HAL Laboratory, early on. He successfully turned around the flagging HAL Lab before it was acquired by Nintendo.

Meanwhile, Miyamoto first came to fame through development of his Donkey Kong arcade game, which introduced the characters Donkey Kong and Mario and which was originally based off of Popeye until the IP could not be acquired for licensing. As a small boy he spent hours running around the hills, forests and mountains outside his home, which inspired many of his later game creations such as Pikmin, Animal Crossing, The Legend of Zelda, etc. He was the first designer Nintendo had ever hired. Miyamoto often utilizes his “Wife-o-meter” to help him understand how to make games that are more broadly appealing.

Miyamoto’s design ethic is best synthesized as populist-perfectionist:

When creating a game, Miyamoto will occasionally find employees from, say, general affairs who aren’t gamers and put a controller in their hands, looking over their shoulder and watching them play without saying anything

He creates game characters, game designs and immersive environments that appeal to everyone, not just the archetypical “hardcore gamer.” But this desire to serve a mass, unsophisticated audience does not mean that Miyamoto considers quality as an afterthought. Miyamoto will “polish [an idea] for years, if he has to, until it satisfies him” and “shelving an idea does not mean throwing it away. Those huge storehouses are full of precious treasure that will someday see the light of day.”

This is part of the value of Nintendo– they have many unrealized ideas waiting to be turned into hardware and games and the only thing preventing them from seeing the light of day is someone like Miyamoto who wants to make sure that when they eventually emerge into the light, they don’t just shine but sparkle.

And this thinking carries over to the company’s hardware efforts, as well. According to a lead engineer, the DS

had to work consistently after being dropped ten times from a height of 1.5 meters, higher than an adult’s breast pocket

Nintendo is “obsessed about the durability of their systems due to an overriding fear that a customer who gets upset over a broken system might never give them another chance.”

“Nintendo-ness”: how Nintendo competes by not competing

In 1999, then-president Yamauchi saw a crisis brewing for video game developers:

If we continue to pursue this kind of large-scale software development, costs will pile up and it will no longer be a viable business. The true nature of the videogame business is developing new kinds of fun and constantly working to achieve perfection

The solution was to adhere ever more closely to “Nintendo-ness”. Nintendo picks people with a “software orientation.”

“Nintendo-ness” is the company’s DNA, once someone has grasped Nintendo-ness, it is rare for them to leave the company. That tendency protects and strengthens the company’s lineage and makes employees feel at home

Manufacturing companies create hardware which are daily necessities, which compete based on being better, cheaper products. Nintendo is in an industry of fun and games, software, where polished content is the goal. Compare this to rival Sony, where hardware specs are key and the software is to follow.

According to Iwata,

Do something different from the other guy is deeply engrained in our DNA

Similarly, Nintendo-ness means delighting customers through creation of new experiences because

if you’re always following a mission statement, your customers are going to get bored with you

This way of thinking goes back to Hiroshi Yamauchi, president of Nintendo for 50 years, according to Iwata:

He couldn’t stand making the same kind of toy the other guy was making, so whatever you showed him, you knew he was going to ask, ‘How is this different from what everybody else is doing?’

For some reason, Nintendo observers and critics don’t get this– why isn’t the company doing what everyone else is doing? Why are they making a console with a TV remote instead of HD graphics (the Wii)?

To Nintendo, the risk is in not trying these things and trying to do what everyone else does. Iwata sums it up nicely:

Creators only improve themselves by taking risks

Of course, not all risks are worth taking. Iwata as a representative of Nintendo’s strategic mind makes it clear that the company is keenly aware of its strategic and financial risks:

The things Nintendo does should be limited to the areas where we can display our greatest strengths. It’s because we’re good at throwing things away that we can fight these large battles using so few people. We can’t afford to diversify. We have overwhelmingly more ideas than we have people to implement them

For example, Nintendo considers the manufacturing of game consoles to be outside its purview, a “fabless” company.

Then there’s the reason for the huge amount of cash on the balance sheet:

The game platform business runs on momentum. When you fail, you can take serious damage. The risks are very high. And in that domain, Nintendo is making products that are totally unprecedented. Nobody can guarantee they won’t fail. One big failure and boom– you’re out two hundred, three hundred billion yen. In a business where a single flop can bankrupt you, you don’t want to be set up like that… To be completely honest, I don’t think that even now we have enough [savings]… That’s why IBM, or NEC, or any number of other companies are willing to go along with us. We’d never be able to do what we do without being cash-rich

That being said, Iwata has not been shy about his policy toward dividends and acquisitions. He has stated that assuming Nintendo’s savings continue to accumulate, passing 1.5T or 2T yen, a large merger or acquisition may become a possibility. Otherwise, excess capital will be distributed as dividends.

The next level

Nintendo’s philosophy is to avoid competition. It sees the hardware arms race as an irrelevant dead-end. The key is to create new ways to interact with game consoles and software that keeps game players on their toes and brings smiles to their faces. According to Iwata,

We’d like to avoid having players think they’ve gotten a game completely figured out

Thus, for Nintendo the next level logically is integration of  User-Generated Content into their software environments, which would have inexhaustible longevity. First they sought to increase the gaming population, now they’re looking at how to increase the game-creating population.

The company’s true enemy is boredom. Whatever surprise you create today becomes your enemy tomorrow.

In the end, Iwata says,

Our goal is always to make our customers glad. We’re a manufacturer of smiles

This is what the company calls “amusement fundamentalism” and it’s what sets them apart from their perceived competition, especially comparisons or criticisms aimed at the company in terms of how it stacks up against a company like Apple. To Iwata, this just doesn’t make sense:

We’re an amusement company and Apple’s a tech company