Quality research or mob action?

March 14, 2012
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Georgia Tech Accounting Lab study reveals eye-opening facts.

Many years ago, when coming of age, I was complaining about the general difficulty of college and how it was near impossible to have any semblance of a social life and make reasonable grades. My bout of self-pity was cut short by a grizzled World War II veteran who commented, “Sounds like you want it easy. Easy is a lie.”

His comment has dogged me for 30 years as I watch the concepts of political correctness, easy compliments and pandering move from the banana world of politics to the general populace. I sometimes think we have become a nation of panderers who avoid the critical comment and higher standard preferring silver-tongue avoidance and comedic relief. 

My opening commentary, for wholesaler readers, concerns the area of research and knowledge work for the industry. There has not been, in my 30 years of association with the industry, a greater need for qualified, critical and hard-hitting research than today. And, to answer the call, there is largely an assemblage of 20-, 30- and 40-year-old fare, repackaged and passed off as cutting edge. 

Futhermore, this cutting-edge fare is often supported by shoddy research design that ensures bias, has very little if any parametric research and no causality in the statistics. Finally, too many panels that control the purses for research have no idea what I said in the previous sentence and why it matters.

Several years back, a friend with a master’s degree in research who worked for a sizable wholesale association quietly left. His passing comment was, “They don’t want well-designed, empirical research with a tough message.” In essence, his association had no appreciation or stomach for hard-hitting and qualified research. Instead, it settled into a comfortable message that created few waves while affirming its vast store of experience-based knowledge. In short, this association demanded easy, got it and fell prey to the lie.

The tipping point

My objection to the low quality of research in the wholesale industry has come to a head in the past few months. First, I went to a technology conference where knowledge-based software providers were pitching the vast capabilities of their product(s). GMROI and margin-based pricing comparisons were the rage. I made the mistake of questioning the unfailing loyalty to GMROI and was duly lectured by a 30-nothing about how wholesaling worked. I didn’t have the desire to tell him that the good research on GMROI worship finds that it suppresses inventory levels, loses sales and impairs customer loyalty. 

In a pricing software seminar, I asked the presenter how he corrected Prospect Theory in his software. He didn’t know what I was talking about. Most pricing issues are behavioral. Prospect Theory states the fear of losing the order is greater than the desire to win margin. Hence, pricers, typically on a cost-plus basis, dampen margins to avoid embarrassment of losing the order. To correct Prospect Theory, the pricing system should use a list and discount logic, which reframes the loss to a win.  

For instance, a 40% cost plus margin on a $100 cost item is $166 in price, but a 40% cost plus margin almost never happens because the pricer is afraid of losing the order. The list and discount mechanism, to correct Prospect Theory, would list price the item at, say, $275, discount it by 40% for a net of $166, and the pricer is doing a “good thing” for the customer.

A month ago, I finally reviewed a book written for wholesalers. I’ve reviewed over 20 books in my newsletter in 10 years of publication.  Most books are average and there are a few stars. This particular book was filled with design standards that were 15 years old and passed off as current knowledge. The author totally negated cutting-edge and current research done by the unchallenged leader in the field.

Furthermore, the text was approved by a distinguished panel of experienced wholesale experts. Many of the supporting footnotes for the book were 20- and 30-year-old knowledge. I gave the book a less than glowing review and likely P.O.’ed a lot of people in the process. I must be nuts - or maybe not.

Why good research matters

The grizzled veteran in my opening commentary believed that if we want easy, we can find it. There’s always someone out there who will pander to our need for approval, water down standards and pass them off as helpful. He also believed that this attitude, if condoned by leaders, was ultimately destructive to the health of the group(s) they represented. 

This belief set was illustrated a week ago when I ran across research done by the Georgia Tech Accounting Lab. Georgia Tech has one of the leading forensic accounting programs in the country. In a short but telling piece on CFO.com, the lab produced a 2011 report on the wholesale industry. The report measures free cash flow in a metric called a free cash flow profile. Using data from 122 publicly traded wholesalers in the $300 million to $800 million in sales range, the report shows that the wholesale Industry was 39th out of 44 sectors in its free cash flow profile. Free cash flow is the foundation of shareholder value as it measures the cash thrown off from investment activities.  Wholesalers had a negative free cash flow profile of 7%.

In essence, the industry in 2011 was earning less on its current base of business than its weighted average cost of capital. Wholesalers in general don’t measure free cash flow and don’t understand how it contributes to shareholder value. However, North America’s best companies do use the measure and understand it and the long-accepted financial formula for value equals Free Cash Flow/Weighted Average Cost of Capital.

The report reveals that at least half of wholesalers were so cash poor that they were borrowing funds for growth.  Our bet is that they never equated investment activities with substandard cash flow and the fact that they had to borrow to get growth. We believe the report from Georgia Tech, because of the sample size and representation of different sectors, is accurate for the industry as a whole. We also believe wholesalers are literally borrowing money to lose money. In essence, the current state of things is untenable for the industry and the Georgia Tech research brings forward a real need for further exploration. 

I found no mention of this report in the leading wholesaler newsletters of firms who tout the latest knowledge, so I sent a copy to the heads of these fine institutions. My bet is that you’ll never hear about or see the output from these organizations who proclaim to be in the thick of cutting-edge research. To us, the report is a prime example of hard-hitting, fact-based research that just isn’t getting to the forefront of distribution. If wholesalers can’t get excited about a report that says the industry’s current state is a model that can’t profitably grow or fund growth, then they are literally lost. 

For us, we will continue to explore the Georgia Tech work and its meaning while lobbying for better research and better standards, including qualified researchers on industry panels with a minimum of a master’s degree in market research. We also believe there should be more parametric research with causal analyses. In the end, the simple fact that outside research with significant and challenging portent wasn’t done intra-industry is not a good sign about the quality and usefulness of work from knowledge leaders within the industry.

Responsibility or mob action

In ancient Rome, when the Emperor(s) had wasted public funds on conquest or building projects for Patricians, they appeased the Plebeian class by opening the grain stores for bread making, brewing free mead and holding free Gladiatorial events in the Colosseum. This would buy off the citizens’ anger from the squandering of public wealth at the hands of the elites. As the story goes, a few of the Stoics, including Cicero and Seneca, referred to the citizens who accepted the appeasement as a mob. 

Our hope is that wholesalers will come together and demand better research and research standards.  If they don’t, they condone the current research that mostly affirms what is already known is all that needs to be known. Unfortunately, a steady diet of the existing stuff, in our opinion, may just lead one to a business model that destroys shareholder value and literally has no lasting financial future. The choice and responsibility for change is up to wholesalers, and real leadership needs to be brought forward.

Over a course of centuries, Roman emperors bought off the mob with the tried-and-true mechanism of grain, mead and entertainment. Eventually, the Empire weakened from within as the citizens lowered their standards and failed to hold their leaders accountable. Alaric sacked the city in 410 AD, marking an end to the Empire and descent into the Dark Ages.

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