The following is an honest review of The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success by William N. Thorndike, Jr. by Seller Accountant CEO Tyler Jefcoat. Seller Accountant did not receive any compensation for this review.
At Seller Accountant, we’ve been spending a lot of time lately thinking about how to improve a key metric called Return on Working Capital. In fact, my team is telling me that I may be a little bit too obsessed with this new metric.
In the midst of my obsession, I was talking to an industry friend a few weeks ago about how crucial ROWC is in the e-commerce space with regards to inventory. I told him that I thought ROWC was going to be the best predictor of equity and exit value for private label brands in the next 12 months.
When he heard me he said, “Oh, it sounds like you’re talking about Outsiders by Thorndike.” I’d never heard of the book but was eager to read a more academic version of the study that I’d been doing over the past 6 months – and I ended up loving it.
The one CEO of the bunch that I had heard of was Warren Buffet, and I later learned that this book is one of his favorites. Here are the nuggets I gleaned from my read and how they specifically apply to e-commerce businesses:
- The most important CEO decisions relate to allocating capital. Because resources are always scarce, deciding which ideas are the right ideas, deciding which channels get funded, and deciding which products are worthy of our precious capital are THE make or break choices that e-commerce CEOs have to make. We make these choices often, and we need to make them carefully.
- Focusing on cash flow and return on capital are more important than focusing purely on net income or reported earnings. At Seller Accountant, we care a lot about PAG (Post Advertising Gross Profit) as our favorite measurement of profit. But our sellers can’t solely focus on PAG! The reason is that long-term value will be better realized if we focus on Return on Investment or more precisely Return on Working Capital (which is my way of focusing specifically on money invested in Inventory).
Return on Working Capital (ROWC) is the measure of how effective my brand is at taking a single dollar (borrowed or invested) and turning that dollar into profit over the course of a year – if I put one ticket in the machine, how many tickets spit out at the end of the year?
Profit still matters! Profit (PAG) is a key driver of ROWC but it isn’t the only driver. Inventory velocity is the other key factor that cannot be ignored. In other words, making a giant profit on the sale of a product that you have to sit on for 18 months is likely worse than making a moderate profit on a product that turns four times per year. VELOCITY x PROFIT MARGIN = FINANCIAL HAPPINESS.
- The implications of the first two points for an e-commerce seller are that choosing your products, testing your products, and yes, killing bad products are the allocation choices that will determine how successful you are. A similar implication is that choosing your sales channels, testing your sales channels and yes, killing bad sales channels will determine how successful you are. Since you have limited access to capital you need your money to be working as hard as it can for you and you can’t afford dead weight in products or in sales efforts and channels.
- These CEOs used data to be obsessively objective in these key “keep/kill” decisions. They didn’t fall into the trap of having a particular product become their baby. They were willing to follow market trends and make acquisitions (even of their own stock shares) when everyone else was freaking out and selling, and they were willing to sell (even key business units or product lines) when the market was hot and everyone else was buying. They followed a hyper-rational approach to investing and as a result, they outperformed their peers by a long shot.
- According to Thorndike, these ultra-successful CEO/Investors were shockingly humble relative to their more press-worthy peers. They were less interested in “buttering up” Wall Street than in making solid business choices and they seemed to be very content with their key partners getting the credit.
What they obsessed over was making great investment decisions and they did this by reading and learning constantly. This is probably why I hadn’t heard of at least half of these leaders: they were busier managing the allocation of their precious capital and making a killing than they were doing TV interviews and publishing guru books.
In closing, I highly recommend The Outsiders by Thorndike if you want to dig into the brains of some brilliant minds who invested against the grain. But more than that I want to encourage you to start viewing your business a little bit differently.
- Yes, focus on your customer because all successful products delight the customer.
- Yes, have your team focus on the details of brand and shipping and search volume and all sorts of other important factors.
- Yes, focus on profit and in particular how effective your products are at generating profit after advertising (PAG).
- But don’t forget that CEOs first and foremost must decide which battles to fight and not just how to win each small battle.
As an e-commerce brand, that means you must start measuring and managing Return on Working Capital. If understanding or measuring ROWC is hard for you, send us a message, and we’d love to chat with you.