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The adage that one cannot serve two masters holds true in business, as it is extremely difficult to survive when distracted by multiple goals. Experienced venture capitalists echo this view by insisting that nascent firms be hyper-focused, thereby increasing their chances of success. Lastly for students of history, upon his return to Apple in 1997, Steve Jobs killed 70% of all projects to focus on the iMac to enhance the chances of success. This installment aims to assist sophisticated institutional investors in recognizing and addressing some of the conflicting aspirations of firms.
Political goals are often at odds with private enterprise goals. For example, to secure broad support, politicians may aim to tax corporate profits, regulate corporate actions, and raise workers’ wages. In contrast, the primary objective for most businesses is to protect and enhance shareholder wealth.
Obviously, there are constraints for both government and corporations. Governments generally don’t seize assets arbitrarily. Corporations are expected to be decent corporate citizens, treating customers, employees, partners, and other stakeholders fairly.
A dilemma arises when corporations do not account for the often-elevated costs of pursuing multiple goals.
Tricolor (which we did NOT rate) pursued under-served, less credit-worthy automobile customers. While TriColor’s demise has been well-publicized, perhaps some of the underlying reasons are poorly understood. From our perspective it is laudable that the company aimed to sell and lend vehicles to under-served customers. However, ignoring the elevated cost of serving those customers and the elevated delinquencies becomes increasingly problematic. The stark reality is that if the elevated costs of serving weaker credits are not accounted for, future viability becomes jeopardized.
A faulty conclusion from the prior comments is that the lower end of the markets is not worth serving. In fact, our view is the exact opposite. Countless entrepreneurs created businesses by focusing on the under-served broad markets and were able to create highly valued businesses via economies of scale. Examples include Ford Motor Company, Charles Schwab, and more recently Amazon. The trick is a recognition of the vulnerabilities of the business and making the appropriate adjustments.
While it is laudable for businesses to serve broader societal interests, if the objective is to ascertain the probability of repayment on time and in full, one should focus on such.
Our credit ratings focus on the likelihood of timely repayment of obligations. ESG scores are relevant to many, but it is dangerous to mix the two.