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Chapter 1
The Importance of Fundamentals
âRizzutoismsâ in practice and why structure matters: Thinking âout of the boxâ without having a box in the first place can be dangerous.
âPhil Rizzuto and âRizzutoismsâ
Before we can âthink out of the box,â it is important to have a box in the first place. Attempting to attack a business problem in a new or inventive way without having a solid foundation in place first can be dangerous. To illustrate what happens to companies that fail to start with fundamentals, we begin this chapter with the story of Phil Rizzuto.
Phil Rizzuto, known in the baseball world as âThe Scooter,â was an interesting character. A former shortstop for the New York Yankees and 1954 American League Most Valuable Player, he is enshrined in the Baseball Hall of Fame in Cooperstown, NY. He is perhaps better known as their longtime television announcer (some of you might remember him as the former spokesperson for The Money Store or for his being featured in the Meatloaf song âParadise by the Dashboard Lightâ). However, he is probably best known for his colorful and convoluted comments.
To illustrate, Phil Rizzuto and his coannouncer, Bobby Murcer, were announcing a game between the New York Yankees and the Milwaukee Brewers. It was a slow Sunday afternoon game, and the two announcers were just trying to kill dead airtime. Now, for non-baseball fans, there are only two things that you need to know about baseball in order for this story to make sense: (1) every game has a winner and a loserâif the game is tied at the end of regulation (nine innings), the two teams go into overtime (extra innings) until one team wins; and (2) games are played during the day and at night. Other than these two facts, you need not know anything about baseball in order for this story to make sense. In any event, here is how Bob Frank, an economist at Cornell University at the time, tells the story:1
The cable TV system where I live in Ithaca, New York, carries most New York Yankee baseball games. One August night, sportscasters Phil Rizzuto and Bobby Murcer were calling a slow game between the Yankees and the Milwaukee Brewers. Between pitches, Rizzuto was looking over his record sheets and remarked that the Brewers had done much better in day games than in [night] games. Murcer checked his own records and found that the Yankees, too, had a much higher winning percentage during the day. With characteristic enthusiasm, Rizzuto then conjectured that all teams have better records for day games. In a brisk exchange of the sort that makes summer evenings in Ithaca seem to fly by, the two then spent the rest of the inning discussing the poor lighting conditions in American League parks and various other difficulties that might help account for why teams do so poorly at night.
But the âfactâ that Rizzuto and Murcer were trying to explain was of course not a fact at all. Without consulting any baseball records, we know that it is mathematically impossible for all teams to have better records during the day than at night. For every team that loses a night game, some other team must win one. Lighting conditions at night may indeed be poor, but they are poor for both sides. Taken as a whole, teams play .500 ball at night, the same as they do during the day.
What is wrong with this picture? As Bob Frank explains: it is simply not possible for all teams to have better records during day games or during night games. If every game has a winner and a loser, teams win an average of 50 percent of their games during the day and 50 percent of their games at night. This is an example of the convoluted logic that pervades business thinking todayâand what we will refer to as a âRizzutoismâ throughout the book.2
Unfortunately, such convoluted logic isn't isolated to baseball game announcers; it abounds in business as well. Examples are almost endless and they range from the silly to the sublime to the serious. Australian telecom provider Optus once had a tagline: âWe make you feel like you're the only one in the world with a telephone.â Think about that for a moment. Perdue Chicken's slogan, âIt takes a tough man to make a tender chicken,â was translated into Spanish as, âIt takes a particularly virile man to impregnate an affectionate chickenââleading customers to wonder exactly what Perdue was selling.
Rizzutoisms in business aren't limited to silly taglinesâsubstantive examples abound. Cost-plus pricing, product-based segmentation, and distributional asymmetric incentive structures are all serious examples that we'll discuss later. For now, however, we will use the term Rizzutoism to refer to the use of convoluted logic in business.
A concrete business example of a Rizzutoism in practice is that of R.J. Reynolds Tobacco Co.'s introduction of Premier cigarettes in the late 1980sâan example made famous in the book Barbarians at the Gate.3 R.J. Reynolds Tobacco had developed the first âsmokeless cigarette,â an interesting technological innovation. On one tip of the cigarette was a piece of carbon placed in front of the tobacco, while the inside of the cigarette consisted of a piece of aluminum with the tobacco wrapped around it. The filter on the other end also had a piece of carbon in the middle of it. When the cigarette was ignited by a lighter, the carbon essentially âlitâ the cigarette from the inside so that it produced virtually no secondhand smoke. The only smoke in the room was that which had already been filtered by the smoker's lungs (i.e., upon exhale)!
In principle, this was a great idea: it attempted to allay peoples' fear of secondhand smoke, providing a new product push into a staid and declining business. R.J. Reynolds made a $350 million investment that, at first glance, was a reasonable business move. However, problems began to emerge as the test market results came inâand weren't that impressive. Less than 5 percent of respondents said that they would try the product again. In fact, the most common terms used to describe the product was that it tasted like âshitâ (literally, the word that was used) and it smelled like a âfart.â The problem was that the cigarette tasted horrible and when the carbon tip was lit by a match, rather than the requisite lighter, the sulfur reacted with the carbon to give off a fart smell. Not exactly what you want to use to describe your productâas James Garner's (playing Ross Johnson, the CEO of R.J. Reynolds at the time) line in the movie by the same name said, âTastes like shit and smells like a fart; that's one unique advertising slogan.â When introduced in the market, the product's repeat ratesâso crucial to its successâwere less than 1 percent.
Now, all of this isn't the Rizzutoism; attempting to innovate and introduce a smokeless cigarette had the potential for success. The Rizzutoism occurred after Reynolds spent $350 million developing this product and after it found out that it tasted like $#!+ and smelled like a #@&+. At that point, the company spent an additional $350 million launching the dang thing! Note that âsunk costsâ should be irrelevant in this case: having already lost $350 million on developing the product isn't a good reason to lose another $350 million. We could argue as to why they decided to proceed with the launch after the poor test results: Barbarians at the Gate provides an excellent accountâarrogance, the sunk-cost fallacy, leveraged buyout motives, to name a few. But regardless of the motives, losing nearly three-quarters of a billion dollars on a product that was an abysmal failure in the market could have been avoided early on. The decision to do the research and develop the product was not the Rizzutoism; the decision to launch it after knowing the customer reaction was!
Sunk Cost Fallacy
Sunk costs should be irrelevant to future decisions. Yet we all make these mistakes in various decisions in our livesâin both the professional and personal realms. Be honestâhave you ever held onto a stock arguing that âI can't sell it now; I've lost so much alreadyâ? Your real decision should be making the best investment with the money you have left. In business, executives can become emotionally involved with the projects in which they invest. Not all these projects are good investments. To avoid deeper losses, it is important to adopt a periodic review process where reviewers are not invested (professionally or emotionally) executives. These reviews (often referred to as non-advocacy reviews) should occur at each key stage of product development (with the option of termination), and again post-launch (if it gets that far). Thus, a non-performing project can be identified early on, and the company may avoid deep financial losses by overcoming the sunk-cost fallacy that leads to escalation biasâthrowing good money after bad at a bad investment.
Distinguishing Rizzutoisms and Sheer Folly from Business Brilliance
Distinguishing a Rizzutoism and sheer folly from ingenious insight and business brilliance can sometimes be a fine line. To illustrate: imagine it was 40 years ago and I put the following proposition on the desk of your venture capital (VC) firm. I've presented you with a business plan and a request for $50 million.
We propose to build a series of retail establishments beginning in one region of the country and eventually expanding throughout the United States and then internationally. We will do no advertising. Our stores will become so ubiquitous that, in some cities, we will position our stores on each corner of various four-corner intersections. We will provide couches and amenities so that customers can just sit in our stores all day for free. And, we will sell only one thing: $3 cups of coffee. Invest in my company?
This is, of course, a simplistic representation of Howard Schulz's vision for what was to become the behemoth that we know as Starbucks.
The average cup of coffee in the late 1980s when he started to build Starbucks cost $0.70. It was sold through a deli or convenience store, and its taste often caused people to refer to it as âswill.â Customers were clamoring for better coffee. However, customers were not clamoring to pay more for a cup of coffee, which was fineâbecause Howard Schulz wasn't selling coffee. His genius was making a connection to the coffee culture in Europe by recognizing the latent attributes, the things besides coffee that customers were willing to pay for. These, of course, included ambience, image, a reward for a hard day's work (most of us can afford a $3 cup of coffee, after all), and a âthird placeâ (that is, a place to go besides home and the officeâother than a bar). Howard Schulz recognized that people would be willing to pay for this third place. While San Francisco-based chain Peet's Coffee was taking the seats out of its retail establishments in order to deter homeless men and women from lounging in its stores, Starbucks was making its couches and chairs more comfortable to encourage the coffee culture that it was promoting.4 And the rest, as they say, is history.
The Key Is Attributes, Not Core Competencies
A crucial difference between Reynolds's Rizzutoism and Howard Schulz's brilliance is the latter's understanding of the custo...
