Business strategy that results in lower ROI to stakeholders is an example of bad business strategy. Business strategy that results in lower ROI to a country is the result of bad politicians. In both cases some decision makers seem to not understand the second law of economics. Recent M&A activity by Pfizer and mega law firms tell it all. 

There’s a story about an economics professor who went into a bar. The local crowd, intellectually curious after a few drinks, asked the professor to explain economics in two sentences. “First, there is no free lunch,” he said. “Second, incentives work.” We must wonder about this professor, though. He should have said a free drink would give him a mighty incentive to answer.

Economics has strayed far from its days as the study of human behavior. The tenure process has transformed economics into a branch of mathematics, quite irrelevant to today’s world. What we must remember is the hugely relevant second law of economics, described so aptly by the sober (?) professor.

Here are a few examples of this second law in action.

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Fair notice: this essay has a trick title.

Mark Zuckerberg, Facebook’s Co-Founder, Chairman, and CEO, recently spent up to $19 billion to buy WhatsApp. You might have heard.

Whether Mr. Zuckerberg overpaid is a subject of frenzied speculation for those who must have an opinion. We do know that no one else thought it was worth more; rather, that no one else with a spare $19 billion thought it was worth more. We know that because Mr. Zuckerberg was 1) willing to pay 2) more than anyone else. Otherwise the media would be all aflutter about what someone else was uniquely willing to pay.

Of course no one knows what WhatsApp is worth. To know what it’s worth implies full know­ledge of the future, including a host of related matters such as the skill Mr. Zuckerberg and his team will bring to bear, how much it’s worth to Facebook to prevent someone else from ac­quiring WhatsApp, what Mr. Zuckerberg could have hit had he aimed his $19 billion else­where, and much more. (In other words, otherwise.) Google, another potential acquirer, had its own calculus.

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Few Americans know Fimi. In Israel, everyone in business does. It is Israel’s first, and now its largest, private equity (PE) fund.

Since its creation in 1996, by Ishai Davidi, a former IDF Special Forces officer, Fimi acquired 72 companies. All but one are in Israel. Forty-one of them were sold, only three at a loss, and 32 are still owned. In the PE industry such a dominant fund is known as a country fund. Among the latest US investors in Fimi one can find Michael Milken, Jim Tisch of the Loews Corporation, and Jay Jordan of The Jordan Company.

There is no one formula for success. Moreover, no one knows in cases of successful investors if superior ability is at work or merely a halo effect. It is similar to Warren Buffett buying a company: everyone immediately assumes this is a company worth doing business with. IMD Professor Phil Rosenzweig documented this phenomenon in his best-selling book The Halo Effect. (Especially appropriate since halo effects lead to self-fulfilling prophecies.)

Even if Davidi’s success is due to halo effects , it is still worth examining the way he looks at the world. We may learn something. Here are some interesting principles he follows:

  • Fimi does not invest in financial or real-estate companies. Right off you can tell the guy is serious.
  • Each investment comes after years of patient monitoring of the target, and meeting with the owners.
  • Before making an offer, the fund assesses risk by running a red team/blue team war game. The stated objective of the war game is devil’s advocacy: argue that the deal should not be done.

Those steps, while prudent, don’t sound particularly innovative. But Fimi goes further. Fimi looks for companies with a) clear strategic plans and b) humble executives. Executive compensation must be correlated not only to performance over several years but also to workers’ compensation. Davidi does not believe in high executive pay and low workers’ pay. That’s not just about morality or generosity; it serves a business purpose. None of Fimi’s companies is unionized, in a country where unions are extremely strong and can be quite destructive, and Fimi wants to keep it that way. Finally, Fimi never looks for an exit. Instead, it improves the company’s performance. Davidi’s philosophy: once performance improves, offers will look for you.

The principles above do not amount to a formula for success; instead, they reflect a systematic, careful process of evaluation. Many investors, including our readers, follow similar logical process. So what makes Davidi different? I believe it is his ability to find the essence of competition in any segment where his portfolio’s companies play. It is almost as if he runs Porter’s Five Forces model for each company he buys. Consider this anecdote.

In 1999, Fimi paid $1 million for a small manufacturer of automobile engine parts. Fimi improved it and several years later sold it for $30 million. The new owners were not as strategic. In 2011, the company was near bankruptcy. Fimi bought it again for around $5 million. Today the company is valued at $210 million. Here is how Davidi summarizes the challenge in competing in the automobile supply market:

It takes years until the big car companies trust you enough to be in their supply chain. So you must participate in as many RFPs as possible, over and again. You must offer very low prices to gain a foothold. Entry into the trusted list is the most important aspect of the strategy, because once you are in, you are in. The car companies do not like to change suppliers. However, at a hint of legal trouble, they will drop you. So, when this company was in financial trouble, Fimi jumped in to avoid any creditors’ litigation or other legal wrangling which would have completely destroyed the company’s standing with the buyers.

In my career, I have met hundreds of executives who were extremely knowledgeable about every little detail of the competition in their industry. They tended to lose the big picture. They tended to think execution matters more than clear strategy. My perspective, as an observer of the skill of competing, is that Davidi’s ability to abstract from the details and focus on the most salient feature of competition is his biggest competitive skill. Once you crystallize the essence of competition in a given sector, you are at least looking at the right challenge to solve with your strategy.

Davidi, is not for sale!

Mark Chussil, co-founder of, adds this: “Not so fast, Ben…”

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This is a sad piece. I typically try to keep emotions out of strategy but I feel bad for this company. It arranged a marriage between a new business and an old one, and it ran against what I’d call irreconcilable differences.

Companies in declining industries can get desperate, especially when they’re accustomed to market-leader status. They get beaten down by Wall Street, shareholders, and columnists. Sometimes they bolt way out of their comfort zone instead of trying to tune up the old business, scale down expectations, and ride peacefully into the horizon, making a lot of money in the process for shareholders.

In itself, venturing boldly into a new area when the old one is in decline is entrepreneurial vision at its best. Unless, of course, the new business is so far from the old business’ comfort zone — i.e., expertise, technology, infrastructure, etc. — that it’s like trying to cross a chasm in two steps. This is the case of Barnes & Noble. As USA Today reports, Barnes and Noble’s CEO, William Lynch, the one who led B&N into the e-commerce age with Nook, resigned on July 8, 2013. The reason is that the e-reader market is highly competitive (red, bloody ocean for sure) and Nook has been losing its shirt.

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I like Rupert Murdoch. The news that he is looking to buy the beleaguered Los Angeles Times and Chicago Tribune from the Tribune Company just made me like him even better.

You might or might not like Murdoch based on his politics. My admiration today, though, isn’t about politics. It’s because expanding your business in an industry everyone thinks is headed for the great recycling bin in the sky is sheer genius, strategy-wise.

Most pundits, industry observers, and Wall Street analysts drool over new hot markets (China! China! China, I tell you, China!) and new high-growth areas (tablets and mobile devices! healthy foods! e-cigarettes! digital readers! especially in China!). They dismiss the old industries threatened by the new.

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In 1987, Michael Porter, then a young academic from Harvard Business School, published a piece called “From Competitive Advantage to Corporate Strategy” (HBR, May-June 1987). While business unit strategy deals with achieving competitive advantage in a given industry (the hallmark of successful competing skill), corporate strategy deals with the question of what industries/businesses the company should be in, and how to manage the portfolio of businesses. These are two very different competing skills.

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