Humans suck at decision-making…

It’s a big problem for people in business and investing. I’d like to highlight some mistakes I’ve seen people make (ourselves included).

1. Anchoring Trap
2. The Narrative Trap
3. Commitment Trap
4. False Strength VS True Strength in Leadership

Problem - The Anchoring Trap

This one comes up anytime you’re in a negotiation.

Let’s use an example:

You’re going to rent an office for your group.

The landlord proposes a lease with 4 key terms.

1. Price per Square Foot - $75.25
2. Annual price increases with inflation
3. The tenant pays for all interior improvements
4. 10 years, with 10-year extension option

Here is where you land after a negotiation:

1. $71 per Square Foot
2. Annual price increases with inflation (same as above)
3. Owner to chip in 20% of interior improvement costs
4. 10 years, with 10-year extension option (same as above)

You got some good terms, that’s pretty good right?

No, wrong…

What happened here?

You fell into the Anchoring Trap. The owners proposed a framework for the negotiation, and you played within their framework limiting your outcome.

A world-class negotiator would come to the table with 15+ asks for the building owner. Some things you missed: set a cap on the annual increases, push for them to happen after year 3, change the terms of the extension, lower the security deposit, give yourself an “out” clause on the lease for a variety of reasons, ask for a ROFR option on the neighboring offices (if you plan to grow).

Solution - The Anchoring Problem

This one has a simple solution to try. Before you see the other side’s offer, sit down with your team and list out all of the things that are interesting, important or could be helpful in order of importance. Try to be as specific as possible Then you won’t be anchored to the proposed structure or price.

Problem - The Narrative Trap

You create a narrative of who you are in your head, and you proceed to work hard to fulfill that image of yourself through all of your actions.

Be careful tying yourself to any particular brand/image:

You are not a visionary entrepreneur.

You are not an activist investor.

You are a business person, working to make the best decisions available to you in your moment in time based on the data you have.

Here’s a personal example from early in our journey.

We have a strong policy in my company that we don’t renegotiate deals. That means if we make a handshake deal with you about a price, we won’t change our mind at the last minute.

Some investors have developed a bad reputation doing that and have hurt business owners in the process. As business owners and entrepreneurs we hate this type of behavior.

When we first started our investment practice we were committed to this but in the wrong way. Even if the deal financials changed, or the business was not as described, we stuck to our original offer.

This of course can become a problem.

Solution - The Narrative Trap

Actively reframe what “good” and “bad” behavior is in your organization. You need to talk about it openly and define how you behave in deals.

Once we noticed our behavior and the risks involved, we redefined what good and bad behavior was in our organization.

Our new stance became:

We don’t retrade unless the business we’re buying changes. Then changing the deal or walking away is OK.

Problem - The Commitment Trap

You make a commitment to a group of people about an outcome. Then you have to pursue that outcome no matter what.

I found this happened to me when I was building products early in my career.

We would pick a product direction, agree to it as a team and pursue it. Sometimes we would totally miss our goals with a new product, but we all felt trapped by our early commitment, so sometimes we would pursue the testing or development of a product far after everyone knew we should “give up”. We wasted a lot of time because of the Commitment Trap.

Solution - The Commitment Trap

Present a way out for you and your team early. If you’re adopting a new investment strategy or building a new product, set some early micro-goals and tell your team: “if we miss our goals, we will reassess and try another product direction”.

That way if you miss your goal, you don’t feel overcommitted to keep pressing the product until you hit your goals. You’ve given yourself a door you can walk through if you need to change directions.

False Strength VS True Strength in Leadership

Young leaders will pretend to know more than they do, and struggle to create a safe space for discussion for their executives to voice concerns or feedback.

True leaders know the journey is full of obstacles, and only if each person is empowered to speak up and provide feedback, then the business will succeed.

Your job as a leader is to filter all of the feedback you’re getting and make an educated decision. If you’re not taking a lot of feedback, you’re missing important data in your decision-making.

🔑Bonus - On Costco

A few weeks ago readers voted to learn why I love Costco.

I grew up going to Costco twice a month on a Sunday. It was my father/son bonding activity.

My love for Costco is made up of 3-parts: nostalgia, my love for value, my love for good business.

Let’s talk about the business of Costo.

First let’s ask ourselves, what qualities would create the most valuable company in the world? Answer:

Offering Size - Huge marketplace

Longevity/Moat - High Barriers to entry

Free cash flow - very low levels of capital deployment

Costco is a perfect flywheel business. As it grows, so does its moat. Let’s take a look.

Moat: unbeatable prices. '

Costco’s volume purchasing allows it to drive down the cost of products. It simply has more negotiation leverage with suppliers. Then they pass through all those savings to you, the customer. They will never mark-up their products above 14%, no matter how good their supplier deal is (Walmart is at ~20%).

So as a consumer you have certainty your prices will always be the best at Costco. The bigger Costco gets, the cheaper your products will be.

Moat: quality of products

Costco (as opposed to Walmart), has made a commitment to providing high quality goods. You can ask any chef, Costco has the best grocery products: meat, vegetables…etc

Here’s why → Costco limits their number of items in store (SKUs) to 4,000. Compare this to an average competitor store at 20,000-60,000 SKUs.

With limited shelf space, Costco merchandisers are negotiating for the best quality at the lowest price, and passing that on directly to customers (most stores charge “rent” for shelf space to suppliers, Costco doesn’t). Due to their high volume/bulk purchasing they get “first dibs” from suppliers.

Moat: beautiful, membership based, sticky free cash flow

In simple terms, the 14% Costco mark-up on merchandise covers all of their operating costs.

The “membership” fee is where Costco generates its cash flow - and where you can really see it’s value.

It’s a beautiful recurring revenue business with 116 Million members (with 85% membership renewal).

I’ve been a member for 25 years. I’ll never unsubscribe.

ps: Costco, I love you.

Reply to let me know if you liked the post on Heuristics or Costco more 😊

Have a wonderful week,

~ Sieva

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