One of the dangers of not encountering any hardships is that you become complacent and overconfident as an investor. For this reason, investors should embrace their mistakes and learn from their experiences.
Of course, it's even better to learn from the mistakes of others. Back in 2013, Bill Ackman (Trades, Portfolio) gave an interview at the Said Business School at Oxford University in which he talked about one of his own mistakes - his investment in J.C. Penney (JCPNQ, Financial).
The customer is always right
Ackman was able to invest in J.C. Penney stock at around $20 a share after it declined from about $80 a share. The business was going through a rough patch; it had a lot of unproductive assets, a lot of expenses, very low sales per square foot and a weak brand mostly associated with discount items. However, he figured that the brand could still be salvaged, and that its real estate portfolio still had value. Thus, Ackman’s Pershing Square took a 16% stake in J.C. Penney and had a business partner take a 10% stake.
The J.C. Penney CEO at that time was retiring, so Ackman brought in a replacement who had an idea to reinvigorate the company by cutting about $1 billion in costs, monetizing $600 million in non-core assets and changing how the company’s stores were structured. In particular, he wanted to change how J.C. Penney was perceived by getting rid of the coupons and discounts that consumers associate with it, as well as by bringing in higher-quality brands. Unfortunately, he overlooked a crucial rule of retail - customers don’t like change:
“This notion of ‘fraudulent pricing,' where J.C. Penney would overprice an item and then mark it down, and mark it down, and coupons - he [the incoming CEO] said “It’s a waste of time. The consumer knows the fair price.” He looked at these $40 dresses and shirts and saw that they all sold for something like $12.30 on average. So he decided to just mark it at 12 bucks. The company had spent a huge amount of man-hours just repricing merchandise... But the customer who had become accustomed to getting coupons in the Sunday newspaper decided not to come.”
J.C. Penney ended up losing about a third of its customer base due to this change. This proved to be a huge problem. Retail businesses inherently have a lot of operating leverage. They have high fixed costs, but once the company makes enough money to cover those, almost all the revenue falls through to the bottom line. Conversely, when things are not going well, those fixed costs really start to add up.
This is exactly what happened with Ackman’s J.C. Penney experiment, and on top of this, the company had spent a large amount on rebranding. Investors in retail can learn a lot from this experience.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Seth Klarman: Investors Are Like Relief Pitchers
- Seth Klarman: How to Balance Risk and Reward
- Charlie Munger: Berkshire Hathaway's Biggest Mistakes
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