“The simple truth is that we aren’t adapted to face the world as it is today. We evolved in a very different environment, and it is that ancestral evolutionary environment that governs the way in which we think and feel. We can learn to push our minds into alternative ways of thinking, but it isn’t easy as we have to overcome the limits to learning posed by self-deception. In addition, we need to practice the reframing of data into more evolutionary familiar forms if we are to process it correctly.”
- James Montier
"Just out of our respective graduate schools, my friend Warren Buffett and I entered the business world to find huge, predictable patterns of extreme irrationality. These irrationalities were obviously important to what we wanted to do, but our professors never mentioned them. Understanding the problem of irrationalities was not easy. I came to study the psychology of human misjudgement almost against my will. I rejected it until I realized that my attitude was costing me a lot of money and reduced my ability to help everything I loved."
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Fortune Magazine recently ran an article about the inside story of J.C. Penney’s failed transition under the former Apple retail superstar Ron Johnson. I found the story fascinating. As a true believer of Charlie Munger (Trades, Portfolio)’s multi-disciplinary approach to investing, I am always interested in the real life application of mental models, especially the ones that can teach us profound lessons. The story of J.C. Penney provides a prime example of how an investor can apply Munger’s human misjudgment framework to avoid investing in a doomed transition.
There are many things that went wrong with Ron Johnson’s turnaround plan and Ackman’s investment in J.C. Penney. For the sake of this article series, I will only analyze the failures of both from the perspective of human psychology. Here I own a debt of gratitude to my hero Charlie Munger (Trades, Portfolio), who laid out the framework perfectly in his famous Harvard speech. This is a must-read for everyone.
1. Excess Self-Regard Tendency and Overoptimism Tendency:
The Excess Self-regard Tendency and Overoptimism Tendency are very obvious in Ron Johnson’s case. Johnson’s success at Apple and Target made him scoff at the idea of testing the new strategy before a full-blown roll-out. He had built up his ego with his past success and he assumed that he would turn around J.C. Penney with ease. Such is the peril of success — it could build up your hubris to the point where you think what worked in the past, at different places will also work in the present, at the new place. Johnson's attitude towards testing is further influenced by his former boss at Apple — Steve Jobs disdained tests because Jobs relied on his gut. Johnson worshiped Jobs. This leads to the next tendency.
2. Liking/Loving Tendency:
“One very practical consequences of the Liking/Loving Tendency is that it acts as a conditioning device that makes the liker or lover tend:
1) to ignore faults of, and comply with wishes of, the object of his affection.
2) to favor people, products, and actions merel associated with the object of his affection.
3) to distort other facts to facilitate love."
The Liking/Loving Tendency is also fairly easy to detect here. If you have a hero and you admire him enormously, you’ll mindlessly follow whatever he did. This is why Johnson favors the retail approach associated with his hero, Steve Jobs. This is why Johnson ignores the objections to the faulty approach he was executing with full confidence. The Liking/Loving Tendency also applies to Bill Ackman (Trades, Portfolio) and Steven Roth, who likes the golden halo of Ron Johnson. This tendency led Ackman publicly to defend Johnson’s strategy in the beginning. This tendency also helped Ackman and Roth to let Johnson recruit his favorite people and get rid of the nay-sayers.
3. Mere-Association Tendency
“Some of the most important miscalculations come from what is accidentally associated with one’s past success, or one’s liking and loving, or one’s disliking and hating, which includes a natural hatred for bad news.
To avoid being misled by the mere association of some fact with past success, use this memory clue. Think of Napoleon and Hitler when they invaded Russia after using their armies with much success elsewhere. And there are plenty of mundane examples of results like those of Napoleon and Hitler
The proper antidotes to being made such a patsy by past success are:
1) To carefully examine each past success, looking for accidental, noncausative factors associated with such success that will tend to mislead as one appraises odds implicit in a proposed new undertaking.
2) To look for dangerous aspects of the new undertaking that were not persistent when past success occurred.”
Boy, if only Johnson had heeded Munger’s advice. He failed utterly to carefully examine each past success. He also failed to look for dangerous aspects of J.C. Penney’s new strategy that were not consistent with his past success at Apple and Target.
Readers may have noticed that the failure of Johnson’s new strategy applies to more than one tendency. In fact, this is a great example of a lollapalooza effect from three powerful tendencies mentioned above. Johnson’s ego, combined with his admiration of Jobs and the mere association of past success at Apple and Target, made him especially vulnerable to missteps in his proposed new undertaking.
Another less obvious point under the Mere-Association Tendency relates to one of J.C. Penney’s advertising adventures. In 2012, J.C. Penney named the lesbian celebrity Ellen DeGeneres as its spokesperson. Is it that hard to see what mere association would do to J.C. Penney’s customers in this case? Considering J.C. Penney’s customer group, this is an ultimate marketing fiasco. Many J.C. Penney’s shoppers were offended by the ads and they stopped shopping.
As the article is getting lengthy, I will stop here. In my next article, I will explore a few other tendencies applicable to J.C. Penney’s case.