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Charlie Munger's Human Misjudgment Framework and JC Penney - Part II

May 22, 2014 | About:
Grahamites

Grahamites

150 followers

In my previous article, I discussed how we could apply a few human psychological tendencies from Charlie Munger (Trades, Portfolio)’s human misjudgment framework to J.C. Penney (JCP)’s failed turnaround plan laid out by Ron Johnson. In this article, I will further apply a few other tendencies to J.C. Penney’s fiasco under Johnson. Again, all the credit goes to Charlie Munger. Without him, this article would never have existed and I would have been deprived of much of the ignorance removal privilege now I enjoy everyday.

4. Contrast-Misreaction Tendency

Because the nervous system of man does not naturally measure in absolute scientific units, it must instead rely on something simpler. The eyes have a solution that limits their programming needs: the contrast in what is seen is registered. And as in sight, so does it go, largely, in the other senses. Moreover, as perception goes, so goes cognition. The result is man’s Contrast-Misreaction Tendency.

Contrast-Misreaction Tendency is routinely used to cause disadvantage for customers buying merchandise and services. To make an ordinary price seem low, the vendor will very frequently create a highly artificial price that is much higher than the price always sought, then advertise his standard price as a big reduction from his phoney price. Even when people know this sort of customer manipulation is being attempted, it will often work to trigger buying.”

-Charelie Munger

The fatal assumption in Ron Johnson’s fair and square pricing strategy is that consumers are rational and therefore, when you get rid of all the pricing games, they will buy more because they know exactly what the fair price is. I still have a hard time believing this strategy came from a retail veteran. J.C. Penney’s long-time customers were so used to the old system of coupons and aggressive seasonal sales that were part of he J.C. Penney brand. While the fair and square pricing strategy in theory would lower customers’ purchase price, in practice, J.C. Penney’s customers argued that the departure from coupons has created a more expensive and less enjoyable shopping experience. By removing the anchor price, J.C. Penney made its customers more confused than ever. Johnson essentially tried to reinvent human nature and boy, was that a good lesson in life.

5. Deprival Superreaction Tendency:

“A man ordinarily reacts with irrational intensity to even a small loss, or threatened loss, of property, love, friendship, dominated territory, opportunity, status, or any other valued things.”

- Charlie Munger (Trades, Portfolio)

In a more subtle sense, Johnson’s fair and square pricing strategy also triggers the Deprival Superraction Tendency. If you ask a typical J.C. Penney’s long-term customer what they like about the brand, or what value they see in shopping at J.C. Penney, that customer may very likely tell you it’s the endless good old promotions. Now imagine the excitement of that customer when they saw J.C. Penney’s coupons in her mailbox every week. Then imagine one day she found out that the coupons and promotions are gone, and what’s left is the cold fair and square price. By taking away coupons and promotions, Johnson also took away the joy that J.C. Penney’s customers got when they

  • Saw the coupon.
  • Planned to use the coupon.

    saw the coupon

  • Actually used the coupon.

Combine Deprival Superreaction Tendency with the Contrast-Misreaction Tendency, we have a superpowerful mini-lollapalooza effect.

6. Doubt-Avoidance Tendency

“The brain of man is programmed with a tendency to quickly remove doubt by reaching some decision. It is easy to see how evolution would make animals, over the eons, drift toward such quick elimination of doubt. After all, the one thing that is surely counterproductive for a prey animal that is threatened by a predator is to take a long time in deciding what to do. And so man’s Doubt Avoidance Tendency is quite consistent with the history of his ancient, nonhuman ancestors.”

- Charlie Munger (Trades, Portfolio)

Johnson’s Doubt-Avoidance Tendency is demonstrated by the speed at which he executed his transformation plan. For a century-old brand such as J.C. Penney, any kind of major transition will have pros and cons. I’m not a retail expert but it seems to me that radical changes in a traditional retail chain should be made gradually, rather than in fast spurts. He changed J.C. Penney’s logo merely three months after becoming the CEO. Shortly after he revealed the new pricing strategy. By the end of 2012, hundreds of J.C. Penney’s stores were revamped. This speed of execution is more than aggressive.I suspect that it is the Doubt-Avoidance Tendency that made Johnson execute his plan as fast as possible. After all, the longer it takes to execute, the more doubts there will be.

7. Inconsistency-Avoidance Tendency

“The brain of man conserves programming space by being reluctant to change, which is a form of inconsistency avoidance. We see this in all human habits, constructive and destructive.

It is easy to see that a conclusion triggered by Doubt-Avoidancy Tendency, when combined with a tendency to resist any change in that conclusion, will naturally cause a lot of errors in cognition for modern man.”

-Charlie Munger (Trades, Portfolio)

“I choose to inspire and create believers. I don’t like negativism. Skepticism takes the oxygen out of innovation.”

- Ron Johnson

According to Fortune Magazine, “Johnson displays the sort of enthusiasm and unwavering commitment that inspires followers.” Anybody who expressed doubt to Johnson’s plan was promptly and duly removed from his sight. Fortune cited the example of J.C. Penney’s former Executive Vice President Steve Lawrence, who suggested that Johnson should conduct a test before eliminating price promotion from one day to the next. When a decision was made to reduce the top merchants from two to one at the end of February, it was Lawrence who was cut than another executive Liz Sweney, who publicly supported the new plan.

While displaying Inconsistency-Avoidance Tendency at the early stage of his tenure, Johnson publicly admitted his mistakes and changed the strategy. I think we have to give Johnson credit for this. It is extremely hard to acknowledge you’ve made some pretty big mistakes in public. It’s also very difficult to essentially undo what you have done. Too bad it was too little too late for Johnson.

Putting It All Together

J.C. Penney’s struggle under Johnson’s leadership is a great example of the Lollapalooza Effect Charlie Munger (Trades, Portfolio) taught us: Extreme consequences can happen due to a confluence of psychological tendencies acting in favor of a particular outcome. Johnson’s lessons are also our lessons. It’s amazing to me how by putting everything together just utilizing Munger’s Human Misjudgment Framework, we can see Johnson’s efforts were doomed from the beginning. Yet it took the market a year and half to recognize what Munger and Buffett could see in probably 30 seconds. I have enormous respect for Bill Ackman (Trades, Portfolio). I think he is unfairly discredited for his investment in J.C. Penney, Borders and Herbalife. At the same time, I really feel the mistake of J.C. Penney could have been completely avoided if he followed Munger’s framework and kept his ego in check.

Of course, Ron Johnson and Bill Ackman (Trades, Portfolio) were not the only victims of the J.C. Penney fiasco. J.C. Penney’s customers, employees and shareholders all suffered. I am deeply saddened by the fact that an avoidable multi-billion dollar mistake has made life worse for so many people. But unfortunately, ignorance removal in basic human psychology, a seemingly simple task, will not be easily achieved.

It seems appropriate to end this short article series with the lesson from the master itself:

“No wise pilot, no matter how great his talent and experience, fails to use his checklist.”

-Charlie Munger (Trades, Portfolio)


Rating: 5.0/5 (13 votes)

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Comments

Enjoylife
Enjoylife premium member - 6 months ago

Hi,

Thank you for the article, very thought provoking. I also like the way Munger breaks down problems in human behavior. However I think you and many others are being a bit unfair to Ron Johnson.

It is very easy in hindsight to pick apart his strategy and say he made all these big mistakes but it is important to put his position into context before we condemn.

Ron had just come off of the huge success of building the Apple stores that were so successful. He is a very creative retail mind who did things there very quicky and differently than anyone ever had in retail. His efforts were partially responsible for Apple having such massive growth over the last 15 years. What allowed him to succeed there is that they Apple store was completely new and he didn't have to break any old habits. The stores were different and hip and fun to go to.

Now JC Penny came looking for a savior. They were already struggling mightily and getting there butts kicked by Target and Walmart and Costco and Amazon when Johnson took over.

With Apples massive growth and no history to fight against; Johnson's speed is what made him so successful. He had highly intelligent customers that were interested in learning about the latest new gadget and then buying it. He made it a fun experience and nerdy became cool.

Now with JCP his speed worked againsted him. Wanting to move equally as fast to save a sinking ship, he didn't test his ideas before moving full force into them. He never had to test at Apple and every new idea was a success. That was a mistake with a mature established customer base like JCP had. He also over estimated the intelligence of the average consumer but again his view was skewed by his experience with the Apple customer.

As for eliminating doubt about his strategy, I would argue he had to do that to have any chance of success. He was trying to change a culture. To modernize it and make an old dying business model viable in the millennium. If others on your management team don't see your vision and buy into it, then need to be removed so the group can go in your direction quickly. Jim Collins talks about this a lot in his books, when you try to change a culture, your team has to be on board. That is just a strong leader and good management.

So I agree not testing at a small number of stores before going full bore with "Fair and Square" and elimanating cupons was a mistake. But it came from success he had implementing a similar model at Apple but just didn't anticipate the lash back from the entrenched older customer base.

Buffett has said multiple times that he will not invest in Penny's or Sears. He says retail is an extremely tough business and the top 1-2 players will take the lions share of the profits.

Between Walmart and Amazon, JCP didn't stand a chance. What Ron Johnson did may have sped up the bleeding rather than stopped it, though I'm not sure another strategy would have worked out any better in the long term. They cannot compete with the lower cost providers and are not differentiated enough to bring something unique or special to consumers.

Put a great pilot on a crashing plane and then discuss all the things he did wrong.

That doesn't seem fair to me.

But it is a good case study to discuss what could have been done differently that wouldn't of had such a negative impact. Here I only see one mistake.

Still I believe it is a doomed business that would be smart to break up and sell the valuable real estate they own and stop losing money for share holders.

But as far as making it a viable business goes, I think Ron Johnson did as good as anyone could trying to modernize and change the culture there but did make the one big mistake of doing away with cupons without testing the idea in a small number of stores first.

Thanks again.

Enjoylife

Grahamites
Grahamites premium member - 6 months ago

Enjoylife: Thanks for your very thought-provoking comment and apologies for my delayed response. Here are my humble opinion on a few points you raised.

It is very easy in hindsight to pick apart his strategy and say he made all these big mistakes but it is important to put his position into context before we condemn.

I want to clarify here I am not condeming anyone. If I were put into his position, I probably would have made even worse mistakes. Turning around a business is an enormously difficult task, not to mention in the tough environment of retail.

I'm not sure if these mistakes are only obvious with the benefits of hindsight though. Buffett and Munger had hinted that JC Penney's strategy was not going to succeed. So I would argue that had Johnson applied Munger's framework to his strategies before he implemented them, he may vwould have thought twice about them.

Put a great pilot on a crashing plane and then discuss all the things he did wrong.That doesn't seem fair to me.

I agree he took a tough job and did what he thought was gonna work. But that doesn't mean it's unfair to hold him accountable for the rapid deterioration of the business. I would argue that JC Penney was not a crashing plane prior to Johnson's arrival. It may be experiencing some turbulence but I don't see signs of crashing. What is unfair, in my opinion, would be to blame everything that hasn't gone well at JCP on Johnson, and if JC Penney's turnaround takes hold, to give all the credits to Ullman. That being said, I may be subject to some of the tendencies Munger mentioned and thus my opinion could very well be biased.

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