The Chinese Businessman Paradox (value of tacit learning + focus)

second, that Chinese businessmen as a group were more superstitious than most, but that this didn’t seem to have much of an effect on their ability to run their businesses

the vast majority of Chinese businesspeople did not think too far ahead. They optimised locally, and by keeping close tabs on the bottom line, shut down lines of business that weren’t performing as well

Let reality be the teacher

The first generation of overseas Chinese businessmen learned by doing. Two generations ago, finishing primary school was considered rare. The traditional Chinese businessman of my grandfather’s generation learnt business by doing business and started young. Ng Teng Fong of Far East Organization never went to school. He started young

It’s telling that business performance is helped little by the quality of formal education one receives. The dominance of family-run Chinese conglomerates in South East Asia imply that the best sort of education in business is to be taken under the wing of a superior operator, and taught the ropes the way a master teaches an apprentice

The more educated ones seemed hampered by their thoughtfulness. The successful ones, on the other hand, seemed pathologically biased towards action. If the educated man always looks before he leaps, the successful Chinese businessman seemed to me to be overly biased towards leaping.

Chinese businessmen believed in learning by trial and error, while making sure they didn't risk ruin by taking stupid bets

Thinking deeply and then acting is optimal for fields where a body of knowledge exists. But in fields where little is known, or where things change too quickly for theory to find handholds, trial and error dominates as the superior problem solving strategy. In these fields, failure is an acceptable cost of learning. In these fields, thoughtfulness takes on a different form

The optimal strategy for learning in business is trial and error, because business changes too quickly for there to be immutable rules. Traditional Chinese businessmen are thus the product of trial and error

When the cost of failure is low, when the effort of testing is cheap, and when there is much that is unknown, trial and error is usually the optimal strategy to pursue

Superstition doesn't count

The two forms of rationality are:

Epistemic rationality — how do you know that your beliefs are true?

Instrumental rationality — how do you make better decisions to achieve your goals?

The Chinese businessmen can be really superstitious and don't care about epistemic rationality. But they do care a lot about instrumental rationality

Don’t do trial and error where error is catastrophic.

Don’t repeat the same trials over and over again (aka don’t repeat the same mistakes over and over again).

Increase the number of trials you can do in your life. Decrease the length and cost of each trial.

In fields with optionality (i.e. your downside is capped but your upside is large) the more trials you take, and the more cheap each trial costs, the more likely you’ll eventually win. Or, as Taleb says: “randomness is good when you have optionality.”

Write down your lessons and approaches from your previous successful trials, so you may generalise them to more situations

Systematically identify the factor that gives positive evidence, and vary that to maximise the expected size of the impact

Actively look for disconfirming evidence when you’ve found an approach that seems to work

Maybe strategy matters

The SME trap

Non-strategic Chinese business don't grow their companies very large. After a few years of execution, most SMEs stagnate and remain small-to-medium sized.

Why?

After a few years of execution, assuming nothing in the macro environment changes, the revenues and profits of most SMEs will stabilise. This happened to us, too — we went from 0 to $4.5 million in annual revenue in two years. My boss developed the skills necessary to scale the sales and customer support organisations, and I learnt how to scale our engineering and product development commensurately. And then we came up against a wall.

It turned out that we were stuck in a loop. If we grew our sales organisation, it wasn't clear that our product was good enough to handle an increased number of bookings, for a wider variety of businesses. Developing to meet this demand would require additional software engineering. But maintaining the current level of revenue took up around 80% of the engineering organisation's bandwidth. And, if we increased bookings, we would need to increase the number of people doing support engineering and deployments and frontline customer support. There wasn't enough free cash to do all of that, not from profits alone, and so we made only marginal improvements.

This series of marginal improvements was a loop of increasing costs, which led to increased revenue, followed by reinvesting profits to increase costs to increase revenue: marginal improvements, never breaking free.

You need capital to break out of the SME trap

The common thread amongst the companies that successfully broke free from the SME loop is this: they had access to a line of capital that enabled their growth. It seems like it was impossible to break free from the SME loop without some sort of external capital injection.

With a few notable exceptions, the vast majority of successful traditional Chinese businessmen have chosen the route of escaping the SME loop by pursuing additional — and completely different — lines of businesses.

This has led to the prevalence of ‘Asian conglomerates’ — where a parent holding company owns many subsidiaries in an incredibly diverse number of industries: energy, edible oils, shipping, real estate, hospitality, telecommunications and so on. The benefit of this structure has been to subsidise new business units with the profits of other business units.

Maybe strategy matters. Maybe trial and error works only for starting small businesses, but breaking past the SME loop requires picking markets or businesses strategically.

The vast majority of Chinese businesses take a very long time to grow. You don't take this path for the short term.

Cash Flow is king

Find businesses that basically print money without doing anything new, once the fixed costs have been paid off

Unlike Intel, Coca-Cola doesn’t need to invest large amounts of capital into new products each year at the risk of being left behind — it can simply sit back and watch as the money pours in. This is what Warren Buffett refers to when he says he likes businesses with an economic moat.

I think the key point to understand here is that free cash flow is truly ‘free’ — that is, it can be redeployed in the business in whatever way that management sees fit.

Recap: SME Loop is a cycle of ploughing profits back into the business, only to get increasingly lower returns on investment.

Imagine that you’re part of the Chinese diaspora in South East Asia. You don’t have access to mature equity markets — all the countries in the region are still developing, and have extremely young bourses. Effectively, you have only two sources of cash available for you to grow: you can take on debt (read: bank loans; bond markets were equally immature, so you couldn’t issue bonds for growth), or you could grow from retained earnings.

So no wonder they’ll say things like “cash (flow) is king” and “pay other people as late as possible”. To a traditional Chinese businessman, growing their business is everything, so FCF is everything. Cash flow is indeed, truly king.