Trading Simplicity, 80/20, and our trading/investing business

Simplicity is beauty

Henry Ford said:

"My effort is in the direction of simplicity. People in general have so little and it costs so much to buy even the barest necessities (let alone the luxuries to which I think everyone is entitled) because nearly everything we make is much more complex than it needs to be. Our clothing, our food, our household furnishings—all could be much simpler than they now are and at the same time be better looking."

It is easy to say simplicity is beauty but beauty needs efforts. If you are not simple and beautiful swans, you have to get the ugly and complicated covering over you away! But simplicity is not easiness. Do we know the simplicity enough to make a simple but very profitable trading/investing business?

Let's put the efforts on it for sometimes!

Extraordinary hypothesis is common in reality

Nearly all businesses have within them chunks of business with widely varying profitability. The 80/20 Principle suggests something quite outrageous as a working hypothesis: that one fifth of a typical company’s revenues account for four-fifths of its profits and cash. Conversely, four-fifths of the average company’s revenues account for only one-fifth of profits and cash. This is a bizarre hypothesis.

What is extraordinary is that when it is tested, the hypothesis generally turns out to be correct, or not very far wide of the mark.

The truth is that the unprofitable business is so unprofitable because it requires the overheads and because having so many different chunks of business makes the organization horrendously complicated. It is equally true that the very profitable business does not require the overheads, or only a very small portion of them.

You could have a business solely composed of the profitable business and it could make the same absolute returns, provided that you organized things differently.

Simplicity is beauty

And why is this so? The reason is the same. It is that simple is beautiful. Business people seem to love complexity. No sooner is a simple business successful than its managers pour vast amounts of energy into making it very much more complicated. But business returns abhor complexity.

As the business becomes more complex, its returns fall dramatically. This is not just because more marginal business is being taken. It is also because the act of making a business more complex depresses returns more effectively than any other means known to humanity.

It follows that the process can be reversed. A complex business can be made more simple and returns can soar. All it takes is an understanding of the costs of complexity (or the value of simplicity) and courage to remove at least four-fifths of lethal managerial overhead.

The complexity scares most of market players. They hate the complicity so that they go opposite oversimplify everything in trading and investing, which didn't make simple profit but very complicated shirt-loss results. Every loser has his own stories in details.

Simple goal, road map, and process are necessary

How could we make our trading/investing business simple? It seems we could structure the simplicity in the following ways:

1. Get goals clear, simple, practical, achievable, and realistic

2. Get road map to approach the goals as simple as possible

3. Make a simple but effective and efficient processes to the goals by following the road map

4. At each step or stage to review what we have done and repeat the cycle from step 1 again.

Why do we want simplicity? It reduces the costs and add value for business which is why business is setup!

Simple is not small

Does this mean that small is beautiful?

No. This is definitely the wrong answer. There is absolutely nothing wrong with the belief long held by business leaders and strategists that scale and market share are valuable. Extra scale gives greater volume over which to spread fixed costs, especially the overhead costs that make up the share of all costs for efficient.

Market share, too, helps to raise prices. The most popular firm, that with the highest market share, the best reputation and brands and the most loyal customers, should command a price premium over lower share competitors.

Yet why is that larger firms are losing market share to smaller firms?

And why does it happen that in practice, as opposed to theory, the advantages of scale and market share fail to translate into higher profitability?

Why is it that firms often see their sales mushroom yet their returns on sales and capital actually fall, rather than rise as the theory would predict?

The cost of complexity

The most important answer is the cost of complexity. The problem is not extra scale, but extra complexity. Additional scale, without additional complexity, will always give lower unit costs. To deliver to one customer more of one product or service, provided that it is exactly the same, will always raise returns.

Yet additional scale is rarely just more of the same. Even if the customer is the same, the extra volume usually comes from adapting an existing product, providing a new product and/or adding more service. This requires expensive overhead costs that are usually hidden, but always real.

And if new customers are involved it is far worse. There are high initial costs in recruiting customers and they generally have different needs to existing customers, causing even greater complexity and cost.

We may not have the cost of complexity of big firm now. But it is better we know the cost of complexity now.

Internal complexity has huge hidden costs

When new business is different to existing business, even if it is only slightly different, costs tend to go up, not just pro rata with the volume increase but well ahead of it. This is because complexity slows down simple systems and requires the intervention of managers to deal with the new requirements.

The cost of stopping and starting again, of communication (and miscommunication) between extra people and above all the cost of the ‘gaps’ between people, when partially completed work is set down to await someone else’s intervention and later picked up and passed on into another gap.

All these costs are horrendous and all the more insidious because they are largely invisible. If the communication needs to straddle different divisions, buildings and countries, the result is even worse.

 

Without simplicity, anything else is ugly

All other things being equal, big is beautiful. But all other thing are not equal. Big is only ugly and expensive because it is complex. Big can be beautiful. But it is simple that is always beautiful.

It has been found that only one characteristic differentiated the winners from the less successful firms: simplicity. The winners sold a narrower range of products to fewer customers and also had fewer
suppliers. The study concludes that a simple organization was best at selling complicated products. When you read all of successful market players, you would find they do their business with very simple but wise rules, principles, and guideline even they put huge efforts to support their simple business!

This mental breakthrough helps to explain why and how the seemingly outrageous claims of the 80/20 Principle, applied to corporate profits, can actually be true. A fifth of revenues can produce four-fifths of profits. The top 20 per cent of revenues can be 16 times more profitable than the bottom 20 per cent (or, where the bottom 20 per cent makes a loss, infinitely more profitable!).

Why did I make a series of mistakes? I let my feeling complicated my selling process, which let me work hard to generate irrational, ignorant, arrogant, and dangerous assertion, such as if I lock the profit when I should do, I would pay too much tax this year! The complication of my feeling got me lost in the way!

Once the things become complicated, all of us become ugly! RIO is a swan, right? But before GFC it made some complicated games and then it became ugly too even it works hard to be not ugly since GFC! Once you are ugly, everyone would spit on you and you would feel painful! It is a lesson we could not forget!

Simplicity tell some reasons why 80/20 works

1. Simple and pure market share is much more valuable than has previously been recognized.

The returns from pure scale have been obscured by the cost of complexity associated with impure scale. And different chunks of business have usually had different competitors and different relative strength of those competitors. Where a business is dominant in its narrowly defined niche, it is likely to make several times the returns earned in niches where one faces a dominant competitor (the mirror
image).

Do you get the sense why Warren Buffett always said you need your circle in the market? Don't know and uncertainty with complicated feeling would kill the money!

2. Parts of the business that are mature and simple can be amazingly profitable.

Cutting the number of products, customers and suppliers usually leads to higher profits, partly because you can have the luxury of just focusing on the most profitable activities and customers, but partly also because the costs of complexity—in the form of overheads and management—can be slashed.

If you know, it would be simple. If you don't know it is hard and complicated. If you keep to google without mulling and pondering, you get lost! If you don't focus on you could not know enough. Simplicity is beauty, which who don't know? We know but we don't know after its up-down and right-left.

3. In different products, firms often have differences in the extent to which they buy in goods and services from the outside (in the jargon, outsourcing).

Outsourcing is a terrific way to cut complexity and costs. The best approach is to decide which is the part of the value-adding chain (R&D/manufacturing/ distribution/selling/marketing/servicing) where your company has the greatest comparative advantage—and then ruthlessly outsource everything else. This can take out most of the costs of complexity and enable dramatic reductions in headcount, as well as speeding up the
time it takes you to get a product to market. The result: much lower costs and often significantly higher prices too.

We, as market business people(assume we want to learn) especially work in a single people market business, have to use outsource to product the product and service to the societies. Our focus should be capital allocation for best partners, the business of our shares. We could not know all of business so that we have to focus on. We need to find the best companies and wait for the chances to buy them in at the lowest price if we could not calculate the value by ourselves or at the reasonable price if we could get the value roughly right. Value can be evaluated by a lot of ways and we need to be experts on some of them.

We have to know we work in service sector which is not the traditional one but very special. We should service the warriors. They buy or sell by feeling. We have to know their sentiment and don't allow ourselves to provide services based on our own feeling. We have to to know we could not outsource this services. If you outsource this part of your business, you would be traded in!

4. It can enable you to do away with all central functions and costs.

If you are just in one line of business, you don’t need a head office, regional head offices or functional offices. And the abolition of the head office can have an electric effect on profits. The key problem with head offices is not their cost. It is the way they take away real responsibility and initiative from
those who do the work and add the value to customers.

For the first time, corporations can centre themselves around customer needs rather than around the management hierarchy. Before the head office is abolished, different chunks of business attract
different degrees of head office cost and interference. The most profitable products and services are usually those that are left to get on with their own life without any ‘help’ from the centre.

This is why, when 80/20 profitability exercises have been carried out, executives are often staggered
to learn that the most neglected areas are the most profitable. It is no accident. (And one of the unfortunate by products of 80/20 Analysis is sometimes that the most profitable areas get a lot more attention from managers at the top. As a result, they can begin to drop down the profitability league table.)

I am amazing by the way Warren Buffett manages his business. He declares that he just does the job as capital allocation for his business empire!

5. Finally, where a chunk of business is simple, the chances are that it is closer to the customer.

There is less management to get in the way. Customers can be listened to and feel that they are important. People are willing to pay a lot more for this. For customers, the quest for selfimportance
is at least as important as the quest for value. Simplicity raises prices as well as lowering costs.

In the market, we could be warriors, which means we are customers of some business; we could be business people to service others. As warriors, since they are customers, they have the right to feel self-important. As business people, you don't have the right to be self-importance since your profit and your dream to service the people in best quality should be the best reward.

A lot of us want to be self-importance, which partly make them to be losers at last in the market. Why did I make a series of mistakes since April? Partly I want to be self-importance or feel I am important in the eyes of others or want to show I am important. While we quest for self-importance, you have to pay something out to exchange. In the market you pay the money out which reduce your quality too service people since you compete with them for the same things. You could get it with your customers together for the same thing.

 

Matters around the simplicity and complexity

Few would like to fight against his own biases to the rules and often ignore the context and conditions to use the rules.

Excuses for in action which contribution to overhead

80/20 analysis shows we need to focus on the profitable segments in our business. We need to setup a profitable line in our business. However in most of times we tend to find excuses to do so. We could argue that the less profitable segments, and even the loss-making segments, is necessary since we don't know the future and these segment could contribute some cash flow for overhead. This is one of the lamest and most self serving defence mechanisms ever contrived in business.

The fact is if we focus on the most profitable segments, we can grow them surprisingly fast—nearly always at 20 per cent a year and sometimes even faster. Remember that the initial position and customer franchise are strong, so it’s a lot easier than growing the business overall.

The need for overhead coverage from unprofitable segments can disappear pretty quickly. Yet the truth is that you don’t need to wait. ‘If your eye offends you, pluck it out!’ Just remove the offending overhead. If your will is strong, you can always do it.

The less profitable segments can sometimes be sold, with or without their overheads, and always be closed. (Do not listen to accountants who bleat about ‘exit costs’; a lot of these are just numbers on a page with no cash cost. Even where there is a cash cost, there is normally a
very quick payback, one that will be much quicker, because of the value of simplicity, than the bean counters will ever tell you.)

A third option, often the most profitable, is to harvest these segments, deliberately losing market share. You let go of the less profitable customers and products, cut off most support and sales effort, raise prices and allow sales to decline at 5–20 per cent while you laugh all the way to the bank.

Since we just allocate the capital for our partners' business, we could make the thing most simple. We simply stay away from the sinking business. That is why Warren Buffett said he want the growth and high quality business at reasonable price. So that he put the money to the company who just focus to make the profit and money!

However in the market, most of us have not any business senses. We have to diversify and stop the losses after we don't have simple goal and process to be sure we have the quality and growth in hands. Since our feeling is so complicated, we run in circle and put one after another excuses to take no action to focus on the action to change our mind for profit!

When we work hard in the losses we lose our future and capital! In the losses we have to depend on our feeling or emotional more heavily. We turn ourselves ugly! We could not be beautiful so that we stay in the hell for reckoning hopelessly!

Go for the most simple 20 per cent

What is most simple and standardized is hugely more productive and cost effective than what is complex.

1. The simplest messages are the most appealing and universal: to owners, consumers and suppliers.
2. The simplest structures and process flows are at once the most attractive and the lowest cost.
3. The simplicity creates choice, economy, speed and spend.

Always try to identify the simplest 20 per cent of any product range, process, marketing message, sales channel, product design, product manufacture, service delivery or customer feedback mechanism. Cultivate
the simplest 20 per cent. Refine it until it is as simple as you can make it.

Standardize delivery of a simple product or service on as universal and global a basis as possible. Pass up thrills, bells and whistles. Make the simplest 20 per cent as high quality and consistent as imaginable.

Whenever something has become complex, simplify it; if you cannot, eliminate it.