by Charlie Munger – Poor Charlie’s Almanac
It is now time to present my practical problem.
And here is the problem:
It is 1884 in Atlanta. You are brought, along with twenty others like you, before a rich and eccentric Atlanta citizen named Glotz. Both you and Glotz share two characteristics: First, you routinely use in problem solving the five helpful notions, and, second, you know all the elementary ideas in all the basic college courses, as taught in 1996. However, all discoverers and all examples demonstrating these elementary ideas come from dates before 1884. Neither you nor Glotz knows anything about anything that has happened after 1884.
Glotz offers to invest two million 1884 dollars, yet take only half the equity, for a Glotz Charitable Foundation, in a new corporation organized to go into the non-alcoholic beverage business and remain in that business only, forever. Glotz wants to use a name that has somehow charmed him: Coca-Cola.
The other half of the new corporation’s equity will go to the man who most plausibly demonstrates that his business plan will cause Glotz’s foundation to be worth a trillion dollars 150 years later, in the money of that later time, 2034, despite paying our a large part of its earnings each year as a dividend. This will make the whole new corporation worth $2 trillion, even after paying out many billions of dollars in dividends.
You have fifteen minutes to make your pitch. What do you say to Glotz?
Here is my solution, my pitch to Glotz, using only the helpful notions and what every bright college sophomore should know.
Well, Glotz, the big “no-brainer” decisions that, to simplify our problem, should be made first are as follows:
First, we are never going to create something worth $2 trillion by selling some generic beverage. Therefore, we must make your name, “Coca-Cola,” into a strong legally protected trademark. Second, we can get to $2 trillion only by starting in Atlanta, then succeeding in the rest of the united States, then rapidly succeeding with our new beverage all over the world. This will require developing a product having universal appeal because it harnesses powerful elemental forces. And the right place to find such powerful elemental forces is in the subject matter of elementary academic courses.
We will next use numerical fluency to ascertain what our target implies. We can guess reasonably that by 2034 there will be about eight billion beverage consumers in the world. On average, each of these consumers will be much more prosperous in real terms than the average consumer of 1884. Each consumer is composed mostly of water and must ingest about sixty-four ounces of water per day. This is eight, eight ounce servings. Thus, if our new beverage, and other imitative beverages in our new market, can flavor and otherwise improve only twenty-five percent of ingested water worldwide, and we can occupy half of the new world market, we can sell 2.92 trillion eight-ounce servings in 2034. And if we can then net four cents per serving, we will earn $117 billion. This will be enough, if our business is still growing at a good rate, to make it easily worth $2 trillion.
In essence, we are going into the business of creating and maintaining conditioned reflexes.
A big question, of course, is whether four cents per serving is a reasonable profit target for 2034. And the answer is yes if we can create a beverage with strong universal appeal. One hundred fifty years is a long time. The dollar, like the Roman drachma, will almost surely suffer monetary depreciation. Concurrently, real purchasing power of the average beverage consumer in the world will go way up. His proclivity to inexpensively improve his experience while ingesting water will go up considerably faster. Meanwhile, as technology improves, the cost of our simple product, in units of constant purchasing power, will go down. All four factors will work together in favor of our four-cents-per-serving profit target. Worldwide beverage-purchasing power in dollars will probably multiply by a factor of at least forty over 150 years. Thinking in reverse, this makes our profit-per-serving target, under l884 conditions. A mere one fortieth of four cent or one tenth of a cent per serving this is an easy to exceed target as we start out if our new product has Universal appeal
Ivan Pavlov (1849-1936)
Ivan Pavlov was born in central Russia and attended seminary until age twenty-one, when he abandoned theology in favor of chemistry and physiology. Earning his M.D. in 1883, he excelled in physiology and surgical techniques. Later, he studied the secretory activity of digestion and ultimately formulated the laws of conditioned reflexes.
Pavlov’s most famous experiment showed that dogs tend to salivate before food is actually delivered to their mouths. This result led him to a long series of experiments in which he manipulated the stimuli occurring before the presentation of food. He thereby established the basic laws for the establishment and section of what he called “conditional reflexes,” later mistranslated from the original Russian as “conditioned reflexes.” He was awarded the Nobel Prize in l904 for his work on digestive secretions.
That decided, we must next solve the problem of invention to create Universal appeal there are two inter wind challenges of large scale first over 150 years we must cause a new beverage market to assimilate about one fourth of world’s water injection second we must so operate that half the new market is hours while all our competitors combined I left to share the remaining these results are lollapalooza results accordingly we must attack our problem by causing every favourable factor we can think of to work for us plainly only a powerful combination of many factors is likely to cause the lollapalooza consequences we desire fortunately, the solution to the winter wind problems turns out to be very easy if one has stayed awake in all the freshman courses.
“I want a can of Coke within arms reach of every American servicemen something to remind him of home.”
-Dwight D, Eisenhower; Supreme Allied Commander, world War II
Let us start by exploring the consequences of our simplifying “no-brainer” decision that we must rely on a strong trademark. This conclusion automatically leads to an understanding of the essence of our business in proper elementary academic terms. We can see from the introductory course in psychology that, in essence, we are going into the business of creating and maintaining conditioned reflexes. The “Coca-Cola” trade name and trade dress will act as the stimuli, and the purchase and ingestion of our beverage will be the desired responses.
The “Coca-Cola” trade name and trade dress will act as the stimuli, and the purchase and ingestion of our beverage will be the desired responses.
And how does one create and maintain conditioned reflexes? Well, the psychology text gives two answers: (1) by operant conditioning and (2) by classical conditioning, often called Pavlovian conditioning to honor the great Russian scientist. And, since we want a lollapalooza result, we must use both conditioning techniques-and all we can invent to enhance effects from each technique. The operant conditioning part of our problem is easy to solve. We need only (1) maximize rewards of our beverage’s ingestion and (2) minimize possibilities that desired reflexes, once created by us, will be extinguished through operant conditioning by proprietors of competing products.
For operant conditioning rewards, there are only a few categories we will find practical:
(l) Food value in calories or other inputs;
(2) Flavor, texture, and aroma acting as stimuli to consumption under neural reprogramming of man through Darwinian natural selection;
(3) Stimulus, as by sugar or caffeine;
(4) Cooling effect when man is too hot or warming effect when man is too cool.
Wanting a lollapalooza result, we will naturally include rewards in all the categories. To start out, it is easy to decide to design our beverage for consumption cold. There is much less opportunity, without ingesting beverage, to counteract excessive heat compared with excessive cold. Moreover, with excessive heat, much liquid must be consumed, and the reverse is not true. It is also easy to decide to include both sugar and caffeine. After all, tea, coffee, and lemonade are already widely consumed. And, it is also clear that we must be fanatic about determining, through trial and error, flavor and other characteristics that will maximize human pleasure while taking in the sugared water and caffeine we will provide. And, to counteract possibilities that desired operant-conditioned reflexes, once created by us, will be extinguished by operant-conditioning-employing competing products, there is also an obvious answer: We will make it a permanent obsession in our company that our beverage, as fast as practicable, will at all times be available everywhere throughout the world. After all, a competing product, if it is never tried, can’t act as a reward creating a conflicting habit. Every spouse knows that.
We must next consider the Pavlovian conditioning we must also use. In Pavlovian conditioning, powerful effects come from mere association. The neural system of Pavlov’s dog causes it to salivate at the bell it can’t eat. And the brain of man yearns for the type of beverage held by the pretty woman he can’t have. And so, Glotz, we must use every sort of decent, honorable Pavlovian conditioning we can think of. For as long as we are in business, our beverage and its promotion must be associated in consumer minds with all other things consumers like or admire.
And the brain of man yearns for the type of beverage held by the pretty woman he can’t have.
Such extensive Pavlovian conditioning will cost a lot of money, particularly for advertising. We will spend big money as far ahead as we can imagine. But the money will be effectively spent. As we expand fast in our new-beverage market, our competitors will face gross disadvantages of scale in buying advertising to create the Pavlovian conditioning they need. And this outcome, along with other volume creates-power effects, should help us gain and hold at least fifty percent of the new market everywhere. Indeed, provided buyers are scattered, our higher volumes will give us very extreme cost advantages in distribution.
Moreover, Pavlovian effects from mere association will help us choose the flavor, texture, and color of our new beverage. Considering Pavlovian effects, we will have wisely chosen the exotic and expensive-sounding name “Coca-Cola,” instead of a pedestrian name like “Glotz’s Sugared, Caffeinated Water.” For similar Pavlovian reasons, it will be wise to have our beverage look pretty much like wine instead of sugared water. And so, we will artificially color our beverage if it comes out clear. And we will carbonate our water, making our product seem like champagne, or some other expensive beverage, while also making its flavor better and imitation harder to arrange for competing products. And, because we are going to attach so many expensive psychological effects to our flavor, that flavor should be different from any other standard flavor so that we maximize difficulties for competitors and give no accidental same-flavor benefit of any existing product.
What else, from the psychology textbook, can help our new business? Well, there is chat powerful “monkey-see, monkey-do” aspect of human nature that psychologists often call “social proof.” Social proof, imitative consumption triggered by mere sight of consumption, will not only help induce trial of our beverage. It will also bolster perceived rewards from consumption. We will always take this powerful social-proof factor into account as we design advertising and sales promotion and as we forego present profit to enhance present and future consumption. More than with most other products, increased selling power will come from each increase in sales.
We can now see, Glotz, that by combining (1) much Pavlovian conditioning, (2) powerful social-proof effects, and (3) a wonderful-tasting, energy-giving, stimulating, and desirably cold beverage that causes much operant conditioning, we are going to get sales that speed up for a long time by reason of the huge mixture of factors we have chosen. Therefore, we are going to start something like an autocatalytic reaction in chemistry, precisely the sort of multifactor-triggered lollapalooza effect we need.
The logistics and the distribution strategy of our business will be simple. There are only two practical ways to sell our beverage: (1) as syrup to fountains and restaurants and (2) as a complete carbonated-water product in containers. Wanting lollapalooza results, we will naturally do it both ways. And, wanting huge Pavlovian and social-proof effects, we will always spend on advertising and sales promotion, per serving, over forty percent of the fountain price for syrup needed to make the serving.
A few syrup-making plants can serve the world. However, to avoid needless shipping of mere space and water, we will need many bottling plants scattered over the world. We will maximize profits if (like early General Electric with light bulbs) we always set the first-sale price, either (1) for fountain syrup or (2) for any container of our complete product. The best way to arrange this desirable profit-maximizing control is to make any independent bottler we need a subcontractor, not a vendee of syrup, and certainly not a vendee of syrup under a perpetual franchise specifying a syrup price frozen forever at its starting level.
Being unable to get a patent or copyright on our super important flavor, we will work obsessively to keep our formula secret. We will make a big hoopla over our secrecy, which will enhance Pavlovian effects. Eventually, food-chemical engineering will advance so that our flavor can be copied with near exactitude. But, by that time, we will be so far ahead, with such strong trademarks and complete, “always available” worldwide distribution, that good flavor copying won’t bar us from our objective. Moreover, the advances in food chemistry that help competitors will almost surely be accompanied by technological advances that will help us, including refrigeration, better transportation, and, for dieters, ability to insert a sugar taste without inserting sugar’s calories. Also, there will be related beverage opportunities we will seize.
This brings us to a final reality check for our business plan. We will, once more, think in reverse like Jacobi. What must we avoid because we don’t want it? Four answers seem clear:
First, we must avoid the protective, cloying, stop-consumption effects of aftertaste that are a standard part of physiology, developed through Darwinian evolution to enhance the replication of man’s genes by forcing a generally helpful moderation on the gene carrier. To serve our ends, on hot days, a consumer must be able to drink container after container of our product with almost no impediment from aftertaste. We will find a wonderful no-aftertaste flavor by trial and error and will thereby solve this problem.
Second, we must avoid ever losing even half of our powerful trademarked name. It will cost us mightily, for instance, if our sloppiness should ever allow sale of any other kind of “cola,” for instance, a “peppy cola.” If there is ever a “peppy cola,” we will be the proprietor of the brand.
Third, with so much success coming, we must avoid bad effects from envy, which is given a prominent place in the Ten Commandments because envy is so much a part of human nature. The best way to avoid envy, recognized by Aristotle, is to plainly deserve the success we get. We will be fanatic about product quality, quality of product presentation, and reasonableness of prices, considering the harmless pleasure we will provide.
Fourth, after our trademarked flavor dominates our new market, we must avoid making any huge and sudden change in our flavor. Even if a new flavor performs better in blind taste tests, changing to that new flavor would be a foolish thing to do. This follows because, under such conditions, our old flavor will be so entrenched in consumer preference by psychological effects that a big flavor change would do us little good. And it would do immense harm by triggering in consumers the standard Deprival super-reaction syndrome that makes “takeaways” so hard to get in any type of negotiation and helps make most gamblers so irrational. Moreover, such a large flavor change would allow a competitor, by copying our old flavor, to take advantage of both (1) the hostile consumer super-reaction to Deprival and (2) the huge love of our original flavor created by our previous work.
Well, that is my solution to my own problem of turning $2 million into $2 trillion even after paying out billions of dollars in dividends. I think it would have won with Glotz in 1884 and should convince you more than you expected at the outset. After all, the correct strategies are clear after being related to elementary academic ideas brought into play by the helpful notions.
How consistent is my solution with the history of the real Coca-Cola Company
Well, as late as 1896, twelve years after the fictional Glotz was to start vigorously with two million 1884 dollars, the real Coca-Cola Company had a net worth under $150,000 and earnings of about zero. And thereafter, the real Coca-Cola Company did lose half its trademark and did grant perpetual bottling franchises at fixed syrup prices. And some of the bottlers were not very effective and couldn’t easily be changed. And the real Coca-Cola Company, with this system, did lose much pricing control that would have improved results, had it been retained. Yet, even so, the real Coca-Cola Company followed so much of the plan given to Glotz that it is now worth about $125 billion and will have to increase its value at only eight percent per year until 2034 to reach a value of $2 trillion. And it can hit an annual physical volume target of 2.92 trillion servings if servings grow until 2034 at only six percent per year, a result consistent with much past experience and leaving plenty of plain-water ingestion for Coca-Cola to replace after 2034. So, I would guess that the fictional Glotz, starting earlier and stronger and avoiding the worst errors, would have easily hit his $2 trillion target. And he would have done it well before 2034.