A lot of times we can get caught up in financially engineering a lease to save an extra 5 or 10%. This is why we bring in quality brokers that know their markets, landlords, and customs. It is also just good business to negotiate the best lease costs possible and structure it around the best terms possible. But this part of the process is the tail end and happens because it needs to and not because it is actually business critical.
The best real estate decisions shouldn’t need to consider the real estate costs at all. Real estate is a force multiplier. Without it, you can’t do the other business functions that you need in order to grow, thrive, and succeed. If the difference between a good and bad decision is a slight change in NPV then you have lost sight of the strategic objectives.
Is cost an important factor? Of course, once you have decided on the generally correct area and have a full business case put together. But at that point, you know the five or ten buildings that are acceptable to support the case and we just need to optimize cost and design to ensure the most optimal outcome. It’s now trivial because even at the non-lowest cost the decision makes sense.
After the very first decision to locate in a market, then cost becomes the critical factor every decision point after unless there is a reason to reassess the strategic basis of the location. The financial negotiation is important but really a few percent of additional cost against the benefits that real estate allows is almost inconsequential.
Many people believe that an answer with 99% confidence is better than one with only 70% confidence. On the surface, with no additional information, maybe this could make sense. But the world of trade-offs almost always makes the 70% solution better.
Trade-offs occur in every decision. Moving any decision from 70% confidence to 99% requires time and complexity. Time is a non-renewable resource that we can never get back. Delaying a decision to increase confidence can often cost a lot of time and only yield false levels of new confidence. Complexity is similar, the more complexity involved in a decision, the more likely an error exists somewhere in the assumptions.
One of the great lessons I’ve learned in my career is that 70% confidence is often enough to move forward with. Get the next 10/20/30% confidence from real life experience and feedback. If you spend time modeling and trying to get everything perfect for release, key opportunities will pass you by.
The best engineers understand this rule. Poor engineers will strive for 100% and take the time to try and get there. This wastes the time it takes and the additional confidence is often false because of the new complexity. But they now have a thick document to fall back on and defend full of assumptions that they can use to justify any change outside of their expectations.
There’s a principle in decision theory called MECE – Mutually Exclusive and Collectively Exhaustive. It essentially says that when you define your decision criteria that shouldn’t overlap and they should include everything you are going to base your decision on.
For example, you shouldn’t leave finance out of your decision list because “it will take care of itself.” Finance is part of 99% of all major decisions and so should be included. Similarly, finance should only exist in one part of the criteria and not exist in multiple places. You shouldn’t have Total NPV as a criterion and then the cost of a single piece of software in another. You are double-counting the software in that instance.
This is a difficult principle to wrap our heads around, particularly if you’ve never encountered it before. Putting all of our HR related issues into one box and finance related issues into another seems like we are separating topics that go in hand. You can’t have a project that expands workforce without also increasing costs.
The goal of MECE is to enable us to understand the trade-offs that exist when we make decisions. Expanding workforce may be good but is the decision ranking offset by the incremental increase in costs? Without understanding our independent thoughts on additional capacity versus added costs we can’t score that trade-off.
At the same time, if our criteria overlap and include combined topics we’ll never have a clean evaluation framework for making our decision. The goal of decision theory is to assist in making quantitatively supported decisions. A decision framework that doesn’t provide clean scores will naturally keep us in the qualitative realm.
There are certainly problems with MECE. The first being that it isn’t always possible to separate criteria completely. To use a baseball analogy, if you value players that hit homeruns but also players that drive in and score runs you are double counting since a homerun always leads to both an rbi and run as a result. It is very difficult to separate criteria without going down to valuing player specific attributes such as bat speed and reaction time – the data for which is either not available or difficult to work with.
With the election of Donald Trump, I have seen an associated uptick in the number of consultants talking about the increasing need for risk management. Everywhere I look I’m seeing “risk management.”
But talking about risk now is like trying to sell fire insurance after your house has burned down. It may be on top of people’s minds but the right time to talk about risk management is always. But especially prior to surprising events like Brexit and the election of President Trump. Risk management should be part of the everyday playbook in how problems get solved.
Consultants, as a group, are very good about selling for the situation in front of us today or that occurred yesterday. Like clockwork:
- If the stock market takes a hit you will see all kinds of mentions about aligning strategy with EPS and EBITDA.
- If something unexpected happens in the world they will bring up Risk Management.
- If unemployment starts going up they will talk about aligning your workforce to the next three years.
- If a treaty is about to be signed addressing climate change or the cost of carbon you will see them going hard after sustainable initiatives.
Anyone focused on yesterday or today is not really looking out for your best interests – as they say on Wall Street, buy low/sell high! When unemployment is going up they should be talking to you about how you can leverage the opportunity to get new customers. When your earnings are strong, you should be paying even closer attention to aligning strategy with financials.
When everyone thinks the same and acts the same you end up with these recurring cycles that strike everywhere at once. Groupthink is very pervasive and can occur even when you don’t know you are part of the group.
Many in real estate like to fall back on the idea that the best decisions are based on location, location, location. I’ll grant that once you know generally where to be that it comes down to location (and cost). But the decision tree to get to the general where to be is full of complex and difficult problems that usually have little to do with location.
In fact, the worst real estate decisions I have ever encountered always began with a decision around simply “optimizing location.” When you start with location, you also have a high likelihood of starting with false assumptions. Is the labor market really ideal in that metro? Is the long-term growth of your business causing a geographic shift? Should you have one distribution center or two or three? Do you need a new location at all?
Location, location, location is not the way to think about real estate.
It may seem unnecessary to point out, but we are living in the Information Revolution. It’s spurred on by the increase in digital communications but the simple fact is that our world is all about harnessing information for the maximum return. If Return on Information could be accurately calculated it would likely be the new #1 metric that every business measures itself on.
- Fast food menus are driven by the purchasing behavior of customers. To maximize profits it is necessary to use information to both optimize menu options and prices – ideally by location. A $1 fry may be successful in Georgia but less so in California.
- Brick and mortar retail is size dependent, sometimes big stores are ideal and sometimes smaller stores are. If you are not able to harness your customer intelligence to know which is right for you then you have a 50/50 shot (or less) of guessing right.
- Locating a corporate HQ is dependent upon the labor in the market and the trends for competition for your target skills as well the growth/decline of that skill in the area. Your decision 20 years ago to locate somewhere may no longer be an optimal solution even if it still seems so on the surface.
- Your retail partners, distributors, customer locations, product mix and inventory levels define the optimal supply chain. The mix of all the above likely changes (beyond some threshold) every 3 months or more. How are you using information around each to model the conditions that necessitate a change in location strategy – even if it is simply changing where inventory is pre-positioned. Sometimes having empty space in a warehouse today is the best long-term cost avoidance option.
Information drives everything about real estate. Knowing what is in your lease contract, a given landlord’s financial drivers, the macro and micro characteristics of the market, the labor pool you are trying to tap, future business plans that could impact the decision 3 to 10 years down the road….all of these need to be brought together to optimize any given real estate decision. There’s a lot that can go into a given decision but that doesn’t mean all of it needs to go in. Overkill is a real problem in analysis.
All this to say: invest in knowing how to harness and use information in your real estate decisions. It doesn’t have to all be some fancy, expensive technology (although that may be a component) but it does need to have a rational and consistent approach that meets your needs.
Risk mitigation and decision making are two topics that go hand-in-hand. You can’t make good decisions without understanding the risks that come with the various choices.
Risk is not always a negative consequence. A lot of time risk goes by another name: opportunity cost. Risk can often be best described as the downside difference of potential outcomes. The greater the best to worst potential outcomes (even if all outcomes are good), the greater the risk.
Sometimes we get thrown off by the word Risk. It has a negative connotation to it. Maybe it comes from all the awful hours spent playing the painful board game of the same name. Maybe it is simply that the association of risk in our minds is tied to the idea of losing money. Regardless, risk is something that exists in all decisions.
There is risk to every post I write. If I publish as-is am I leaving readers out that wanted something shorter? If I don’t spend more time editing do I hurt my credibility through the use of bad grammar? Is this really a topic that is worth posting here? These are all risks – every, ordinary, daily risks.
Thinking through the downside is how good decisions are made – even when the downside is still a good outcome. Maximizing upside is always worthwhile.