The Wealth Paradox

A hot dog vendor works the crowd during a Boston Red Sox game against the Oakland Athletics at Fenway Park in Boston Photograph by Matthew Cavanaugh/The New York Times via Redux

In baseball and in business, there is a “wealth paradox.” Teams and companies with extreme riches often fail because that wealth reduces creativity, judgment, and focus.

This year, three baseball teams spent more than $170 million on player salaries, and two of them (the Boston Red Sox and the Philadelphia Phillies) have losing records. Meanwhile, the Oakland A’s, with the lowest average salary ($55 million total payroll), have the second-best record in the American League. As if to underscore my point, the A’s swept the Red Sox in a three-game series this weekend by a combined score of 33-5. A’s General Manager Billy Beane of Moneyball book and movie fame has been scrappy and creative, while the Red Sox overpaid for bad talent.

In many businesses we see this same phenomenon. Wealth leads to poor decisions, while scrappy, cash-constrained upstarts rule the day.

In 1970, Kmart dominated discount retailing, and Wal-Mart was a startup with just 24 stores. Kmart had plenty of expansion capital, while Wal-Mart—funded almost entirely by Sam Walton—had little. Wal-Mart’s limited resources led it to develop innovative cost-saving strategies: cross-docking, computer-managed inventories, and everyday low pricing, concepts that redefined discount retailing. Kmart used its cash for acquisitions like Borders, Builder’s Square, and Sports Authority instead of building its core capabilities. As a result, Kmart lost market share and soon went bankrupt.

At many companies today, cash is a distraction, not an enabler, or at best it’s poorly invested. For years General Motors churned out cash but failed to invest wisely. During the early 2000s, the company routinely invested more than $8 billion per year in R&D—enough to send a man to the moon—but got very little in return.

Meanwhile Toyota used its smaller R&D budget to develop hybrid engines, lower-cost production, and better fuel economy, gaining market share and ultimately contributing to GM’s bankruptcy.

Small companies can have too much money for their own good, too. Remember Webvan? The grocery home-delivery service raised over $400 million from Sequoia Capital, Goldman Sachs, and an early IPO in 2000. Rather than get its business model right and prove it had a customer base (which would have taken a fraction of the money raised), Webvan foolishly began a costly 26-city expansion, only to find out that the basic concept was flawed. By 2001 it had spent all of the money and went bankrupt.

Solyndra, the now-bankrupt solar power company, was a promising idea and might have been successful had it not been given $500 million before it had its business model right. The money was wasted on a manufacturing plant, which became a white elephant the day it was built because the company’s cost structure was out of whack.

Another greentech company, Westport Innovations, started by University of British Columbia professor Philip Hill, has been a successful builder of natural gas engines without much cash or fanfare. Initially, Hill couldn’t get funding and had to fabricate all the engine parts himself. The limited resources drove Westport to quickly find a realistic business plan. Westport partnered with engine makers Cummins and Volvo, went public, and is on a solid growth track today.

Looking for one more reason to hate Facebook? Check out their post-IPO cash reserves—over $10 billion. There are few other public companies sitting on that much cash. Facebook is not even in an industry that needs cash to expand. So at best the money will be wasted on boneheaded moves. Or worse, it will be invested in adjacent businesses that cause management to take its eye off the ball—and create an opening for a competitor. We can only hope Mark Zuckerberg is an Oakland A’s fan.

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