Chapter 3
Forget Conventional Wisdom
When you have done the unreasonable thing, which is what most people call thinking for yourself, and asked the forbidden question “Why not?” you’ve empowered yourself with conventional wisdom’s polar opposite: unconventional insight. That’s the quality you always need to start a business, take a risk, or make any major decision.
Economically and personally, there couldn’t have been a worse time to start a new business than 1956, the year I launched what ultimately became a Fortune 500 company. The first major downturn of the postwar era—the so-called Eisenhower recession—was about to start, and the homebuilding market was already jittery. Edye and I were expecting our first child. We had a mortgage. I had lost my $67.40-a-week accounting job, and we were living on my income from a few accounting clients and the night classes I was teaching at the Detroit Institute of Technology.
Actually, I liked both teaching and accounting, but my meager earnings weren’t quite enough to give Edye the life I had promised. All I could see when I looked at the years ahead was more of the same, and that was not the future I wanted. As everyone else trimmed their expectations and ambitions to fit the nation’s prevailing pessimism, I ignored the conventional wisdom and came to the unreasonable conclusion that even recessions can yield opportunity.
Conventional Wisdom Strangles Innovation
Reasonable people treat conventional wisdom with respect. Those of us who are unreasonable regard it as an expression of the herd instinct. It’s a fine quality for sheep—creatures that usually end up getting sheared—but not for entrepreneurs.
Most successful businesses have to begin by bucking conventional wisdom. Invention and innovation don’t happen without it. Someone certainly told Jeff Bezos of Amazon.com that no one would buy a book without picking it up and looking at it in a store. People probably told Ted Turner when he was starting CNN that no one would want to watch—let alone advertise on—a 24-hour news channel.
The first bit of conventional wisdom that my homebuilding partner, Don Kaufman, and I encountered was the firm belief that no one in Detroit would buy a house without a basement. We asked, “Why not?” The answer produced our first big idea: no basements.
From reading industry magazines, I already knew that homebuilders in Indianapolis, Indiana, and Dayton, Ohio, were building houses without basements and families were buying them. Basements had historically been the place to store coal to heat your home for the winter. New gas heating eliminated the need to stockpile coal, so basements weren’t a necessity. If we skipped building them, we could put up homes faster and sell them for less than our competitors. We also could price our houses for first-time buyers, who I figured wouldn’t move out of their apartments unless mortgage payments were less than their rent.
We constructed two basement-less model homes and bought options on 15 more lots. We also made a few other departures from convention to build a better-priced product. We used a combination of wood and brick facing rather than the more expensive all-brick fronts that were popular at the time. There were no architects’ fees because I designed the floor plan myself. I made sure that there was as little hall space as possible, which meant bigger living areas. We threw in a carport, a nice perk at a time when many families in Detroit still parked on the street.
I carefully studied every step that went into putting up a home, and by scrutinizing every expense and eliminating all the nonessentials, I came up with a no-frills house that could be constructed on an accelerated schedule. Less time with guys standing around on the job site and no wasted materials created instant advantages for our company.
Unconventional economies allowed us to set our price at $13,740, which was a full $2,000 less than the closest competition. That translated into a monthly payment of around $65, depending on the down payment. If the buyer was a veteran, as many in those days were, a down payment wasn’t even needed. Don and I papered the city with flyers advertising our bare-bones, unfurnished models, which I christened “The Award Winner.” Thankfully, nobody ever asked what prize we had won.
The weekend our models opened, I wanted to be anywhere but in Detroit. Everyone was throwing shovelfuls of the conventional wisdom at us: Nobody would buy a house without a basement, and even if they did, we would go broke trying to sell houses at such a low price. We were confident, but we were a little nervous too. So Edye; Don; his wife, Glorya; and I drove to Dayton, Ohio, for the weekend. We looked at a few model houses, just to compare notes, and had a steak dinner. We started the drive back to Detroit on Sunday. Halfway there, I couldn’t wait any longer to find out how we had done. I pulled off the road, walked into a diner, went straight to the pay phone, and dialed our sales rep. He gave me the incredible news: We had sold 15 houses, all the lots we had, with sales of more than $200,000.
In our first year of business, we sold 120 houses, generating $1.7 million in revenue for our new company. That was a long way from scraping by as a $67.40-a-week accountant. I had enough money to pay back my father-in-law, and a few years later, I treated myself to a new car, a Thunderbird convertible. To build that beauty, Ford had bucked the conventional wisdom too. No one thought anyone would buy a two-seater that looked like a sports car but didn’t have the engine to qualify—the Thunderbird was just a standard chassis dressed up in a fancy new suit. But Ford went with it. They called it a “personal luxury car” and that’s precisely what it felt like to me.
Innovation Is a Permanent Revolution
Conventional wisdom abhors innovation. It’s never a good time to change—far better to return to your company’s fundamentals, or to focus on the next quarter’s revenue, or just to continue doing what you do best. That may sound wise, but it’s a recipe for stagnation. Consider the examples of the companies I mentioned earlier. Amazon.com discovered that along with books, customers would buy most any imaginable product online. CNN launched its news website in 1995, and it is now the most popular news site on the Web—and my source during the day for news of the financial markets. Successful companies innovate constantly—the products they offer, how they sell them, or how they conduct operations. Whether you’re starting a business or launching a nonprofit or civic initiative, now is the time to innovate.
If Kaufman and Broad had remained simply a company that built homes without basements, someone else would have come along and done it better. We knew we had to come up with our next move soon after we sold those first 15 houses.
We started by looking at some of the industry’s most fundamental operating principles, what most people would call the basics. They represent the strongest, stickiest—and most unexamined—kind of conventional wisdom. Often they’ve gone so long without scrutiny that they’re accepted as gospel. That’s what makes these core assumptions the best place to look for opportunities to innovate, no matter what business you’re in.
One of the things I quickly noticed was that, although our competitors called themselves homebuilders, they really thought they were in the real estate business. Obviously, a builder needs land, which you sell right along with the house. For homebuilders who saw themselves as being in real estate, it made sense to buy a lot of land and hold on to it, treating it as inventory to be drawn down as needed. But by holding on to inventory, you’re also tying up cash that could be put to work elsewhere.
So we changed the basics of our business. Instead of thinking of Kaufman and Broad as a real estate business, I decided we were manufacturers. We made and sold a product—a house. Back then, only the biggest homebuilders, like Bill Levitt, had the scale and capital to truly operate as manufacturers. But I studied their methods and figured out a way to do it at Kaufman and Broad despite our smaller size. We would treat land as just another raw material, like lumber or nails. We would buy it when we needed it and let someone else own it when we didn’t.
Once we saw ourselves as manufacturers, we also kept watch over every bit of material we used. This was not a typical practice among our competitors in Detroit. Our contractors were used to allowing a lot of materials to go to waste. Don and I would stalk our construction sites, pointing out every scrap and adjusting our orders until we knew pretty much down to the last bolt, brick, and two-by-four what it took to build a house. That’s all we paid for, nothing more. That attention to even the smallest expense has remained with me throughout my career, no matter that the numbers are bigger.
Along with keeping costs low, we had to make sure our financing wasn’t expensive. We had to avoid taking out costly construction loans like most homebuilders did to cover building expenses. I realized we could pay contractors and suppliers from the money we received when the house was built and the sale closed. That meant we had to build a house within 45 days, which was four weeks faster than our closest competition. Then we could pay the contractors by the end of the month following the completion of their work. Bills came due, depending on when we completed a house, between 31 and 60 days after the work was done. The money flow would average out without us having to draw on expensive borrowed cash.
The schedule worked. Our cash flow from closings covered our bills—something that was unheard of in the homebuilding business.
My accounting background and my focus on the bottom line helped us continue to innovate financially. We developed a reputation among banks and investors for doing what no other homebuilder had ever done: gaining access to unsecured credit and eventually issuing our own commercial paper, both of which enabled us to reduce costs. We even launched our own mortgage company so customers could more easily arrange financing when they bought one of our houses. That venture was so successful that we started selling mortgages to other homebuilders’ customers.
Success Is a Starting Point, Not a Conclusion
Changing the basics of our business helped Kaufman and Broad lay a foundation for growth. We grew faster than anyone expected, including ourselves. We looked around, saw we had the capital and the organizational culture to play in a bigger league, and thought, “Why not?”
We expanded first to Arizona and then to California, a market dominated by bigger and more experienced builders who knew how to maneuver within complex regulatory and political structures. To beat the big guys we knew we would have to come out of the starting gate with something new. This time our innovation was a contemporary version of the traditional East Coast row house. We would build in what was then a middle-class beachside community in Orange County called Huntington Beach.
Much like Midwestern houses without basements, no one thought row houses would work in the West, which was, in those days at least, all about space and sprawl. But I thought they made great sense. Everyone in Southern California wanted to live by the coast, but fewer and fewer could afford it. We designed smaller homes that shared one or two walls, making them less costly than stand-alone structures. We made sure they had distinct façades to give each house a unique appearance. We added a community clubhouse with a pool for all the homeowners to share, an added perk to make up for the lost square footage and side yards.
We called them “townhouses.” Today they’re a staple of the housing market throughout Southern California. We sold our first 756 Huntington Continental Townhouses in five weeks.
I did make one rookie mistake. We should have sold 50 at one price and then raised prices. Step pricing might have slowed sales, but it would have been financially smarter. We could have covered any unexpected changes in our materials and labor costs while boosting our profits. Pricing can be a big tripping point for a new business, especially because it can seem as if the only way into a market is to slash the price and make it up in volume. We stuck to our pricing strategy too long. We set the price according to our costs, which we kept low.
Nothing Lasts Forever
When you’re on a winning streak, it’s easy to think it will last forever. It won’t. It never does.
By 1971 Kaufman and Broad was Wall Street’s darling. We went public on the American Stock Exchange in 1961 and became the first homebuilder listed on the New York Stock Exchange in 1969. We had almost single-handedly taken our industry out of an era of private ownership—when investors regarded homebuilders as unstable and poorly managed, liable to go bust in any down market. We had convinced analysts that a well-run housing company was immune to the ups and downs of the business cycle. Most stock pickers thought homebuilding would boom in the 1970s.
But I wasn’t totally convinced myself. It’s important to pay attention to the lessons of history and know the realities of your industry. In other words, don’t believe the conventional wisdom you create about yourself.
So while investors bid up Kaufman and Broad’s stock, we bought a small life insurance company to help stabilize earnings during downturns in the housing market. The biggest housing slump since the Great Depression hit three years later, and that acquisition, Sun Life Insurance Company of America, pulled us through.
Look Outside Your Personal and Professional Comfort Zone
Sun Life was an old-line insurance company based in Baltimore, Maryland, and when we bought it in 1971, it operated much the same way it did when it was founded in 1890. It had a history of modest growth, no better or worse than most other insurers. The company focused on the basics of the insurance business: taking in premiums, holding on to them, and making sure there was enough in the bank to pay claims. They kept their cash from premiums in traditional, low-return investments.
About eight years after we acquired the company, I looked at the industry to see where we might find a niche. Other insurers—most of them bigger and better known—were introducing new kinds of life insurance policies. I figured they would do well selling those products, and we would just lag behind if we tried the same. Instead, I pushed Sun Life away from life insurance and toward retirement savings. Our customers would be the same baby boomers who purchased Kaufman and Broad’s houses: a big generation of spenders who would live long past retirement age and, therefore, would be thinking more about retirement than death. That’s when I thought to introduce fixed and variable annuities—which actually were mutual funds in life insurance wrappers.
With variable annuities, we made money on fees while the policyholder decided how to invest and received the returns from and assumed the risks of their investment. With fixed annuities, we promised a particular rate of return while handling the investment and risk ourselves. We made our profit on the “spread”—the difference between what we ultimately paid out and what we could earn from investing the premiums.
Profiting from the spread required changing the basics of the business, as we had done with Kaufman and Broad. We decided that instead of thinking like an insurer, we should think like a bank. What banks do is pretty simple: They buy money at one price, and sell it at another; that is, banks take in deposits and promise to pay you interest at a given rate. Then they loan money out at a higher rate, and the difference between your interest rate and the borrower’s is profit. I decided we would adopt a banking mentality at Sun Life. We promised a certain rate of return to our customers on their policies, and we would earn a higher rate of return from our investments.
We changed the name of our company in 1993 to SunAmerica, in part to reflect that we were a new type of company, not a plain old insurer. We focused our energies on our investments, which began to grow at a faster rate than other insurers’, and earned 2 to 3 percent more a year than our competitors. That sort of performance enabled us to do even more for our customers, such as introducing new products and promising better returns.
Kaufman and Broad and SunAmerica both prospered beyond all expectation because I was unreasonable enough to ask fundamental questions about unexamined assumptions. We came up with ways to reimagine our businesses. A real estate company became a manufacturer and a life insurer became a bank. Both became Fortune 500 companies. That’s the value of unconventional insight.