A new series of posts
Welcome to a new series of posts! We’re going to explore the concepts of goodwill in detail, discussing and defining three types of goodwill: personal goodwill, business goodwill, and GAAP goodwill. I plan to intersperse personal anecdotes with math and business case studies, to keep things interesting. This series will consist of around 5 posts, which we’ll link here in the opening header as they’re published.
A personal experience with goodwill in business
Small business in crisis
Over the course of two years, I helped an acquaintance transition a business from a husband with rapidly advancing terminal cancer to his soon-to-be widow. The process was painful, but I walked away from the effort with a litany of life lessons learned. The company sold a niche, handmade product with a strong brand. The business operated on a shoestring budget, and the owners raided the company coffers to the point that accounts payable were constantly in arrears. They ran retail and wholesale sales channels with massive backlogs in both houses. As the man’s health declined, he was less and less able to produce, and the backlogs became staggering mountains of impossibility. I helped them hire enough artisans to chip away at the orders, but the situation was unsustainable.
A potential solution
I determined that the wholesale business had to be halted, at least until another hiring blitz could be brought up to speed. The retail sales alone would suffice for the wife’s income needs, but they had to fulfill orders! With sales channels stuffed full, I suggested a substantial retail price increase to slow orders and increase profit, allowing more hiring. However, the owners had both given away and cashed in too much goodwill with their wholesale customers. Late in the game, I discovered that some wholesale orders had been paid in full upon procurement, the proceeds of which funded personal expenditures. A couple large customers even gifted and loaned the couple money.
The owners took products that had been completed for retail customers at 600%+ margins and used those products to fill partial deliveries to wholesale customers who barely paid a 20% margin. Flabbergasted, I was told regarding the wholesale customers, “We’ve known these people for decades. We don’t even know who the retail customers are! We don’t have the money to repay the wholesale orders, so we must deliver them as much product as we can.” All the while, they continued to accept new wholesale orders, and the internet sent a steadily increasing stream of retail cash to the treasury only to be refunded after 6+ weeks of delays and excuses.
I stayed for a year after the man’s death to help as much as I could with his widow’s agonizing loss and the floundering business. Less than 5% of outstanding orders were ever filled, to my knowledge. As gracefully as I could, I exited my advisory position before the situation became even more dire.
My own role in the debacle
For now, I’ll let most of the business lessons speak for themselves here. What changed me most was the self-reflection that followed my resignation. I gave too much of myself, too much of my capacity for goodwill, to someone who wasn’t very close to me. All this work on top of my day job was hardly compensated, but that wasn’t why I was helping. I thought I was doing a good deed while learning about business, and while the latter is true, for the former: I was only delaying the inevitable. I allowed my emotions to interfere with my own time management and well-being.
With those many squandered hours, I wish I had instead enjoyed the company of loved ones I lost soon after I departed the company. You only have a limited amount of time. Guard your hourglass ferociously; you never know when someone you love needs to borrow it.
Tapping into goodwill reduces its value
If you take a gander at our investing philosophies, it should come as no surprise that outside of index funds, I’d never purchase Amazon stock in its current or past states of existence. With P/E ratios measured in the hundreds or that include the word “negative” year after year, quarter after quarter: no promise of capital gains (greater fool principle) or future profits (compressed P/E, anyone?) could convince me to abandon my conservative investing principles. The business simply doesn’t fit into the mold of reliably profitable companies with which I stock my stables. That said, the company is a grandmaster at building goodwill with its customers and vendors.
Amazon Prime is a shining monument to goodwill manufactured by a business, nestled in a ruined wasteland of failed retail subscription models. Whether you believe the service is worth the cost or not, Amazon’s war chest is bursting with recurring revenue from its delighted customers, myself included. In the coming years, Amazon will be testing the depths of its Prime goodwill as it raises prices to support its ever-expanding empire. The question is: how far is too far? $150 per year? Probably not. $400 per year? Almost definitely. There’s a breaking point, and Amazon will find it. They’re smart, so I doubt that they’ll push too far and impair the goodwill they’ve built. Can you imagine if Amazon announced tomorrow that Prime would cost $400? How many of their customers would choke out a cough in response “Super saver shipping!” or “I’m going to Walmart!” The point is that translating goodwill into income is risky business, fraught with backlashes that can permanently impair a brand – or a person’s reputation.
A friend’s greedy relative
I once visited a close friend’s home soon after he endured a debilitating medical crisis that prevents him from working ever again. He and his wife are of modest means yet are extraordinarily charitable people. I was visiting his wife, while he lay in a hospital bed. On their refrigerator was a letter from one of the man’s relatives, a much younger cousin. I’m not too nosy, but as a speed reader, it only took one glance for me to understand the situation. The letter was dated 2 weeks after my friend’s much-publicized ordeal. This letter … and this is hard to type… asked my friend’s wife to give his cousin money so that his cousin could go on vacation. That’s perhaps the most egregious example of bleeding a gift horse dry that I’ve ever witnessed.
We’ve taken a quick breeze through the concept of goodwill, from a personal and business perspective. It’s a form of currency that exists in every relationship, and measuring its value can be difficult. Drawing income from reserves of goodwill is often a temporary, painful solution to a long term problem. Like most things in life, many businesses and people fail to understand and appreciate the value of goodwill until it’s gone. Even vast pools of goodwill can evaporate instantly.
Coming soon! GAAP goodwill vs colloquial goodwill
Every single mention of goodwill in this article thus far has been colloquial usage. In other words – it’s easy to understand the meaning in normal writing, but what about when you open a 10K? You’ll find that goodwill is a measured asset that sits on most companies’ balance sheets. This measurement has a precise definition in General Accepted Accounting Principles (GAAP), the accounting rules to which all publicly traded companies must adhere.
The next article in this series will dive deep into GAAP goodwill, a concept that some have called the most misunderstood line on the balance sheet. Don’t worry – I still have a couple good stories to interlace with the dryness of FASB (Financial Accounting Standards Board) guidance. We’ll be taking a look at Walmart, Chipotle, American Airlines, and GT Advanced Technologies. Stick around for the next episode, and drop me a line in the comments if you like where this is going!