When I was self-studying the bankruptcy code in preparation for the bar exam, I came across an old Tennessee bankruptcy case in which a pet store that earned almost $150,000 per year with only $85,000 in debt against the building and inventory went bankrupt within the third year of two brothers taking over the business after the death of their father.
In the court filings, one of the brothers claimed that the other one (who managed the day-to-day operations of the store) was responsible for the bankruptcy due to mismanagement. Specifically, he alleged that his brother alienated customers by abandoning the store’s policy of giving new fish to customers who bought some that died shortly after the purchase.
The old policy was highly informal—if you bought some fish and they died, you’d get new ones. The new policy required that you bring in the dead fish, a water sample, and a receipt, all within three days, and the water would be tested to determine if it was your fault that the fish died.
From a narrowly drawn economic and moral perspective, this policy could have made sense. It is almost always the customer’s fault that the fish dies in transition between tanks, especially if the aquarium is brand new. And, an open-ended refund policy fails to provide any incentive to take care of your fish properly.
But a broader view indicates that this policy was likely foolhardy. Samuel Johnson, once praising Samuel Richardson at the expense of Henry Fielding, said “that there was as great a difference between them as between a man who knew how a watch was made, and a man who could tell the hour by looking on the dial-plate.”
Clearly, the father that ran the business understood something about how the watch was made in a way that his son did not.
There is wisdom in being able to identify when business losses are tolerable. In 2002, the median cost for a pet store can obtain 1,000 guppies for about $200, or about $0.20 each. They retailed for $3.95 each at this particular pet store.
If a customer buys 10 guppies that die, they are out $40+ plus tax. Granting a second offering would have meant making $40 on about $4 in costs instead of making about $40 on $2 in costs. The cost absorbed by the pet store here is minimal compared to what you are otherwise asking the customer to absorb—the payment of $40+ without any live fish in the aquarium plus a vague accusation from the pet shop that you are an irresponsible pet owner. If you were a hobbyist that knew of an alternative pet store, wouldn’t you go there?
A simplistic strain of thought, which seems to have come en vogue in the United States over the past thirty years, seems to treat indiscriminate cost-cutting and intelligent entrepreneurialism as one and the same. When this new policy was implemented, there may very well have been a small uptick on the balance sheet.
Over time, this six-figure business went bankrupt because customers don’t want to be held strictly liable for getting the water quality in their tank right and don’t want to be hassled and then blamed for their imprecisions in developing a side hobby for themselves or for their children. It is amazing how much successful businesses have that “touch” of the founder, which often involves a mixture of common-sense and recognition that there are important business characteristics that do not show up directly in the matter, that their children and heirs ignore to their peril when succeeding to the throne.
Originally posted 2018-06-27 01:20:04.