Unprofitable Prophets - Part II

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This article is a short follow-up to our discussion of the low profitability of Israeli firms. I recently had the pleasure of sitting with the Chairman of a very well-established Israeli firm, not one of those discussed explicitly in the previous article. I raised the issue of Israeli profitability with him. His perception was that Israel, being a small country, is subject to an excess of information. You could almost name it the "too-efficient market" hypothesis. Because each customer knows how the costs of each supplier, including salaries and margins, customer squeeze suppliers down to bare-minimum gross margins. As he put it, "we have a pricing problem."

I take issue with these comments for several reasons, but specifically note the insight it provides into at least part of the Israeli business mentality.

  1. There is no such thing as too much information. Buying Dell servers in Israel is no more transparent than buying consulting services in Palo Alto. Any good executive knows, or can quickly find out, the variable and overhead costs of each and every supplier. If anything, the US market is actually more transparent than the Israeli one, since the size of it provides many more opportunities and a broader data set. Outliers are less likely to dominate or skew.
  2. Many of the companies that have higher margins - and the only ones I can directly analyze without inside information - are publicly traded. These companies issue annual reports, and thus have all of their costs, at least at a high level, publicly available.
  3. Many of the Israeli companies with poor margins actually do the majority of their business internationally. Thus, their customers are the exact same customers, with the same pricing negotiations, as their US or European competitors with higher margins.

What I find most notable, however, is the insight this provides into the mentality of at least part of the Israeli business market. Many Israelis, due to their culture, are natural salesmen, doers, dealmakers. As such, they focus on constantly making a sale, and have the salesman's mentality. This is great for volume and top-line revenues. Unfortunately, if unrestrained by a CEO with an eye on profits, can lead to many low gross-margin deals. This focus on sales at the (possibly unconscious) expense of profits leads to higher revenues, low profitability, and poor return on investment for investors.

Israeli companies appear to be trapped in the mindset of "deal at any price." In order to grow into profitably, Israeli firms need to learn the investor's profit mantra, how to measure deals based not on their revenue but their margin, and learn to differentiate their products and services sufficiently, at least in their customers' views, so that they can charge rates with sufficiently high gross margins. Their problem is one of both marketing and sales.