Toys R Us – How Bad Assumptions Fed Bad Financial Planning Creating Failure

Toys R Us – How Bad Assumptions Fed Bad Financial Planning Creating Failure

Toys R Us filed for bankruptcy this week.  And the obvious response was “another retailer slaughtered by Amazon and on-line retailing.”  But this conclusion comes short of describing why Toys R Us leadership did not do the obvious things to keep Toys R Us relevant.

Amazon and WalMart both eclipsed Toys R Us in toy retail sales.
Chart courtesy of Felix Richter, Statista

Everyone, and I mean everyone, knew over the last decade that customers were buying more stuff on-line, including toys. And everyone also knew that WalMart was pushing extremely hard to keep customers going to their stores by offering products like toys at low prices.  And, it was clear that customers were shifting to buying more toys from both these retailers.  If this was so obvious to everyone, why didn’t Toys R Us leadership do something?  After all, Toys R Us is a multi-billion dollar revenue company.

The LBO

It was over 30 years ago when financiers discovered they could buy a company, sell off some assets and otherwise increase the company’s cash, then convince banks and bondholders to load the company with debt.  These financiers would then pull out the cash for themselves, and leave the company with a ton of debt.  The LBO (leveraged buy out) was born, invented by investment bankers like KKR (named for founders Kohlberg, Kravis & Roberts.) They would use a small bit of private equity, and then use the company’s own assets to raise debt money (leverage) to buy the company.  By “restructuring” the company to a lower cost of operations, usually with draconian reductions, they would increase cash flow to make higher debt repayments.  Then they would either take the money out directly, or take the company public where they could sell their shares, and make themselves rich.  This form of deal making birthed what we now call the Private Equity business.

In 2005, KKR and Bain Capital (which included former Presidential candidate Mitt Romney) bought Toys R Us for about $6.6billion, plus assuming just under $1B of debt, for a total valuation of $7.5billion.  But the private equity  guys didn’t buy the company with equity.  They only put in $1.3billion, and used the company’s assets to raise $5.3billion in additional debt, making total debt a whopping $6.2B.  Total debt was now a remarkable 82.7% of total capital!  At the time of the deal interest rates on that debt were around 7.25%, creating a cash outflow of $450million/year just to pay interest on the loans.  At the time Toys R Us was barely making a profit of 2% – so the debt was double company net profits.

KKR and Bain buy Toys R Us logos

Debt led to bad management decisions and ultimately bankruptcy of the U.S. company

The biggest assumption behind a debt-financed takeover is that the company can cut costs to improve cash flow and thus pay the interest.  But behind that assumption is an even bigger assumption.  That the marketplace won’t change dramatically.  The KKR and Bain Capital leaders assumed they could shrink Toys R Us in a way that would lower operating costs.  They also assumed they could sell some under-utilized assets to raise cash.  They did not assume they would need contingency money if competition, and the marketplace, changed in some unplanned way.

eCommerce was pretty new in 2005.  Amazon was an $8.5 billion company, but it didn’t make any profits and very few predicted then it would become today’s $100 billion behemoth.  Because the financiers didn’t anticipate a big market shift to ecommerce, they focused on the war with Walmart and Target.  Their plans were to lower operating costs, close some stores that were underperforming, license some offshore stores, and sell some assets (like real estate owned or leases) to raise cash and repay the debt.

amazon.com toy car screen shot

But they weren’t prepared to take on another, entirely different competitor on-line.  As Amazon’s growth affected all retailers, Toys R Us simply did not have the resources to fight the traditional discount and dollar brick-and-mortar retailers, and build a major on-line presence, and keep paying that debt. While it is easy to sit on the sidelines and say that Toys R Us should have spent more money building its on-line presence in order to remain relevant, the fact is that the deal in 2005 left the company with insufficient cash flow to do so.  Regardless of what leadership might have wanted to do, simply keeping the lights on was a tough challenge when having to pay out so much cash to bondholders.

And the investors simply did not expect that the growth of on-line retailing would stall traditional retail stores, thus creating a major loss of value for retail real estate.  U.S. retail real estate value had increased in value for decades.  The assumption was that the real estate, whether owned or leased, would continue to go up in value.  Real estate was a “hard” asset that KKR and Bain Capital could bank on for raising cash to repay the debt.  But as on-line retail grew, and traditional retail declined, America became “over stored” with far too much retail space.  Prices were shattered in many markets, and it was not possible for Toys R Us to sell those assets for a gain that would meet the debt obligations.

With $400 million of debt coming due next year, Toys R Us simply doesn’t have the cash flow, or assets, to repay those bondholders

Old assumptions about finance are a big problem for companies today.  Assumptions about “leveraging” hard assets, and intangibles like brand value, are no longer true.  Competitors emerge, markets change, and old assets can lose value very fast.  Assumptions about business model stability are no longer true, as new competitors using newer technology create new ways to sell, and often at lower cost than was ever expected.  Assumptions about customer loyalty, and market share stability, are no longer true as new competitors appeal to customers differently and cause big shifts in buying behavior very fast.  The speed with which technology, competitors, markets and customers shift now requires companies have the funds available to invest in change.

This story isn’t just about debt.  The very popular activity of “returning money to shareholders by repurchasing stock” is a terrible idea.  Stock repurchases do not make a company more valuable, nor a stronger competitor.  Instead they burn through cash to reduce the company’s capitalization, and manipulate ratios like EPS (earnings per share) and P/E (price/earnings) multiple.  Stock repurchases hurt companies, and make them less competitive.  Good companies return money to shareholders by investing in growth, which raises sales, profits and increases the stock price making the company truly more valuable.

Toys R Us isn’t a story about Amazon, or eCommerce, taking out another retailer

A&P Family store 1950's painting

The important part of the Toys R Us story is realizing that the wrong financial decisions can doom your organization.  You can have a great vision, and even great ideas about new ways to compete.  But if you don’t have the money to invest in growth, it won’t happen.  If leaders don’t have the money to spend on new projects and new markets, because they’re sending it all to bondholders or using it to  repurchase shares in hopes of propping up a stock price, eventually there will be a market shift that will doom the old business model and leave it unable to compete.

To succeed today leaders need the money to invest in change, and they have to constantly invest it in change, or their companies will lose relevancy and end up like Toys R Us, Radio Shack, Circuit City, Aeropostale, The Limited, Payless Shoes, Gander Mountain, Golfsmith, Sports Authority, Borders Books and the great, original American retailer A&P.

The Case For Trian’s Nelson Peltz Joining P&G’s Board

The Case For Trian’s Nelson Peltz Joining P&G’s Board

Months ago Trian’s Nelson Peltz began buying Procter & Gamble (P&G) shares.  He invested about $3.5 billion, making Trian’s ownership 1.5%.  Since then he has been lobbying, unsuccessfully, for a seat on P&G’s board of directors.  He has said that although P&G already has 10 outside directors on its 11 member board, adding him would make a tremendous difference increasing P&G’s market valuation.  P&G is now the largest company ever to engage in a proxy battle between the existing board and an outside investor.

Today, Peltz offered his plan to change P&G, continuing his attack on management, saying that P&G has not sufficiently cut costs, nor has it created growth via innovation – citing no new innovation platform since Swiffer was introduced almost 20 years ago.  He attacked the company for selling off brands without returning sufficient funds to shareholders.  He believes management’s targets are too low, and it is too easy for managers to make their bonus.  He also believes there is a need to hire more managers from outside the company.

He informed the company if he were a director he would reorganize the company to make it more streamlined, change the compensation plan, and do a better job of cutting costs.

P&G is dead set against adding Peltz, saying he would disrupt the board, and the company, in negative ways. CNBC.com reported Peltz’ claims the company is spending $100 million on the proxy fight to keep him off the board. P&G’s proxy statement puts that sum at $35 million.  Either number indicates P&G is spending a lot of money to stop the appointment of Peltz.

Nelson Peltz, Trian Partners

Nelson Peltz, Founder Trian Partners, LLC

The company defended itself, saying leadership has been growing EPS (earnings per share,) making productivity improvements, growing sales organically at 2%/year and returning huge value to shareholders.  They accuse Peltz of simply planning a split of the company into 3 parts so each can go public on its own – adding little value to shareholders while damaging the company’s ability to operate.

Unfortunately, P&G’s leadership has pretty much set itself up for this battle.  And shareholders may have good reason to add Peltz to the board in hopes of additional change.

P&G’s financial performance has been poor

Firstly, in the last 10 years the value of P&G has risen about 44%. But the S&P 500 has grown by 154.5%.  Shareholders would have done better owning the average than owning P&G.  Claims about how well P&G have done since the CEO arrived 2 years ago overlook the fact that just prior to his arrival, in November, 2014 P&G shares traded at $90-$93.85/share, which is just about where they are now.  So all that’s happened is a recovery to where things were previously, not a great success.  Shareholders have a right to be frustrated.

EPS has risen, but that has everything to do with share buybacks rather than earnings growth.  EPS has risen about 11%.  But since 2nd quarter of 2007 P&G has spent ~$61billion on share repurchases, reducing the number of shares from 3.32 billion to 2.74 billion, or 17.5%.  Rather than growing earnings, leadership has been making the capital structure smaller – and thus EPS has risen while earnings have not.  This is actually a program that goes all the way back to 1995, which indicates a long-term approach of focusing on EPS, which are manipulated, rather than earnings.

P&G has favored divestitures and share repurchases over innovation and acquisitions for growth

Meanwhile, P&G’s buyback program has been financed by a dramatic divestiture program, selling off very large businesses to raise cash.  Over the last decade major sales included:

2009 – selling the P&G pharma business
2012 – selling the water filtration business including Pur
2012 – selling Pringles (along with several other iconic brands)
2014 – selling the dog food business
2016 – selling the Duracell battery business
2016 – selling the beauty brand business

Management tried in its response to say that innovation was just fine at P&G.  But what it cited were line extensions like Tide PODs, GAIN Flings, Pampers Pants, and Oral B power toothbrush.  None of these are great new innovations launching significant sales.  None are new product platforms for high growth.  Rather they are typical sustaining innovations applied to brands that are long in the tooth.

This is typical of the long-term lack of valuable innovation at P&G. Do you recall in 2009 when the company lauded its development of the “P&G Public Toilet Database App?” Not exactly on the top 20 iTunes list.  Or do you remember in 2014 when P&G launched its “Basic” line of products, where it literally sold a less-good quality product hoping to attract a brand-conscious but quality uncaring targeted niche?  Peltz is making a good point, that leadership at P&G really has forgotten what good, long-term profit producing innovation is, while succumbing to the strategy of selling major business units (reducing revenue) then using the money to buy back shares rather than investing in future growth.

P&G has not shown it understands how trends are quickly changing its business

Meanwhile, the consumer goods industry is changing dramatically, and it is not clear that P&G’s leadership is really preparing for future changes.  P&G still relies heavily on television advertising to sell its products. But that approach had stopped generating profitable growth as far back as 2010. Back then Colgate was holding its market share, and growing revenues, on all its brands that compete with P&G while spending 25% less, and often much less, on advertising.

 

P&G is still stuck using marketing strategies that have been outdated for almost a decade. Comcast lost 90,000 subscribers in Q2, and the stock lost 7% today when Comcast management alerted investors it expects to lose 150,000 more in Q3.  And while viewership is declining, ad pricing is going up, making TV advertising a less effective and more expensive marketing tactic for consumer goods. As P&G brands have fallen further behind competitors in Instagram followers, and lack good social media programs like Wendy’s, Peltz has proposed a substantial increase in digitally savvy marketers.

P&G and Walmart logo

Simultaneously, distribution is changing dramatically.  Once P&G could rely on its product dominance to dictate space usage in grocery stores and discounters.  But the rise of e-commerce has dramatically affected these historical distribution channels.  Today the fastest growing grocer is Aldi, which eschews brands like P&G’s in favor of its own private label.  And after stunting the growth of discounters like WalMart, the leading e-commerce company, Amazon.com, has now purchased Whole Foods.  This is leading everyone to expect greater growth in on-line grocery shopping and additional at-home delivery, which undercuts the former strength P&G had in traditional brick-and-mortar stores with warehouse delivery models.

Management bragged of its $3 billion in e-commerce sales, but that is a drop in the bucket.  Is P&G ready to compete for sales in future markets where social media is more important than advertising?  Where mobile ads have more power than print, TV, radio and traditional internet banners?  Where social media groups drive more consumption behavior than company-sponsored social media pages with coupons and use recommendations?  Will P&G dominate product volume when it has to rely on Amazon.com and other sites to sell and deliver its products?  If people move to daily home deliveries, and less stock-up purchasing what will happen to P&G’s former brand advantage via high numbers of SKUs (stock keeping units) and large packaging options?

This will be an interesting proxy battle.  There is no doubt Peltz wants to shake up the board’s behavior, compensation plans, hiring programs, targets and many of the ways management runs the company.  Simultaneously, the P&G board believes it is moving in the right direction.  Large shareholders are conservative, and don’t like to create problems (P&G’s largest shareholders are Vanguard, Blackrock, State Street, BofA, Capital World, Trian, Northern Trust – which combined control 24% of P&G stock.)

But this isn’t about a complete change in the board.  It’s just a vote to add one additional member who is not happy with things the way they are.  Will these large shareholders see a need for someone to shake things up, or will they accept current leadership’s claims that things are on the right track?

It will be interesting to watch, because Peltz isn’t without some objective concerns about P&G’s future, given its performance the last decade and the amount of change facing the industry.

Uber: Be Very Careful Before Hiring Jeff Immelt As CEO

Uber: Be Very Careful Before Hiring Jeff Immelt As CEO

We learned last week that Jeff Immelt is a front-runner to be the next CEO of Uber.  There are many reasons to be concerned about this possibility.

Uber has received nothing but bad news for a while now:

Amidst these scandals, Uber’s big investors are writing down the value of their Uber holdings by 15%. After pushing the board for new leadership, and restructuring, it appears investors are losing faith in the company.
This puts the board in the hot seat.  Investors want a new CEO that will eliminate the scandals.  They want stability at the company.  Reeling from so much bad news, they want someone atop the organization who will “right the ship” with “a steady hand on the tiller” so they can regain confidence.  Amidst the turmoil, and the need to please investors, an executive who spent 35 years at GE, and over a decade in the top job, probably sounds like a good candidate.  He’s known as a stable guy, numbers-focused, genteel, well-schooled (Harvard MBA) and above all “seasoned.”
Delete uber app screen image

But the stakes are incredibly high.  Picking the wrong person at this moment could well lead to a horrible long-term outcome.  While meeting short-term needs sounds like the #1 goal right now, for Uber to succeed means putting someone in the CEO job who can guide the tech company through a decade or more of tough decisions in a fast-paced market.  Other boards have suffered horribly from making this decision hurriedly and poorly.

Remember the CEO turmoil at Yahoo:

  • Yahoo was an early leader on the web, first in search, content distribution, on-line sales and advertising under CEO Tim Koogle from 1995-2001.
  • Due to controversies (remember when he sold Nazi memorabilia?) he was replaced by proven media exec (25 years at Warner Brothers) Terry Semel from 2001-2007. He’s the one who missed the opportunities to buy Google and Facebook.
  • Worried the company needed more pizzazz to catch leapfrogging competitors, the board brought back founder Jerry Yang for 17 months (2007-2008).
  • When sales didn’t improve the board brought in brash, blunt speaking Carol Bartz, CEO of Autodesk, to turn around the company (2009-2011.) After months of cost-cutting but no sales improvement, she was gone.
  • In January 2012 the board hired the President of Paypal, Scott Johnson, as CEO. But 5 months later he was fired for lying on his resume.
  • Amidst a need to find someone to lead the company long-term, in 2012 the board hired Google darling Marissa Mayer as CEO.  She left when Yahoo dissolved.
yahoo logo
twitter logo
apple logo

Or how about Twitter:

  • From 2007-2008 Jack Dorsey was the founder who drove growth and early funding.
  • Dorsey was replaced by Evan Williams (2008-2010) who was to supply a steadier, more seasoned hand at the top.
  • Looking to grow and go public, the board replaced Williams with Dick Costolo (2010-2015). Although the IPO went well, lack of investor enthusiasm led to stock weakness.
  • In 2015 Costolo was replaced by the returning Dorsey. He supposedly would rejuvenate the company. Since his return the stock has dropped about 50% amidst concerns regarding insufficient user and revenue growth.

But this is not a new problem in tech.  Remember the CEO litany at Apple:

  • Apple’s first CEO (1977-1981) was Michael Scott from National Semiconductor, brought in to support the inexperienced Steve Jobs and Steve Wozniak. But he was unable to get along with the founders, and built a reputation of firing those he didn’t like.
  • Mike Markkula, Apple’s early investor and 3rd employee, replaced Scott as CEO from 1981-1983.
  • Hoping to put someone with a better pedigree, more big-company experience and a steadier hand in the top job, Markkula hired John Sculley (former Pepsi CEO) to Apple’s top job in 1983. Markkula agreed with Sculley to fire the mercurial Jobs in 1985. Sculley remained CEO until 1993, when he was removed as Apple lost the war with Microsoft for corporate desktops and sales tanked.  Sculley, the much heralded, experienced corporate leader, ended up ranked the 14th worst CEO of all time by Conde Nast Portfolio.
  • The board replaced him with insider Michael Spindler (1993-1996) who tried to sell Apple to IBM, Sun and Philips, but failed.
  • Spindler was replaced by Gil Amelio (1996-1997) former CEO of National Semiconductor, who was considered the kind of mature, dedicated leader Apple needed. As Apple shares slumped to all time lows, he bought Jobs-owned NeXt.
  • Jobs (CEO 1997-2011) succeeded in convincing the Board to fire Amelio. Jobs subsequently fired the board. The rest is well documented.

Jeff Immelt is no Steve Jobs

Clearly, Uber’s board needs to find a Steve Jobs.  And by all accounts, for all his skills, Jeff Immelt is NOT a Steve Jobs.  During his tenure as CEO of GE things might have been boring, but the company also lost a third of its revenues, and a third of  its market cap.  After more than a decade of stagnation, Immelt was forced out.  It is hard to imagine he is the right person to guide Uber, a high-tech company in a fast changing marketplace filled with techie employees who want a culture of rapid growth with opportunities to build fortunes in company equity.  To maintain its value Uber needs to keep growing at 20%+/year, and Immelt has no experience creating that sort of revenue success.

So what should the board look for?  Last summer Chris Zook and James Allen of Bain & Co. published their treatise on how to lead high growth companies The Founder’s Mentality – How To Overcome the Predictable Crises of Growth .  I interviewed Chris Zook last year, and he offered great insights that would be incredibly valuable for the Uber board now:

  1. Being great is hard. Most companies are focused on going from mediocre to good, far from going from good to great. Uber is the undisputed champion in ride-sharing today.  The leader must be unassailable as a visionary.  Someone who understands how to build a GREAT company.  The last CEO may have been problematic, but he built Uber – a tremendous business success.  The new leader has to be on a par with other leaders of companies considered great by the employees (and investors) or he will not be respected, and there will be more problems, not fewer.

 

 

  1. “Next Generation CEOs” (as Zook calls them) are flexible thinkers who can figure out the hidden core, and build on it. The incoming CEO of Marvel realized its core was story telling, not comics, and directed the company into films and other growth venues. Jobs realized Apple was more than the Mac, and tied the company to offering easy-to-use products that fit emerging mobile needs. Uber’s next CEO has to go deeper than the scandals and obvious business model to understand what made Uber the leader, and expand on that nugget of strength to keep the company growing, and beating competitors.  (Software for the gig economy?  Time sharing assets?)

 

  1. Blockages are what kill companies. Most big-company CEOs are great at creating organizational blockages to create stability. They tend to be numbers first, customers and technology second.  They put in place middle managers with the primary job of stopping behaviors that could be problematic.  They instill “no” in order to stop mistakes.  Do not ever forget the Sculley/Apple experience.  The next Uber CEO has to be willing to operate in a culture with few barriers, direct access from the bottom employee to the CEO, and the ability to move quickly to deal with problems rather than attempting to eliminate the possibility of problems.
  1. The CEO has to be willing to make big bets. Today markets move fast. Leaders have to project trends, understand where customers are headed and place big bets that keep the company on top.  Think about Bezos pushing Amazon to implement Prime, and buying Whole Foods.  Think about Jobs directing Apple’s massive bet on mobile and the iPod.  Think about Reed Hastings making the big bet at Netflix on streaming, and more recently on original content.  To be a successful leader today of a growth company is not for the timid, nor for those who want to make small, progressive bets over time.  It requires vision, the willingness to make big bets and the ability to convince your employees, your board of directors and your investors to buy into that bet.

The Uber board is apparently a bit tired of their search.  Perhaps that’s because they aren’t looking for the right kind of person.  As Mr. Zook told me, you rarely find leaders with a “Founder’s Mentality” through a search firm.  You find them already competing, offering insight, doing new things in situations where the competition is intense.  Like Jobs was at Pixar, and NeXt.

The right leader is out there – we’ve seen the type in companies mentioned here, and others like Google and Facebook.  But you have to search for them intensely.  What seems very, very unlikely is that Mr. Immelt is “the right man for the job” at Uber today.

A Bitcoin Is Worth $4,000–Why You Probably Should Not Own One

A Bitcoin Is Worth $4,000–Why You Probably Should Not Own One

Even though most people don’t even know what they are, Bitcoins increased in value from about $570 to more than $4,300 — an astounding 750% — in just the last year.  Because of this huge return, more people, hoping to make a fast fortune, are becoming interested in possibly owning some Bitcoins.  That would be very risky.

Bitcoins are a crypto-currency.  That means they can be used like a currency, but don’t physically exist likeBitcoin dollar bills.  They are an online currency which can be used to buy things.  They are digital cash that exist as bits on people’s computers.  You can’t put them in a drawer, like dollar bills or gold Krugerrands.  Bitcoins are used to complete transactions – just like any currency.  Even though they are virtual, rather than physical, they are used like cash when transferred between people through the web.

Being virtual is not inherently a bad thing.  The dollars on our financial institution statement, viewed online, are considered real money, even though those are just digital dollars.  The fact that Bitcoins aren’t available in physical form is not really a downside, any more than the numbers on your financial statement are not available as physical currency either. Just like we use credit cards or debit cards to transfer value, Bitcoins can be spent in many locations, just like dollars.

What makes Bitcoins unique, versus other currencies, is that there is no financial system, like the U.S. Federal Reserve, managing their existence and value.  Instead Bitcoins are managed by a bunch of users who track them via blockchain technology.  And blockchain technology itself is not inherently a problem; there are folks figuring out all kinds of uses, like accounting, using blockchain.  It is the fact that no central bank controls Bitcoin production that makes them a unique currency.  Independent people watch who buys and sells, and owns, Bitcoins, and in some general fashion make a market in Bitcoins.  This makes Bitcoins very different from dollars, euros or rupees.  There is no “good faith and credit” of the government standing behind the currency.

Why are currencies different from everything else?

Currencies are sort of magical things.  If we didn’t have them we would have to do all transactions by barter.  Want some gasoline?  Without currency you would have to give the seller a chicken or something else the seller wants.  That is less than convenient.  So currencies were created to represent the value of things.  Instead of saying a gallon of gas is worth one chicken, we can say it is worth $2.50.  And the chicken can be worth $2.50.  So currency represents the value of everything.  The dollar, itself, is a small piece of paper that is worth nothing.  But it represents buying power.  Thus, it is stored value.  We hold dollars so we can use the value they represent to obtain the things we want.

Currencies are not the only form of stored value.  People buy gold and lock it in a safe because they believe the demand for gold will rise, increasing its value, and thus the gold is stored value.  People buy collectible art or rare coins because they believe that as time passes the demand for such artifacts will increase, and thus their value will increase.  The art becomes a stored value.  Some people buy real estate not just to live on, but because they think the demand for that real estate will grow, and thus the real estate is stored value.

But these forms of stored value are risky, because the stored value can disappear.  If new mines suddenly produce vast new quantities of gold, its value will decline.  If the art is a fake, its value will be lost.  If demand for an artist or for ancient coins cools, its value can fall.  The stored value is dependent on someone else, beyond the current owner, determining what that person will pay for the item.

Assets held as stored value can crash

Tulip photo with value lineIn the 1630s, people in Holland thought of tulip bulbs as stored value.  Tulips were desired, giving tulip bulbs value.  But over time, people acquired tulip bulbs not to plant but rather for the stored value they represented.  As more people bought bulbs, and put them in a drawer, the price was driven higher, until one tulip bulb was worth 10 times the typical annual salary of a Dutch worker — and worth more than entire houses.  People thought the value of tulip bulbs would  go up forever.

But there were no controls on tulip bulb production.  Eventually it became clear that more tulip bulbs were being created, and the value was much, much greater than one could ever get for the tulips once planted and flowered.  Even though it took many months for the value of tulip bulbs to become so high, their value crashed in a matter of two months.  When tulip bulb holders realized there was nobody guaranteeing the value of their tulip bulbs, everyone wanted to sell them as fast as possible, causing a complete loss of all value.  What people thought was stored value evaporated, leaving the tulip bulb holders with worthless bulbs.

While a complete collapse is unlikely, people should approach owning Bitcoins with great caution. There are other risks. Someone could hack the exchange you are using to trade or store Bitcoins. Also, cryptocurrencies are subject to wild swings of volatility, so large purchases or sales of Bitcoin can move prices 30% or more in a single day.

Be an investor, not a speculator, and avoid Bitcoins

There are speculators and traders who make markets in things like Bitcoins.  They don’t care about the underlying value of anything.  All they care about is the value right now, and the momentum of the pricing.  If something looks like it is going up they buy it, simply on the hope they can sell it for more than they paid and take a profit on the trade.  They don’t see the things they trade as having stored value because they intend to spin the transaction very quickly in order to make a fast buck.  Even if value falls they sell, taking a loss.  That’s why they are speculators.

Most of us work hard to put a few dollars, euros, pounds, rupees or other currencies into our bank accounts. Most of those dollars we spend on consumption, buying food, utilities, entertainment and everything else we enjoy.   If we have extra money and want the value to grow we invest that money in assets that have an underlying value, like real estate or machinery or companies that put assets to work making things people want.  We expect our investment to grow because the assets yield a return.  We invest our money for the long-term, hoping to create a nest egg for future consumption.

Unless you are a professional trader, or you simply want to gamble, stay away from Bitcoins.  They have no inherent value, because they are a currency which represents value rather than having value themselves.  The Bitcoin currency is not managed by any government agency, nor is it backed by any government.  Bitcoin values are purely dependent upon holders having faith they will continue to have value.  Right now the market looks a lot more like tulip mania than careful investing.

Five Reasons I Regret Writing About Millennial Entrepreneurs

Recently, I wrote a column about 10 young entrepreneurs.  Originally I titled it “10 under 20” but the Forbes editors thought that was too close to their “30 under 30” column so they changed it to “10 Great Lessons From Millennial Entrepreneurs.”  I didn’t like that title, because it implied these were “great” entrepreneurs, and I really didn’t think they were all that great.  Now that some time has gone by, I really regret having written the column.

1 – PR Inundation

I’ve written this column at Forbes for almost 7 years.  So I am pitched for unsolicited columns every day by PR firms.  On average, about 10 pitches every day. But nothing compared with the onslaught of emails I received after the millenial column.  Firm after firm, and even individuals, contacted me by email, on Facebook, Linked-in, and Twitter to tell me about some incredible young person who just absolutely needed to be written about.  You would think that every high school, and small university, in America had at least one, if not multiple, young prodigies all of which were destined to change the world.  It was an avalanche of pitches, from which I could not even begin to fully read, much less respond.

But, almost universally these businesses were not that fantastic.  Most were the modern day equivalent of someone opening a lawn service in 1960. Simple businesses that had little to distinguish them. Many had no revenues, and many were little more than somebody’s idea of a business they would like to build.  Those that had revenues were so small as to be meaningless, and almost none made any impact on their industry or competition.

The pitches were, without a doubt, the most hyped pitches I have ever received. Over and over I kept asking “why would anyone think this is in the slightest interesting?

Multitasking PR person

The only reason this is being pitched is because it involves someone under the age of 25.  And usually that someone lacks any credentials and offers no new insight to the industry or product.”

2 -Not a sustainable business

Writing an app is not a business.  Even if it sold a few thousand copies. Nor is trading baseball cards, or selling someone else’s stuff on eBay.  Nor is buying bitcoins.  By and large, 99% of the pitches were for one-product opportunities that clearly lacked any sense of being a sustainable business which could produce recurring revenue over multiple years.  Almost none had any employees, and those that did had a mere handful with no plans to scale any larger.

At best most were simply a single shot situation which generated some revenue for the millennial founder. And most could only pay the founder because the business had no overhead and a highly subsidized cost structure due to support from parents.  Many had no, or little, profits and there was nowhere near enough cash to repay traditional investors.  Because there was no cost for financing, overhead or even variable activities like payroll, these businesses could not be considered a success in any traditional sense.

3 – These were not really entrepreneurs

Jean Baptiste Say, French economist

French economist Jean-Baptiste Say coined the term entrepreneur. He used it to describe people who seek out inefficient uses of resources and capital then redeployed them into more productive, higher-profit uses.  None of the pitched businesses actually redeployed any resources.  And none really developed a new industry that created greater productivity.  These were just ideas that manifested into a product that fit an immediate need.  Most used an existing infrastructure, such as an app store, to do one thing – like sell an app.  Maybe someday they’ll write another – but there was no indication any research was happening, customer analysis or market testing to create a long-term business.

Additionally, for entrepreneurs there is some element of risk-taking.  For taking risk, by investing in something where others won’t invest, there is the opportunity for outsized returns.  But these folks didn’t take any risk at all.  It wasn’t their money they invested, but rather their family’s.  Most either lived at home, or lived in housing paid for by family (such as a college dorm room.)  Most had nothing invested in their “business” other than personal time, and if this failed there was almost nothing lost.  And most had minimal gains relative to the size of the risk they undertook with other people’s resources.

And they all lacked any sense of a business plan.  Now I’m all for innovation and trying new things, but business success requires the ability to generate ongoing revenue for a prolonged period that covers all costs and creates returns for investors.  These folks simply promoted ideas with no description of how this was to be a long-term profitable venture that succeeded for customers, suppliers and financial backers.  I found that I would not have been an investor in hardly any of these “businesses” and surely would not recommend readers to back them.

4 – These folks were big self-promoters, not business promoters

Almost to a pitch every story was about some individual – not a business success.  I was told over and over and over about how some 17, 18, 19 or 20 year old was absolutely a genius; a modern miracle of incredible business insight.  Yet, there was little to back-up these claims.  In the end, these were just young folks who had some sense of ambition and fortitude that were doing a few experiments and had (in some instances, not all) sold a few things.  But their stories really weren’t that interesting.

One young fellow washed vehicles.  He got a contract to wash trucks.  And he had expanded his truck washing capability to multiple trucking companies.  OK, ambitious and hard working.  But nothing fantastic.  No technology breakthrough.  Just a basic service that he sold cheaply enough to win some contracts.  But, he was unwilling to discuss his margins, how much he paid himself or others and how he financed the company or paid a return to his backers.  Yet, he was certain that he could franchise his truck washing business and soon enough he would be the next Ray Kroc.  He, and his PR person (and it was unclear who paid her) failed to realize that his story might be interesting in 20 years after he proved he could build the next McDonald’s making himself, his investors and his franchisees rich.

Add onto this the fact that almost all of these people had nothing good to say about anyone older.  For some reason I was informed over and again that nobody over 40 could really understand how brilliant this person is, and how guaranteed was future success.  These people universally had no value for advice from people older than them, senior woman meetingno value for those with experience (all experience was seen as irrelevant to their brilliant insight,) and no value for education.  There was no reason to study business practices, or even business history, much less anything like engineering, because they simply had taught themselves all they needed to know – and if they needed to know anything else they would teach that to themselves as well.

I kept saying to myself “get over yourself kid. You are working hard, but so are a lot of other people.  You really haven’t accomplished anything of merit yet.  And there’s not really anything here that indicates you will achieve great things.  You may win awards for just showing up at school, or at the soccer match, but in business you have a LOT more to prove than you can show up and possibly accomplish some of the basics.  Once..”

5 – No sense of how to build something, or even engage in quid pro quo

Bill Gates built a company that produced software millions of people wanted.  Steve Jobs built a company that made devices (computers initially) that millions wanted.  Henry Ford made cheap cars that millions of people wanted. Mark Zuckerberg created an interaction engine that millions of people wanted (and advertisers would pay to reach.) These founders understood that building a successful business meant combining multiple resources into an organization that functions capably to build products and markets.

If you asked them “why should I write about you?” they would answer, “to tell folks about the improvement in their life from my company’s products.”

When I asked these millennial entrepreneurs why I should write about them, the answer was “because I’m young and great and going places.”

Worse, when I pointed out that in today’s world columnists rely on readers, and therefore columnists want to know the topic will generate reads, they were without even a good idea of how a column on them would generate reads.  When I asked “will you promote this through a large social media conduit to drive readers to the column?” they responded with “but isn’t that what Forbes does, bring in readers?  I think you should write about me so Forbes readers can become enlightened.  Why should I be asked to promote your column, isn’t that what you and Forbes do?”

Conclusions

It was completely unclear to me who was paying for these PR firms.  But to them, and to the hundreds of millennials who sent me Facebook, Linked-in and Twitter messages:

  1. Quit focusing on yourself and actually accomplish something.  Don’t be proud you’re a drop-out, go finish school.
  2. Listen more and talk less.  You really don’t have much that’s interesting to say.  Pay attention to those who are older, wiser and could help you reach your goals.  You need them, and most of them don’t need you.  You’re really not as interesting as you think you are.
  3. Get some education.  Bill Gates and Steve Jobs are my age – not yours.  Every generation needs more skills than the one before it.  Mark Zuckerberg is THE exception, not the rule.  Dropping out of Harvard did not make him great.  Before you decide you have all the answers, go learn what the questions are.  Learn how to think, how to reason, before you decide you know all that’s needed to take action.
  4. Quit living on subsidies.  If your parents or grandparents or aunts and uncles are paying for your rent, or car, or supplies then you still don’t understand basic economics.  Become self-sufficient.  Make enough money to buy your own new car, buy your own house, and pay 100% of your bills – and even enough that you could afford to raise children. Until you are self-reliant it is very hard to take you seriously as a business leader.
  5. Life is NOT a one-round event.  You are very likely to live 100 years.  Do you have the skills to maintain your lifestyle for that full 100 years? Quit crowing about the 1 success (by your definition) you’ve had so far and instead figure out how you’ll lead a productive 100 year existence.  You’re only 20% of the way there.

I hear folks say we need to advance millennials onto boards of directors for public companies.  Or fund their new ventures without business plans or traditional benchmarks. Or put them into highly placed positions of major corporations. I can’t agree with that.  From what I observed, millennials are similar to all other young people. They don’t know what they don’t know.  And only time, failures, successes, education (formal and informal) and hard work will prepare them to be tomorrow’s leaders.

I started my entrepreneurial life while a college junior.  I was lucky enough to hook up with several people at least a decade older, and they found investors that were a generation older.  The company made computer hardware, and largely due to good luck as well as hard work the company was successfull, and was sold for a great return to the investors and some money for the founders.  Simultaneously I completed my undergraduate degree in 4 years, summa cum laude. What made me most excited about that experience was not trying to be featured in any journal, but rather that the folks at the Harvard Business School felt this experience was good  enough to admit me to their institution to complete an MBA.  And there is no doubt in my mind that what I learned in college, and grad school, was incredibly important to generating a lifetime of ongoing business accomplishments – long after that first company disappeared into the dustbin of obsolete technology.

President Trump: The 5 Reasons You Are Not A Disruptive Leader And Instead Create Chaos

President Trump: The 5 Reasons You Are Not A Disruptive Leader And Instead Create Chaos

The news was filled this week with stories about President Trump’s “unorthodox” management style. From tweeting his thoughts on replacing Attorney General Jeff Sessions, to tweeting his multiple positions on healthcare law changes, to hiring a new communications director who lets loose with expletive-laden rants, people have been left questioning what sort of leadership style President Trump is trying to display.

Donald Trump promised to be a “disruptive leader”

Donald Trump ran for office as an outsider who pledged to disrupt Washington politics.  This was a message well received by many people.  They felt that “business as usual” in national politics was not serving them well, so they wanted change.  To them a disruptor could find a way to steer national politics back onto a course that was more aligned with the conservative middle Americans.  These voters felt that a businessman entrepreneur just might be the kind of leader who could disrupt the status quo in order to get something done for them.

Unfortunately, things have not worked out that way.  And largely this can be traced to the leadership style of President Trump.  Rather than a dedicated disruptor, ready to implement change, President Trump has proven to be a chaos generator that has stymied progress on pretty nearly all issues.  Disruptions can lead to positive change.  Chaos leads to stagnation and degradation as the system searches for homeostasis and a path forward.

From early age, we are taught not to be disruptive.  Disrupting someone during school, religious ceremonies, entertainment events leads to distractions and an inability to remain focused on the goal.  Thus, we are mostly taught to listen, learn and do what we’re told.  However, we also recognize there is a time to be disruptive, because the act of intervening in the process at times can lead to far more positive outcomes than maintaining the course.

But it takes good judgement, and reasoned action, to be a positive disruptive influence.  If you are in a crowded theater and you recognize a blaze it is time to disrupt the stage presentation.  But you have a choice.  If you jump up and yell “fire” you will create chaos.  Everyone suddenly realizes a problem, but with no idea how to deal with it a thousand different solutions emerge simultaneously.  Everyone starts looking out for their own interest, and they trample those around them in an effort to implement their own plans.  Many people get hurt, and frequently the goal of saving everyone by disrupting the presentation is lost in carnage created by the bad disruption leading to chaos.

What is successful disruptive leadership?

So, if you sense a pending fire you are far smarter to develop a plan, such as activating the evacuation notices and opening the exits, prior to making an alert.  And then, instead of yelling “fire” you say to folks “an issue has developed, please make your way down the evacuation routes to the open exits while we deal with the situation.  Please remain calm so everyone can exit safely.”  Your disruption can lead to successful outcome, rather than chaos.

I’ve spent over 20 years focusing on how disruptions can lead to positive change.  And it is clear that with disruptive innovations, and disruptive business models, their success relies on leaders that understand how to implement disruptions effectively.  Leadership matters.

Disruptive leaders think very hard about their desired outcomes, and they go to great lengths to describe what those future, better outcomes will look like.  They then create a plan of action before they do anything.  While the innovation might well be known, they are very, very careful to think through how that innovation will be adopted, then nurtured to gain acceptance and hopefully become mainstream.  These leaders are very careful about their language choices, and where they communicate, in order to encourage people to accept their vision and join with their plan.  They seek adoption rather than confrontation, and they discuss the desired outcomes rather than the disruption itself.  They gain trust and build a consensus for change, and then they systematically roll out their plan, which they adjust as necessary to meet unexpected market conditions.  They gradually move people along the implementation route by relentlessly focusing on the better outcome and reducing the fear inherent in accepting the disruption.

Five ways Donald Trump fails as a successful disruptive leader:

  1. The President has not portrayed a superior outcome which he can use to rally people to his viewpoint.  Despite talking about “making America great again” there is no picture of what that looks like.  What is this future “great” America he envisions and wants us to buy into?  What are the poor outcomes of today that he will greatly improve, leading to vastly superior future outcomes?  Without a clear description of the future, it is hard to gain supporters.  For example, will changes in health care improve care?  Lower the cost? What are the benefits, the better outcomes, of change?  What is the benefit of replacing the sitting attorney general?
  2. The President has not laid out his plan for bringing people on board to his future. Look at the recent effort to implement new health care legislation. At times the President has said there is a need to repeal current legislation and replace it, but he has offered no description of what the replacement should look like.  At other times he has said to repeal current legislation, but he has offered no insight into how that would lead to better outcomes than the current legislation provides.  At yet other times he has said to do nothing, and he expressed his hope that current legislation would fail even though he admitted this would lead to an outcome far worse than the status quo.  By not creating a plan, and bringing people on board to his plan, he has created chaos in the legislative process.
  3. President’s Trumps messages are built on negative language, not positive language about the future. His messages are long on how some person or current situation is weak, rather than explaining what a strong future would look like. He frequently attacks his predecessor, or his former electoral opponent, but does little to say what is good about his Presidency or recommendations or what he is specifically going to do that will create better outcomes.  He frequently talks about firing people in his administration, but talks little about the specifics of what good work people in his administration are doing.  These language choices are exclusive, not inclusive, and they create chaos among those who work in his administration, and members of Congress.  Instead of understanding the President’s goals and objectives people are wondering “what will he say next?”  And by appointing a communications director who uses outrageous, unacceptable and incendiary language he further exacerbates the problem of everyone losing any insight to his message because we are stunned and amazed at the choice of language.
  4. President Trump has the ability to communicate from the most Presidential locations. He can provide TV, radio and internet addresses from the oval office, or the White House platform. He can invite media in for press conferences or interviews to discuss his goals and ambitions, plans and pending decisions.  Or he can make himself, or his staff, available for press interviews.  And while he does some of this, we all spend every day wondering what Tweet he will send over the Twitter social network next.  Several million people use Twitter. It is for social exchange.  For the President to announce policy positions (such as banning transgenders from military service) or evaluations of key subordinates (such as referring to the attorney general as weak) or military policy (such as opining on the potential retribution toward North Korea) via Twitter belies the nature of the office and his role.  His selection of communication venues only serves to make his comments less valuable, rather than more important.
  5. President Trump neither remains consistent in his communications, nor does he exert loyalty. Changes on health care and denouncing his own staff does not create trust. How are people in the legislature, regulatory agencies or military going to become advocates for his goals when they don’t know if he can be trusted to support their actions, or support them as employees?  If you want people to take a different course of action, to let go of the status quo, they have to trust you.  Disruptive leaders time and again must state their positions with clarity and demonstrate support for those who do their best to promote the disruptive agenda.  They battle fear of the future with clarity around their support for future outcomes those who help describe how the future will be better.

There are times for disruptive leadership.  Status quo models become outdated, and outcomes decline as a result.  Change offers the opportunity for better outcomes, and helping people migrate to new innovations helps them toward a better future.  But implementing innovation and change requires skill at being a disruptive leader.  If the process is bungled, you can look like the guy who started a deadly rampage by yelling “fire” when a more reasoned approach would have prevailed.  If you don’t follow the best practices of disruptive leadership, you will create chaos.

Like The Best Tech Companies, Publicis Launches A Great Strategic Pivot

Like The Best Tech Companies, Publicis Launches A Great Strategic Pivot

People like to discuss “strategic pivots” in tech companies.  The term refers to changing a company’s strategy dramatically in reaction to market shifts. Like when Apple pivoted in 2000 from being the Mac company to its focus on mobile, which lead to the iPod, iPhone, and other mobile products.  But everyone needs to know how to pivot, and some of the most important pivots haven’t even been in tech.

Take for example Netflix.  Netflix won the war in video distribution, annihilating Blockbuster.  But then, when it seemed Netflix owned video distribution, CEO Reed Hastings pivoted from distribution to streaming.  He cut investment in distribution assets, and raised prices.  Then he spent the money learning how to become a tech company that could lead the world in streaming services.  It was a big bet that cannibalized the old business in order to position Netflix for future success.

Analysts hated the idea, and the stock price sank.  But CEO Hastings was proven right.  By investing heavily in the next wave of technology and market growth Netflix soared toward far greater success than had it kept spending money in lower cost distribution of cassettes and DVDs.

(From L to R) Philippe Dauman, US actress and singer Selena Gomez, MTV President Stephen Friedman and US director Jon Chu attend a Viacom seminar during the 59th International Festival of Creativity – Cannes Lions 2012, on June 21, 2012 in Cannes, southeastern France. The Cannes Lions International Advertising Festival, running from June 17 to 23, is a world’s meeting place for professionals in the communications industry.  (VALERY HACHE/AFP/GettyImages)

This week Arthur Sadoun, the CEO of the world’s third largest advertising agency (Publicis) announced he was betting on a strategic pivot.  And most in the industry questioned if he made a good decision.

Simply put, CEO Sadoun announced at the largest ad agency awards conference, the Cannes International Festival of Creativity, that Publicis would no longer participate in Cannes.  Nor would it participate in several other conferences including the very large South by Southwest (SXSW) and Consumer Electronics Show (CES.)  Instead, he would save those costs to invest in AR (artificial or augmented reality.)

In an industry long dominated by highly creative people who love mixing with other agency folks and clients, this was an enormous shock.  These conferences were where award winners marketed their creative capability, showing off how much they were admired by peers.  And they wined and dined clients seeking to build on awards to gain new business.  No one would expect any major agency to drop out, and most especially not an agency as large as Publicis.

In changing markets strategic pivots make sense.

And strategically this pivot makes a lot of sense.  The ad industry was once dominated by ads placed in newspaper, magazines and on TV.  But today print journalism is almost dead.  The demand for print ads is a fraction of 20 years ago.  And TV is no longer as prevalent as before.  Today, people spend more time looking at their smartphone than they do their TV.  The days of thinking high creativity would lead to high sales are in the past.  Fewer and fewer big advertisers care about who wins awards, and fewer are going to these conferences to decide who they would like to hire.

Today advertising is going “programmatic.”  Increasingly ads are placed by computers, on web and mobile sites.  Advertising is about finding the right eyeballs, at the right time, next to the right content in order to find a buyer.  Advertisers no longer spend money lavishly on mass media hoping for good results.  Instead ads are targeted, measured for response and evaluated for ROI based on media, location, user and a raft of other metrics.

And the industry has changed.  There still is an advertising agency business.  But it is under attack from tech companies like Google, Facebook, Twitter and Snap that promote to advertisers their ability to target the right clients for high returns on money spent.  The content is important, but today almost everyone in the industry will tell you success depends on your budget and how you spend it, not the creative.  And that is a lot more about understanding how we’re all interconnected, knowing how to measure device usage, profiling user behavior and programming the computers to put those ads in the right place, at the right time.

To pivot you must stop doing the old to start doing the new

Publicis has something like $10B in revenue.  Thus, dropping $20M on filing award applications at events like Cannes, and sending a contingent of employees to receive awards, meet people and have fun doesn’t sound like a lot.  But multiple that across the year and the total amount could well come to $100M-$200M.  That’s still only 2% of revenues – at most.  It would seem like not that much money given what has been a core part of historical marketing.

But, if Publicis is to compete in the future with the tech leaders, and emerging digital-oriented agencies, it has to develop technology that will make it a leader.  Publicis can’t invent money out of thin air, so it has to stop doing something to create the funds for investing in what’s coming next.  And stopping investing in something as “old school” as Cannes actually sounds really smart.  As boomer ad execs retire the newer generation is not going to conventions to find agencies, they are looking under the hood at the technology engines these companies provide.

In new strategic areas a little money can go a long way

And while $100M to $200M may not sound like a lot, it is enough money to make a difference in creating a tech team that can work on future-oriented technology like AI.  If spent wisely, that could truly move the needle.  If Publicis could demonstrate an ability to use proprietary AI technology to better place ads and manage the budget for higher returns it can survive, and perhaps thrive, in a digitally dominated ad industry future.  At the very least it can find its place next to Facebook and Google.

WPP, Omnicom and Interpublic should take serious notice.  Will they succeed in 2025 if they keep marketing the way they did in 1985?  Will this spending grow revenues if customers really don’t care about creative awards?  Will they remain relevant if  they lack their own technology to develop ads, campaigns and demonstrate positive rates of return on ad dollars spent?

CEO Sadoun’s approach to make the announcement without a lot of preliminary employee discussion shocked a lot of folks.  And it shocked the festival owners who now have to wonder what the future of their business will be.  But strategic pivots are shocking.  They demonstrate a dramatic shift in how resources are deployed to position a company for the future, rather than simply trying to defend and extend the past.

It’s a lot smarter to try what you don’t know than hope everything will stay the same.

Will this work?  There is no way to know if the Publicis leadership team can maneuver through the technology maze toward something great.  But, at least they are trying.  And that alone gives them a lot better shot at longevity than if they simply decided to do in 2018 what  they have always done.  Is your company ready to reassess its preparation for the future and address your strategy like you’re a tech company?  Are you spending money on market shifts, or simply doing the same thing you’ve always done?

The 9 Reasons Why Amazon Buying Whole Foods Is A Good Idea

The 9 Reasons Why Amazon Buying Whole Foods Is A Good Idea

Whole Food flagship store in Austin, Texas.

Amazon announced it was paying $13.7B to buy Whole Foods.  While not without risks, there are a lot of reasons this is a great idea:

1 – It makes Amazon a national grocery competitor overnight

Building any retail chain takes a long time.  Due to the intensity of competition, and low margins, building a grocery chain takes even longer.  Amazon would have spent decades trying to create its own chain.  Now it won’t lose all that time, and it won’t give competitors more time to figure out their strategies.

2- Now Amazon can get the necessary “deal dollars” to compete in groceries

Few people realize that no grocer makes money selling groceries. Revenues do not cover the costs of inventory, buildings and labor. On its own, selling groceries loses money.  Grocers survive on manufacturer “deal dollars.”

Companies like P&G, Nabisco, etc. pay grocers slotting fees to obtain shelf space, they pay premiums for eye level shelves and end caps, they pay new product fees to have grocers stock new items, they pay inventory fees to have grocers keep inventory on shelf and in back, they pay advertising fees to have signs in the stores and products in circulars, and they pay volume rebates for meeting, and exceeding, volume goals.  It is these manufacturer “deal dollars” that cover the losses on the store operations and create a profit for investors.

One reason Whole Foods prices are so high is they stock less of the mass market goods and thus receive fewer deal dollars.  Now Amazon can use Whole Foods to increase its volume in all products and dramatically increase its deal dollar inflow.  Something that Amazon sorely missed as a “delivery only” grocer.

3 – Amazon obtains a grocery distribution system

Grocery distribution is unique.  For decades grocers have worked with manufacturers, cooperatives, growers and other suppliers to create the shortest, most efficient distribution of food with the lowest inventory. In many instances replenishment quantities are shipped based on manufacturer access to real grocer sales data. Amazon is the best at what it does, but to compete in groceries it needed a grocery distribution system – and with Whole Foods it obtains one at scale without having to create it.

Additionally Amazon will obtain the corporate infrastructure of a grocer, without having to build one on its own.  All those buyers, merchandisers, real estate professionals, local ad buyers, etc. are there and ready to execute – something building would be very hard to do.

4 – Amazon obtains great locations

Whole Foods has 460 stores, and almost all are in great locations. Whole Foods focused on upscale, growing and often urban or suburban locations – all great for Amazon to grow its distribution footprint.  And hard sites to find.

These can be used to sell other products, such as other grocery items, or some selection of Amazon products if that makes sense.  Or these can be used to augment Amazon’s distribution system for local delivery – or as neighborhood drop-off locations for people who don’t want at-home delivery to pick up Amazon-purchased products. Or they can be sold/leased at very attractive prices.

5 – Amazon can change the Whole Foods brand in important, positive ways

“Whole Paycheck” has long been the knock on Whole Foods.  As mentioned before, the lack of mass market items meant their products lacked deal dollars and thus had to be priced higher. And their stores are large, and not the best use of space. The result has been a lot of trouble keeping customers, and one of the lowest sales per square foot in the grocery industry.

Amazon can easily use its low-price position to alter the Whole Foods brand concept to include things like Pepsi, Coke, Bounty, Gain – a slew of branded consumer goods previously eschewed by Whole Foods.  Adding these products could make the stores more useful to more customers, and greatly lower the average cost of a cart full of goods.  On its own, this brand transition has been impossible for Whole Foods.  As part of Amazon remaking the brand will be vastly easier.

6 – Amazon can personalize grocery shopping like it did general merchandise

If you shopped Amazon you know they really figure out your needs, and help you find what you want.  Amazon keeps track of your searches and purchases, and makes recommendations that often help the shopping experience and delight us as customers.

But today all that information on grocery shopping is un-mined.  Despite using a loyalty card, traditional grocers (and WalMart) have been unable to actually mine that information for better marketing. Now Whole Foods will be able to use Amazon’s incredible technology skills, including big data mining and artificial (or augmented) intelligence to actually help us make the grocery shopping experience better – less time intensive, and most likely less costly while still allowing us to fill our carts with what we need and what makes us happy.

7 – The deal is cheap

$13.7B is only 65% of the cash Amazon had on hand end of last quarter.  And Amazon has only $7.7B in long-term debt.  With a $460B market cap Amazon could easily take on more debt without adding significant financial risk.

But even more important, Amazon has the amazingly cheap currency that is Amazon stock.  Even at the offering price, Whole Foods trades at 34x earnings.  Amazon trades at 185x earnings.  Thus by swapping Amazon shares for Whole Foods shares Amazon lowers the price 80%!  Amazon isn’t spending real dollars, it is using its stock – which is an incredibly valuable move for its shareholders.

8 – This is a serious attack on WalMart

For the last several years WalMart’s general merchandise sales have been declining due to the Amazon Effect and growing on-line competitor sales.  For the last 3 years overall revenues have not grown at all.  To maintain revenue Walmart has shifted increasingly to groceries – which account for well over half of all WalMart revenues. By purchasing Whole Foods, Amazon takes direct aim at the only part of WalMart’s “core” business that it has not attacked.

Walmart’s net profit before taxes is ~4%. If Amazon can use Whole Foods to combine stores and on-line sales to take just 3% of WalMart’s grocery business away it could remove from Walmart ($485B revenues * 60% grocery * 3% market share loss) a net revenue decline of ~$9B.  Given that the cost of grocery goods sold is about 50% – that would mean a net loss in contribution of $4.5B – which would cut almost 25% out of Amazon’s $20B pre-tax income.  Raise the share taken to 5% and Amazon could cut WalMart’s pre-tax income by $7.25B, or ~35%.

The negative impact of declining store sales on the fixed costs of WalMart is atrocious. Even small revenue drops mean cutting staff, cutting inventory, cutting store size and eventually closing stores.  Look at how fast Sears and Kmart fell apart when sales started declining.  Like dominoes falling, declining sales sets off a series of bad events that dooms almost all retailers – as the quickened pace of retail bankruptcy filings has proven.

9 – This could be a huge win for Amazon shareholders

The above analysis, taking 3-5% out of Walmart’s grocery sales, say over 3 years, would be a huge gain attributed to the creation of a new Whole Foods combined with Amazon’s e-commerce.  Growing grocery revenues by $9-$14B would mean practically a doubling of Whole Foods.  Which sounds enormous – and most likely impossible for Whole Foods to do on its own, even if it did launch some kind of e-commerce initiative.

But this is not so unlikely given Amazon’s track record.  Amazon has been growing at over 25%/year, adding between $20-$25B of new revenues annually. In 3 years between 2013 and 2016 Amazon doubled its revenues.  So it is not that unlikely to expect Amazon puts forward an extremely ambitious push to turn around Whole Foods, increase store sales and use the combined entities to grow delivery sales of groceries and other general merchandise.

Is there risk in this acquisition?  Of course.  Combining any two companies is fraught with peril – combining IT systems, distribution systems, customer systems and cultures leaves enormous opportunities for missteps and disaster.  But the upsides are enormous.  Overall, this is a bet Amazon investors should be glad leadership is making – and it is a great benefit for Whole Foods investors.

As Immelt Leaves GE, Investors And Employees Have Little To Cheer

As Immelt Leaves GE, Investors And Employees Have Little To Cheer

GE Chairman and CEO Jeff Immelt walks off stage after being interviewed during the Washington Ideas Forum at the Harmon Center for the Arts September 28, 2016 in Washington, DC. A proud Republican, Immelt said it would hurt the United States and cripple President Barack Obama — and the next president of the U.S. — not to agree to trade deals like theTrans Pacific Partnership (Photo by Chip Somodevilla/Getty Images)

Readers of this column know I’m not a fan of General Electric’s CEO, Jeffrey Immelt.  In May, 2012 I listed CEO Immelt as the 4th worst CEO of a large publicly traded American company.  Unfortunately, his continued tenure since then did nothing to help make GE a stronger, or more valuable company.  GE’s lead director says this is the culmination of a transition plan first developed in 2011.  One can only wonder why it took the board so incredibly long to replace the feckless CEO, and why they allowed GE’s leadership to continue destroying shareholder value.

The longer back you look, the worse Immelt’s performance appears.

Few company analysts can say they’ve followed a company for 3 years. Fewer yet can say 5 years.  Nearly none can say a decade.  Yet, CEO Immelt was in his job for 16 years – much longer than almost all business analysts or writers have followed GE.  Therefore, their lack of long-term memory often leaves them unable to give a proper overview of the company’s fortunes under the long-lived CEO.

I have followed GE closely for almost 35 years.  Ever since I graduated from HBS class of 1982 along with Mr. Immelt. Several fellow alumni worked at GE, and a large number of my BCG (Boston Consulting Group) colleagues joined GE in senior positions during the mid-1980s as GE grew exponentially. I have followed several of these alumni as the years passed allowing me to take the “long view” on GE’s performance, during Welch’s leadership and more recently since Mr. Immelt took the top job.

I was very pleased to include a positive case study of GE’s business practices in my book “Create Marketplace Distruption – How to Stay Ahead of the Competition” (Financial Times Press, 2007.)  CEO Welch used a number of internal processes to help GE leaders identify disruptive opportunities to change industries – whether markets where GE already competed or new markets.  He relentlessly encouraged entering new businesses where GE could bring something new to the game, and he put GE’s money to good use growing revenues, and market cap, enormously.  No other CEO in American history made as much value for shareholders as Jack Welch.  His leadership pushed GE to the top position in most industries, and his relentless focus on growth helped even rank-and-file employees build million dollar IRAs to go with well funded pension and retiree benefit plans.

GE’s performance could not have changed more dramatically than it has under Mr. Immelt. But there are now a number of apologists who would say GE’s smaller size, and lower valuation, are due to market conditions which were out of Mr. Immelt’s control.  They contend CEO Immelt was a good steward of the company during difficult market conditions, and the results of his tenure – notably lower revenues, lower valuation, fewer markets, fewer employees and lower community involvement – are not his fault.  They argue he did a good job, all things considered.

Balderdash. Immelt was a terrible CEO

There is an overall reluctance to say bad things about any huge American icon, and its CEO. After all, columnists and analysts who are non-congratulatory don’t usually get called by the company to be consultants, or advisors.  Or to be on the board.  And publishers of columnists who say negative things about big companies and their execs risk having ad dollars moved to more favorable journals, and often unfriendly relationships with their ad departments and agencies.  So it is far easier, and more acceptable, to sugar coat bad strategy, bad leadership and bad results.

But we should move beyond that bias. Mr. Immelt was the CEO of the ONLY company on the Dow Jones Industrial Average (DJIA) to have been on that list since it was created.  He inherited the most successful company at creating shareholder value during the 1980s and 1990s.  He surely should be held to the highest of comparative bars.

Those who say CEO Immelt was “set up to fail” are somehow making the case that Immelt would have been more successful if he had inherited a company with a bad brand image, weak history, and inadequate performance.  They are rewriting history to say Jack Welch was not a good CEO, and his outsized gains destined GE to do poorly under his successor.  That simply defies the facts – and logic.

Looking at the last 16 years of “difficult times,” when GE has struggled under Immelt’s leadership, one should ask “why did so many other companies do so well?”  After all, the DJIA has more than doubled.  The S&P 500 has almost doubled.  The Russell 2000 has almost tripled. Overall, far more companies have gone up in value than down.  Why were Immelt’s circumstances so difficult that all of those CEOs did so much better?  They dealt with the same financial meltdown, same Great Recession, same increase in regulations, same federal reserve, same government administration – yet they were able to adapt their companies, grow and increase value.

Yes, GE was huge in financial services when Immelt took the reigns, and financial services saw a major crash. But look at the performance of JPMorganChase under CEO Jamie Dimon (also a classmate of Mr. Immelt.)  JPM is stronger today than ever, growing and gaining market share and increasing its value to shareholders.  Prior to the crash, in spring 2007, GE was trading at $41/share, and now it is $29 – a decline of ~30%. Back then JPM was trading at $53, and now it is $93 – a gain of ~75%.  There obviously was a strategy to adapt to market conditions and do well.  Just not at GE.

Immelt reacted to market events, poorly, rather than having a prepared, proactive strategy

Let’s not rewrite history.  Prior to the banking crash CEO Immelt was more than happy for GE to be in the “easy money” world of finance.  Welch had created GE Capital, and Immelt had furthered its growth when lending was easy and profitable.  And he supported the enormous growth in GE’s real estate division.  When this industry faced the crash, GE faced a near-bankruptcy not because of Welch, but because of Immelt’s leadership during the over 6 years he had been CEO.  If there were risks in the system CEO Immelt had ample time to re-arrange the portfolio, reduce lending, offload financial assets and reduce exposure to real estate and mortgages.  But Immelt did not do those things.  He did not prepare for a reversal in the markets, and he did not prepare the balance sheet for a significant change of events.  It was his leadership that left GE exposed.

As GE shares fell to $7  Immelt made a famous deal with Berkshire Hathaway’s CEO Warren Buffet to increase GE’s capital base in order to stave off demise. And this deal saved GE.  But this was an extremely sweet deal for Buffett, giving Berkshire very good interest (10%) on the preferred shares and warrants allowing Buffett to buy future shares of GE at a fixed price.  Berkshire made a profit, over and above the interest, of $260M on the deal, and overall at least $1.2B.  By being prepared Buffett saved GE and made a lot of money. GE’s investors paid the price for a CEO that was unprepared.

But the changes brought about by the crash, and Dodd-Frank, were more than CEO Immelt could manage.  Thus GE exited the business selling many assets at fire sale prices.  This “turn tale and run” strategy was sold to the public as a way for GE to “focus” on its “core manufacturing business.”  Rather, it was a failure of leadership to understand how to manage this business to future success in changed markets.  Where Welch’s GE had grasped for disruption as opportunity, Immelt’s GE gasped at disruption and fled, destroying billions in GE value.

Immelt could not grow GE’s businesses, so he divested GE of many.

GE was to be the “industrial internet giant.”  GE was to be a leader in the internet-of-things (IoT) where sensors, the cloud and remote devices created greater productivity.  And, to be sure, companies like Apple,  Google and Samsung have made huge gains in this market.  Even small companies, like Nest, were able to jump on this technology shift with new products for the residential market.  But name one market where GE is the dominant IoT player.  During 16 years the internet and remote services markets have exploded, yet GE is not the market leader.  Rather it is barely recognized.

Rather than growing GE with disruptive innovations and visionary products in emerging technology markets, Immelt’s GE was primarily shrinking via divestitures. In dismantling GE Capital he eliminated the lending and real estate operations.  After decades as a leader in appliances, that division was sold. Welch built the extremely successful entertainment division around NBC/Universal, which Immelt sold.

The water business that was to be a world leader under Immelt’s vision, likewise sold – and largely to make sure GE could close the deal on selling its oil & gas unit.  Even the famed electrical distribution business, going back to the start of GE, is now close to being sold.

And what happened to all this money?  Well, about $50B went into share buybacks – which ostensibly would help shareholders.  Only it didn’t, because GE is still worth less than when buybacks started. So the money just disappeared.  At least Immelt could have paid it to shareholders as a dividend – but then that would not have boosted his bonuses.

GE’s website says Mr. Immelt wanted to create a “simpler, more valuable industrial company.”  Mr. Immelt is definitely leaving behind a simpler, much smaller and weaker company.  The brand is gone from consumer products, and severely tarnished in commercial products.  GE lacks a great product pipeline, and even a strong development pipeline due to the rampant divestitures.  When Mr. Flannery takes over as CEO he will not inherit a powerhouse company.  He will inherit a company that is shrinking and rudderless, and disconnected from most growth markets with almost no product, technology or brand advantages.  And he will report to the Chairman that created this mess, Mr. Immelt.

The most likely outcome is that Mr. Peltz and his firm, Trian Partners, will buy more GE shares and seek directorships on the board.  Then, in a move not unlike the deaths of DuPont and Dow, there will be a massive cost cutting effort to bring expenses in-line with the shrunken GE business.  R&D will be discontinued, as will product development.  Support groups will be shredded.  Customer service will be downsized.  Then the remaining pieces will be sold off to buyers, or taken public, leaving GE a dismantled piece of history.

While that may work for the capital markets, and some short-term investors will share in the higher valuation, what about the people?  People who dedicated their careers to GE, and are pensioners or current employees?  What about cities and counties where GE has been a major employer, and civic contributor?  What about customers that bought GE industrial products, only to see those products dropped due to low profitability, or little growth opportunity?  What about suppliers that invested in developing new technologies or products for GE to take to market?  What will happen to the people who once relied on GE as America’s largest diversified industrial company?

These people all have an ax to grind with the very wealthy, and now departing, CEO Immelt.  He inherited what may well have been the most successful company on earth.  He leaves behind a far weaker company that may not survive.

Why the ‘Amazon Effect’ Is So Huge In The USA, And Not In Other Countries

Why the ‘Amazon Effect’ Is So Huge In The USA, And Not In Other Countries

Originally posted: May 31, 2017

On the day after Memorial Day Amazon stock hit $1,000/share — a new record high. Amazon is up about 40% the last year. It’s market capitalization doubles Wal-mart. And the vast majority of investment analysts expect Amazon to rise further.

The Amazon logo is displayed at the Nasdaq MarketSite, in New York’s Times Square, Tuesday, May 30, 2017. Online retail giant Amazon.com traded above $1,000 a share for the first time. (AP Photo/Richard Drew)

Amazon competes in dozens of international markets, as do many on-line retailers, yet the ‘Amazon Effect’ is far greater in the USA than anywhere else. And there’s a good reason — America is vastly over-served when it comes to traditional retail.

Retail space of various countries adjusted for population

Chart courtesy of Felix Richter, Statista.com https://www.statista.com/chart/9454/retail-space-per-1000-people/

Retail space of various countries adjusted for population

America is enormously over-built with retail space

Looking at square feet of retail space per 1,000 people, this infographic shows that, adjusted for population size, the USA has 8x the retail of Spain, 9x the retail of Italy, 11x the retail of Germany, 22x the retail of Mexico, 51x the retail of China and 400x the retail of India! Overall, this is remarkable. I’ve been to all of these countries, and in none did I feel that I was unable to buy things I needed. Clearly, the USA has had such a robust retail sector that it has dramatically over-expanded – with individual stores, suburban strip malls, elaborate horizontal malls, vertical urban malls and multi-floor urban retail complexes far outpacing the needs of American shoppers.

All these stores created a very competitive retail environment. This competition, and the lack of any sort of national value added tax (VAT,) kept prices for most things in America among the lowest in the world. Simultaneously according to the Department of Labor, Retail is the third largest employer in America. Couple that with the enormous wholesale distribution networks of warehouses and truck fleets — and selling things becomes the country’s largest employer — even bigger than the sum total of all federal, state and local government employees .

Additionally, retail has produced the largest local taxes of any industry, combining local sales taxes with property taxes, which has funded schools and public works projects for decades. And this retail space has helped drive demand for all kinds of support services from utilities to maintenance.

U.S. retail consumers are tremendously over-served, and the market is set to collapse

But now retail is wildly overbuilt. Organic demand for all retail grows about equal to population growth, so about 3%/year.  But retail real estate grew far faster since World War II as developers kept building more malls, and large retailers like Sears, KMart, Walmart, Target, Lowe’s and Home Depot built more stores. Now demand for products through traditional retail is declining. People are simply ordering on-line.

Net/net, America’s consumers are now over-served by retailers. There is too much space, and inventory. And now that store-to-home distribution has faded as a problem, with multiple carriers offering overnight service, people are increasingly happy to avoid stores altogether, greatly exacerbating the overcapacity problem. Thus, the ‘Amazon Effect’ has emerged, where stores are closing at a rapid rate and many retailers are failing altogether leaving vast amounts of empty retail space.

Foreign markets are under-served, and benefit from Amazon’s entry

Contrarily, in other countries consumers were to some extent under-served. They actually dealt with local stock-outs on desirable items. And frequently lived in a world with a lot less product choice. And, generally, international consumers expected to travel farther to shop at the few larger stores, malls and urban shopping centers with greater selections.

In those countries local economies became far less dependent on retail real estate for jobs — and for taxes. Most have little or no property taxes as deployed in the USA. Additionally, rather than adding a local sales tax to the price of goods, most countries use some sort of national VAT to collect the tax during distribution. When Amazon starts distributing in these markets it is seen as a good thing! Consumers have more choice, less hassle and often better service. Also, Amazon collects the VAT so no taxes are lost.

Contrarily, American communities could never stop adding retail space. Whenever Walmart or Best Buy wanted a new store, no community leaders turned down the potential local economic gains. But it led to too much space being built for a healthy sector, and certainly far too much given the market shift to on-line retail. Now retail is a classic over-served market, sort of like the need for stagecoaches and livery barns after the railroads were built.

Expect 50-67% of retail space to go vacant within a decade

How much retail space could go vacant in the USA?  Just invert the multiples from above. For the USA to have the same retail space as Spain implies an 87.5% reduction, Italy -89%, Germany -91%, Mexico -95.5%. Thus it is not hard to imagine a full 50-67% of America’s retail space to be empty in just 5 or 10 years. Americans would still have 2-3 times the retail space of other developed markets.

There is no doubt Amazon is a good employer, and on-line sales growth will employ hundreds of thousands at Amazon, and millions across the marketplace. Further, most of those jobs will pay a lot better than traditional retail jobs. But there is no sugar-coating the huge impact the ‘Amazon Effect’ will have on local economies and jobs. America is vastly overbuilt and over-supplied by retailers. There will be a huge shake-out, with dozens of retail failures. And there will be enormous amounts of vacant property sitting around, looking for some kind of alternative use. And local communities will find it difficult to meet constituent needs as sales tax and property tax receipts fall dramatically.

As I wrote in my column on February 28, this is going to be an enormous shift. Far bigger than the offshoring of manufacturing. The ‘Amazon Effect’ is automating retailing in ways never imagined by those who built all that retail space. As people keep buying on-line there will be a collapse of retail space pricing, and a collapse of industry participants.  Industry players always greatly under-estimate these shifts, so they aren’t projecting retail armaggedon. But in short order the need for retail will be like the need for dedicated, raised-floor computer centers to house mainframes, and later network hubs. It’s just going to go away.