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.
Poke’Mon Go is a new sensation. Just launched on July 6, the app is already the #1 app in the world – and it isn’t even available in most countries. In less than 2 weeks, from a standing start, Nintendo’s new app is more popular than both Facebook and Snapchat. Based on this success, Nintendo’s equity valuation has jumped 90% in this same short time period.
Some think this is just a fad, after all it is just 2 weeks old. Candy Crush came along and it seemed really popular. But after initial growth its user base stalled and the valuation fell by about 50% as growth in users, time on app and income all fell short of expectations. And, isn’t the world of gaming dominated by the likes of Sony and Microsoft?
A bit of history
Nintendo launched the Wii in 2006 and it was a sensation. Gamers could do things not previously possible. Unit sales exceeded 20m units/year for 2006 through 2009. But Sony (PS4) and Microsoft (Xbox) both powered up their game consoles and started taking share from Nintendo. By 2011 Nintendo sale were down to 11.6m units, and in 2012 sales were off another 50%. The Wii console was losing relevance as competitors thrived.
Sony and Microsoft both invested heavily in their competition. Even though both were unprofitable at the business, neither was ready to concede the market. In fall, 2014 Microsoft raised the competitive ante, spending $2.5B to buy the maker of popular game Minecraft. Nintendo was becoming a market afterthought.
Meanwhile, back in 2009 Nintendo had 70% of the handheld gaming market with its 3DS product. But people started carrying the more versatile smartphones that could talk, text, email, execute endless apps and even had a lot of games – like Tetrus. The market for handheld games pretty much disappeared, dealing Nintendo another blow.
Competitor strategic errors
Fortunately, the bitter “fight to the death” war between Sony and Microsoft kept both focused on their historical game console business. Both kept investing in making the consoles more powerful, with more features, supporting more intense, lifelike games. Microsoft went so far as to implement in Windows 10 the capability for games to be played on Xbox and PCs, even though the PC gaming market had not grown in years. These massive investments were intended to defend their installed base of users, and extend the platform to attract new growth to the traditional, nearly 4 decade old market of game consoles that extends all the way back to Atari.
Both companies did little to address the growing market for mobile gaming. The limited power of mobile devices, and the small screens and poor sound systems made mobile seem like a poor platform for “serious gaming.” While game apps did come out, these were seen as extremely limited and poor quality, not at all competitive to the Sony or Microsoft products. Yes, theoretically Windows 10 would make gaming possible on a Microsoft phone. But the company was not putting investment there. Mobile gaming was simply not serious, and not of interest to the two Goliaths slugging it out for market share.
Building on trends makes all the difference
Back in 2014 I recognized that the console gladiator war was not good for either big company, and recommended Microsoft exit the market. Possibly seeing if Nintendo would take the business in order to remove the cash drain and distraction from Microsoft. Fortunately for Nintendo, that did not happen.
Nintendo observed the ongoing growth in mobile gaming. While Candy Crush may have been a game ignored by serious gamers, it nonetheless developed a big market of users who loved the product. Clearly this demonstrated there was an under-served market for mobile gaming. The mobile trend was real, and it’s gaming needs were unmet.
Simultaneously Nintendo recognized the trend to social. People wanted to play games with other people. And, if possible, the game could bring people together. Even people who don’t know each other. Rather than playing with unseen people located anywhere on the globe, in a pre-organized competition, as console games provided, why not combine the social media elements of connecting with those around you to play a game? Make it both mobile, and social. And the basics of Poke’Mon Go were born.
Then, build out the financial model. Don’t charge to play the game. But once people are in the game charge for in-game elements to help them be more successful. Just as Facebook did in its wildly successful social media game Farmville. The more people enjoyed meeting other people through the game, and the more they played, the more they would buy in-app, or in-game, elements. The social media aspect would keep them wanting to stay connected, and the game is the tool for remaining connected. So you use mobile to connect with vastly more people and draw them together, then social to keep them playing – and spending money.
The underserved market is vastly larger than the over-served market
Nintendo recognized that the under-served mobile gaming market is vastly larger than the overserved console market. Those console gamers have ever more powerful machines, but they are in some ways over-served by all that power. Games do so much that many people simply don’t want to take the time to learn the games, or invest in playing them sitting in a home or office. For many people who never became serious gaming hobbyists, the learning and intensity of serious gaming simply left them with little interest.
But almost everyone has a mobile phone. And almost everyone does some form of social media. And almost everyone enjoys a good game. Give them the right game, built on trends, to catch their attention and the number of potential customers is – literally – in the billions. And all they have to do is download the app. No expensive up-front cost, not much learning, and lots of fun. And thus in two weeks you have millions of new users. Some are traditional gamers. But many are people who would never be a serious gamer – they don’t want a new console or new complicated game. People of all ages and backgrounds could become immediate customers.
David can beat Goliath if you use trends
In the Biblical story, smallish David beat the giant Goliath by using a sling. His new technology allowed him to compete from far enough away that Goliath couldn’t reach David. And David’s tool allowed for delivering a fatal blow without ever touching the giant. The trend toward using tools for hunting and fighting allowed the younger, smaller competitor to beat the incumbent giant.
In business trends are just as important. Any competitor can study trends, see what people want, and then expand their thinking to discover a new way to compete. Nintendo lost the console war, and there was little value in spending vast sums to compete with Sony and Microsoft toe-to-toe. Nintendo saw the mobile game market disintegrate as smartphones emerged. It could have become a footnote in history.
But, instead Nintendo’s leaders built on trends to deliver a product that filled an unmet need – a game that was mobile and social. By meeting that need Nintendo has avoided direct competition, and found a way to dramatically grow its revenues. This is a story about how any competitor can succeed, if they learn how to leverage trends to bring out new products for under-served customers, and avoid costly gladiator competition trying to defend and extend past products.
My last column focused on growth, and the risks inherent in a Growth stall. As I mentioned then, Apple will enter a Growth Stall if its revenue declines year-over-year in the current quarter. This forecasts Apple has only a 7% probability of consistently growing just 2%/year in the future.
This usually happens when a company falls into Defend & Extend (D&E) management. D&E management is when the bulk of management attention, and resources, flow into protecting the “core” business by seeking ways to use sustaining innovations (rather than disruptive innovations) to defend current customers and extend into new markets. Unfortunately, this rarely leads to high growth rates, and more often leads to compressed margins as growth stalls. Instead of working on breakout performance products, efforts are focused on ways to make new versions of old products that are marginally better, faster or cheaper.
Using the D&E lens, we can identify what looks like a sea change in Apple’s strategy.
For example, Apple’s CEO has trumpeted the company’s installed base of 1B iPhones, and stated they will be a future money maker. He bragged about the 20% growth in “services,” which are iPhone users taking advantage of Apple Music, iCloud storage, Apps and iTunes. This shows management’s desire to extend sales to its “installed base” with sustaining software innovations. Unfortunately, this 20% growth was a whopping $1.2B last quarter, which was 2.4% of revenues. Not nearly enough to make up for the decline in “core” iPhone, iPad or Mac sales of approximately $9.5B.
Apple has also been talking a lot about selling in China and India. Unfortunately, plans for selling in India were at least delayed, if not thwarted, by a decision on the part of India’s regulators to not allow Apple to sell low cost refurbished iPhones in the country. Fearing this was a cheap way to dispose of e-waste they are pushing Apple to develop a low-cost new iPhone for their market. Either tactic, selling the refurbished products or creating a cheaper version, are efforts at extending the “core” product sales at lower margins, in an effort to defend the historical iPhone business. Neither creates a superior product with new features, functions or benefits – but rather sustains traditional product sales.
Of even greater note was last week’s announcement that Apple inked a partnership with SAP to develop uses for iPhones and iPads built on the SAP ERP (Enterprise Resource Planning) platform. This announcement revealed that SAP would ask developers on its platform to program in Swift in order to support iOS devices, rather than having a PC-first mentality.
This announcement builds on last year’s similar announcement with IBM. Now 2 very large enterprise players are building applications on iOS devices. This extends the iPhone, a product long thought of as great for consumers, deeply into enterprise sales. A market long dominated by Microsoft. With these partnerships Apple is growing its developer community, while circumventing Microsoft’s long-held domain, promoting sales to companies as well as individuals.
And Apple has shown a willingness to help grow this market by introducing the iPhone 6se which is smaller and cheaper in order to obtain more traction with corporate buyers and corporate employees who have been iPhone resistant. This is a classic market extension intended to sustain sales with more applications while making no significant improvements in the “core” product itself.
And Apple’s CEO has said he intends to make more acquisitions – which will surely be done to shore up weaknesses in existing products and extend into new markets. Although Apple has over $200M of cash it can use for acquisitions, unfortunately this tactic can be a very difficult way to actually find new growth. Each would be targeted at some sort of market extension, but like Beats the impact can be hard to find.
Remember, after all revenue gains and losses were summed, Apple’s revenue fell $7.6B last quarter. Let’s look at some favorite analyst acquisition targets to explain:
- Box could be a great acquisition to help bring more enterprise developers to Apple. Box is widely used by enterprises today, and would help grow where iCloud is weak. IBM has already partnered with Box, and is working on applications in areas like financial services. Box is valued at $1.45B, so easily affordable. But it also has only $300M of annual revenue. Clearly Apple would have to unleash an enormous development program to have Box make any meaningful impact in a company with over $500B of revenue. Something akin of Instagram’s growth for Facebook would be required. But where Instagram made Facebook a pic (versus words) site, it is unclear what major change Box would bring to Apple’s product lines.
- Fitbit is considered a good buy in order to put some glamour and growth onto iWatch. Of course, iWatch already had first year sales that exceeded iPhone sales in its first year. But Apple is now so big that all numbers have to be much bigger in order to make any difference. With a valuation of $3.7B Apple could easily afford FitBit. But FitBit has only $1.9B revenue. Given that they are different technologies, it is unclear how FitBit drives iWatch growth in any meaningful way – even if Apple converted 100% of Fitbit users to the iWatch. There would need to be a “killer app” in development at FitBit that would drive $10B-$20B additional annual revenue very quickly for it to have any meaningful impact on Apple.
- GoPro is seen as a way to kick up Apple’s photography capabilities in order to make the iPhone more valuable – or perhaps developing product extensions to drive greater revenue. At a $1.45B valuation, again easily affordable. But with only $1.6B revenue there’s just not much oomph to the Apple top line. Even maximum Apple Store distribution would probably not make an enormous impact. It would take finding some new markets in industry (enterprise) to build on things like IoT to make this a growth engine – but nobody has said GoPro or Apple have any innovations in that direction. And when Amazon tried to build on fancy photography capability with its FirePhone the product was a flop.
- Tesla is seen as the savior for the Apple Car – even though nobody really knows what the latter is supposed to be. Never mind the actual business proposition, some just think Elon Musk is the perfect replacement for the late Steve Jobs. After all the excitement for its products, Tesla is valued at only $28.4B, so again easily affordable by Apple. And the thinking is that Apple would have plenty of cash to invest in much faster growth — although Apple doesn’t invest in manufacturing and has been the king of outsourcing when it comes to actually making its products. But unfortunately, Tesla has only $4B revenue – so even a rapid doubling of Tesla shipments would yield a mere 1.6% increase in Apple’s revenues.
- In a spree, Apple could buy all 4 companies! Current market value is $35B, so even including a market premium $55B-$60B should bring in the lot. There would still be plenty of cash in the bank for growth. But, realize this would add only $8B of annual revenue to the current run rate – barely 25% of what was needed to cover the gap last quarter – and less than 2% incremental growth to the new lower run rate (that magic growth percentage to pull out of a Growth Stall mentioned earlier in this column.)
Such acquisitions would also be problematic because all have P/E (price/earnings) ratios far higher than Apple’s 10.4. FitBit is 24, GoPro is 43, and both Box and Tesla are infinite because they lose money. So all would have a negative impact on earnings per share, which theoretically should lower Apple’s P/E even more.
Acquisitions get the blood pumping for investment bankers and media folks alike – but, truthfully, it is very hard to see an acquisition path that solves Apple’s revenue problem.
All of Apple’s efforts big efforts today are around sustaining innovations to defend & extend current products. No longer do we hear about gee whiz innovations, nor do we hear about growth in market changing products like iBeacons or ApplePay. Today’s discussions are how to rejuvenate sales of products that are several versions old. This may work. Sales may recover via growth in India, or a big pick-up in enterprise as people leave their PCs behind. It could happen, and Apple could avoid its Growth Stall.
But investors have the right to be concerned. Apple can grow by defending and extending the iPhone market only so long. This strategy will certainly affect future margins as prices, on average, decline. In short, investors need to know what will be Apple’s next “big thing,” and when it is likely to emerge. It will take something quite significant for Apple to maintain it’s revenue, and profit, growth.
The good news is that Apple does sell for a lowly P/E of 10 today. That is incredibly low for a company as profitable as Apple, with such a large installed base and so many market extensions – even if its growth has stalled. Even if Apple is caught in the Innovator’s Dilemma (i.e. Clayton Christensen) and shifting its strategy to defending and extending, it is very lowly valued. So the stock could continue to perform well. It just may never reach the P/E of 15 or 20 that is common for its industry peers, and investors envisioned 2 or 3 years ago. Unless there is some new, disruptive innovation in the pipeline not yet revealed to investors.
Leading tech tracking companies IDC and Gartner both announced Q1, 2016 PC sales results, and they were horrible. Sales were down 9.5%-11.5% depending on which tracker you asked. And that’s after a horrible Q4, 2015 when sales were off more than 10%. PC sales have now declined for 6 straight quarters, and sales are roughly where they were in 2007, 9 years ago.
Oh yeah, that was when the iPhone launched – June, 2007. And just a couple of years before the iPad launched. Correlation, or causation?
Amazingly, when Q4 ended the forecasters were still optimistic of a stabilization and turnaround in PC sales. Typical analyst verbage was like this from IDC, “Commercial adoption of Windows 10 is expected to accelerate, and consumer buying should also stabilize by the second half of the year. Most PC users have delayed an upgrade, but can only maintain this for so long before facing security and performance issues.” And just to prove that hope springs eternal from the analyst breast, here is IDC’s forecast for 2016 after the horrible Q1, “In the short term, the PC market must still grapple with limited consumer interest and competition from other infrastructure upgrades in the commercial market. Nevertheless….things should start picking up in terms of Windows 10 pilots turning into actual PC purchases.”
Fascinating. Once again, the upturn is just around the corner. People have always looked forward to upgrading their PCs, there has always been a “PC upgrade cycle” and one will again emerge. Someday. At least, the analysts hope so. Maybe?
Microsoft investors must hope so. The company is selling at a price/earnings multiple of 40 on hopes that Windows 10 sales will soon boom, and re-energize PC growth. Surely. Hopefully. Maybe?
The world has shifted, and far too many people don’t like to recognize the shift. When Windows 8 launched it was clear that interest in PC software was diminishing. What was once a major front page event, a Windows upgrade, was unimportant. By the time Windows 10 came along there was so little interest that its launch barely made any news at all. This market, these products, are really no longer relevant to the growth of personal technology.
Back when I predicted that Windows 8 would be a flop I was inundated with hate mail. It was clear that Ballmer was a terrible CEO, and would soon be replaced by the board. Same when I predicted that Surface tablets would not sell well, and that all Windows devices would not achieve significant share. People called me “an Apple Fanboy” or a “Microsoft hater.” Actually, neither was true. It was just clear that a major market shift was happening in computing. The world was rapidly going mobile, and cloud-based, and the PC just wasn’t going to be relevant. As the PC lost relevancy, so too would Microsoft because it completely missed the market, and its entries were far too tied to old ways of thinking about personal and corporate computing – not to mention the big lead competitors had in devices, apps and cloud services.
I’ve never said that modern PCs are bad products. I have a son half way through a PhD in Neurobiological Engineering. He builds all kinds of brain models and 3 dimensional brain images and cell structure plots — and he does all kinds of very exotic math. His world is built on incredibly powerful, fast PCs. He loves Windows 10, and he loves PCs — and he really “doesn’t get” tablets. And I truly understand why. His work requires local computational power and storage, and he loves Windows 10 over all other platforms.
But he is not a trend. His deep understanding of the benefits of Windows 10, and some of the PC manufacturers as well as those who sell upgrade componentry, is very much a niche. While he depends heavily on Microsoft and Wintel manufacturers to do his work, he is a niche user. (BTW he uses a Nexus phone and absolutely loves it, as well. And he can wax eloquently about the advantages he achieves by using an Android device.)
Today, I doubt I will receive hardly any comments to this column. Because to most people, the PC is nearly irrelevant. People don’t actually care about PC sales results, or forecasts. Not nearly as much as, say, care about whether or not the iPhone 6se advances the mobile phone market in a meaningful way.
Most people do their work, almost if not all their work, on a mobile device. They depend on cloud and SaaS (software-as-a-service) providers and get a lot done on apps. What they can’t do on a phone, they do on a tablet, by and large. They may, or may not, use a PC of some kind (Mac included in that reference) but it is not terribly important to them. PCs are now truly generic, like a refrigerator, and if they need one they don’t much care who made it or anything else – they just want it to do whatever task they have yet to migrate to their mobile world.
The amazing thing is not that PC sales have fallen for 6 quarters. That was easy to predict back in 2013. The amazing thing is that some people still don’t want to accept that this trend will never reverse. And many people, even though they haven’t carried around a laptop for months (years?) and don’t use a Windows mobile device, still think Microsoft is a market leader, and has a great future. PCs, and for the most part Microsoft, are simply no more relevant than Sears, Blackberry, or the Encyclopedia Britannica. Yet it is somewhat startling that some people have failed to think about the impact this has on their company, companies that make PC software and hardware – and the impact this will have on their lives – and likely their portfolios.
We all like to think the world is a meritocracy, where hard work is important and results matter.
As we watched Mitt Romney, and others, frontally assault Donald Trump this week it was clear they were saying Mr. Trump is not the right person to be President. They are pointing out his use of bankruptcies to protect his personal wealth, while leaving investors holding the empty bag. And his flip-flopping on various issues, including how he would deploy military forces. And his use of misogynistic language against women, while simultaneously referring to most Mexicans and lawbreakers and all Muslims as terrorists, are gross generalities they say are not supported by facts.
Yet, while many sober-minded leaders are denouncing Mr. Trump, it is not clear that it matters. His followers seem to remain passionately loyal, and completely unmoved by any factual representation of their candidate as anything other than a savior for America. The “Super Saturday” delegate selection resulted in Mr. Trump winning 2 more contests (Louisiana and Kentucky) while coming in second in 2 others (Kansas and Maine.) And it demonstrated the ongoing pattern of Mr. Trump winning the popular vote in primaries.
Everyone remembers a situation where a very hard working, smart, industrious person did things well for years. But they weren’t promoted, or even given large pay increases. Or, worse, they made one mistake and lost their position, or job.
Simultaneously, we all also can think of at least one, or more, person who simply wasn’t that good, and often didn’t work that hard, but was promoted (often beyond their competency) and given large pay increases. And every time this person made a mistake it was explained away as a “learning experience” that would make them a better future performer. They were blessed with continuous upward mobility, and could seemingly do no wrong.
For each of us these experiences seemed unique, and we often tied them to the specific individuals involved – including not only the person at the center of these experiences but their superiors, subordinates and peers. And many people are saying the political rise of Donald Trump is unique to him and the current state of his political party.
But rather than each being unique, these experiences all have something in common. The actual frequency of these experiences belies the notion that they are all unique. Rather, what all of these demonstrate is the implementation of selective bias. They demonstrate that very often we prefer people because they reinforce our bias, and their past results do not matter.
Bosses who promote incompetency don’t really care about the competency as much as they care that the individual reinforces their inherent Beliefs, Interpretations, Assumptions and Strategies about the world. There is often a familial, geographic, academic, business relationship, religious or gender trait (or often multiple traits) which reinforces in these bosses that their view of the world is right, and should be promoted.
This may be due to the person being very much similar to the boss. But, not always. It just requires that the target be a visible, walking, talking implementation of how they think the world works. Whether or not the person is successful really does not matter. If they are different from the boss’s viewpoint, no success will be great enough to have the boss support them. If they fulfill the boss’s bias then they often can do no wrong.
Donald Trump has been leading his candidate competitors not because he was wildly successful. Rather, he is attracting a larger group of people who identify with him; who share his basic Beliefs, Interpretations of the world, Assumptions about how people behave, and Strategies for how to succeed. They share his bias, and thus they select him. As Mr. Trump said himself “I could stand in the middle of 5th Avenue and shoot somebody and I wouldn’t lose voters.”
Regardless of the robustness of the American economy and the ongoing growth in jobs creation, they Believe America is in terrible shape, and that almost all media participants are liars. No matter what the truth is about the value of immigrants on the economy, they Interpret all immigrants as job-stealing bad people that have made their lives worse. No matter the truth about the spirit of Islam and the goodness of Muslims, they Assume all of them terrorists out to blow up the world. And they agree with Strategies like stopping immigrants with walls, killing civilian Muslims as collateral damage in a religious war, torturing prisoners of war (possibly to death,) eliminating international trade, and depriving poor people of health care and other services.
Thus, selective bias ties these voters to Mr. Trump with a bind that is not breakable by discussing his performance, or pointing out his failings. Facts are not relevant. Their judgement is not based on historical facts, but rather a clear alignment with their bias. No matter who says Mr. Trump may have lied, or exaggerated, or misinterpreted history that messenger will not be believed. Because the real results don’t matter. What matters is reinforcing their bias.
Unfortunately we see this selective bias all too often in business. Leaders that favor some over others simply because of bias, rather than results. It has long been a problem which has restricted diversity in the workforce, and inhibited equal pay. It has long created a caste system for admission to top schools and places of employment. And because selective bias is so rampant in American business, it is second nature to Mr. Trump. It is easy for him to say what is on his mind, and expect that lots of people will agree with him. It’s how he sees the world, it is his bias, and he’s used to having it reinforced by those who wish to work with him.
Whatever happens in this Presidential campaign, as business leaders we can learn from this situation that if we allow selective bias to sway us then we are no longer really paying attention to results. As leaders which of the following should be important – promoting those who reinforce our beliefs, interpretations, assumptions and strategies, or finding the best people to do the job and rewarding those who really have worked hard for good results?
Walmart announced quarterly financial results last week, and they were not good. Sales were down $500million vs the previous year, and management lowered forecasts for 2016. And profits were down almost 8% vs. the previous year. The stock dropped, and pundits went negative on the company.
But if we take an historical look, despite how well WalMart’s value has done between 2011 and 2014, there are ample reasons to forecast a very difficult future. Sailors use small bits of cloth tied to their sails in order to get early readings on the wind. These small bits, called telltales, give early signs that good sailors use to plan their navigation forward. If we look closely at events at WalMart we can see telltales of problems destined to emerge for the retailing giant:
1 – In March, 2008 WalMart sued a brain damaged employee. The employee was brain damaged by a truck accident. WalMart’s insurance paid out $470,000 in health care cost. The employee’s family sued the trucking company, at their own expense, and won a $417,000 verdict for lost future wages, pain and suffering and future care needs. Then, WalMart decided it would sue the employee to recover the health care costs it had previously paid. As remarkable as this seems, it is a great telltale. It demonstrates a company so focused on finding ways to cut costs, and so insensitive to its employees and the plight of its customers that it loses all common sense. Not to mention the questionable ethics of this action, it at the very least demonstrates blatant disregard for the PR impact of its actions. It shows a company where management feels it is unquestionable, and a believe its brand is untouchable.
2 – In March, 2010 AdAge ran a column about WalMart being “stuck in the middle” and effectively becoming the competitive “bulls-eye” of retailing. After years of focusing on its success formula, “dollar store” competition was starting to undermine it on cost and price at the low end, while better merchandise and store experience boxed WalMart from higher end competitors – that often weren’t any more expensive. This was the telltale sign of a retailer that had focused on beating up its suppliers for years, cutting them out of almost all margin, without thinking about how it might need to change its business model to grow as competitors chopped up its traditional marketplace.
3 – In October, 2010 Fortune ran an article profiling then-CEO Mike Duke. It described an executive absolutely obsessive about operational minutia. Banana pricing, underwear inventory, cereal displays – there was no detail too small for the CEO. Another telltale of a company single-mindedly focused on execution, to the point of ignoring market shifts created by changing consumer tastes, improvements at competitors and the rapid growth of on-line retailing. There was no strategic thinking happening at WalMart, as executives believed there would never be a need to change the strategy.
4 – In April, 2012 WalMart found itself mired in a scandal regarding bribing Mexican government officials in its effort to grow sales. WalMart had never been able to convert its success formula into a growing business in any international market, but Mexico was supposedly its breakout. However, we learned the company had been paying bribes to obtain store sites and hold back local competitors. A telltale of a company where pressure to keep defending and extending the old business was so great that very highly placed executives do the unethical, and quite likely the illegal, to make the company look like it is performing better.
5 – In July, 2014 a WalMart truck driver hits a car seriously injuring comedian Tracy Morgan and killing his friend. While it could be taken as a single incident, the truth was that the driver had been driving excessive hours and excessive miles, not complying with government mandated rest periods, in order to meet WalMart distribution needs. This telltale showed how the company was stressed all the way down into the heralded distribution environment to push, push, push a bit harder to do more with less in order to find extra margin opportunities. What once was successful was showing stress at the seams, and in this case it led to a fatal accident by an employee.
6 – In January, 2015 we discovered traditional brick-and-mortar retail sales fell 1% from the previous year. The move to on-line shopping was clearly a force. People were buying more on-line, and less in stores. This telltale bode very poorly for all traditional retailers, and it would be clear that as the biggest WalMart was sure to face serious problems.
7 – In July, 2015 Amazon’s market value exceeds WalMart’s. Despite being quite a bit smaller, Amazon’s position as the on-line retail leader has investors forecasting tremendous growth. Even though WalMart’s value was not declining, its key competition was clearly being forecast to grow impressively. The telltale implies that at least some, if not a lot, of that growth was going to eventually come directly from the world’s largest traditional retailer.
8 – In January, 2016 we learn that traditional retail store sales declined in the 2015 holiday season from 2014. This was the second consecutive year, and confirmed the previous year’s numbers were the start of a trend. Even more damning was the revelation that Black Friday sales had declined in 2013, 2014 and 2015 strongly confirming the trend away from Black Friday store shopping toward Cyber Monday e-commerce. A wicked telltale for the world’s largest store system.
9 – In January, 2016 we learned that WalMart is reacting to lower sales by closing 269 stores. No matter what lipstick one would hope to place on this pig, this telltale is an admission that the retail marketplace is shifting on-line and taking a toll on same-store sales.
10 – We now know WalMart is in a Growth Stall. A Growth Stall occurs any time a company has two consecutive quarters of lower sales versus the previous year (or two consecutive declining back-to-back quarters.) In the 3rd quarter of 2015 Walmart sales were $117.41B vs. same quarter in 2014 $119.00B – a decline of $1.6B. Last quarter WalMart sales were $129.67B vs. year ago same quarter sales of $131.56B – a decline of $1.9B. While these differences may seem small, and there are plenty of explanations using currency valuations, store changes, etc., the fact remains that this is a telltale of a company that is already in a declining sales trend. And according to The Conference Board companies that hit a Growth Stall only maintain a mere 2% growth rate 7% of the time – the likelihood of having a lower growth rate is 93%. And 95% of stalled companies lose 25% of their market value, while 69% of companies lose over half their value.
WalMart is huge. And its valuation has actually gone up since the Great Recession began. It’s valuation also rose from 2011- 2014 as Amazon exploded in size. But the telltale signs are of a company very likely on the way downhill.
2015 was not short on bad decisions, nor bad outcomes. But there are 5 major leadership themes from 2015 that can help companies be better in 2016:
1 – Cost cutting, restructurings and stock buybacks do not increase company value – Dow/DuPont
There was no shortage of financial engineering experiments in 2015 intended to increase short-term shareholder returns at the expense of long-term value creation. Companies continued borrowing money to buy back their own stock – spending more on repurchases than they made in profits.
Unfortunately, too many companies continue to increase earnings per share (EPS) via financial machinations rather than creating and introducing new products, or creating new markets.
In a grand show of value reducing financial re-engineering, 2015 is ending with the massive merger between Dow and DuPont. There is no intent of introducing new products or entering new markets via this merger. Rather, to the contrary, the plan is to merge these beasts, lay off tens of thousands of employees, cut the R&D staff, cut new product introductions and “rationalize” the company into 3 new businesses intended to be relaunched as new companies, with fewer products, less business development and less competition.
Massive cost cutting will weaken both companies, put thousands out of work and leave the marketplace with fewer new products. All just to create 3 new, different profit and loss statements in the hopes of improving the EPS and price to earnings (P/E) multiple. This story has become all too familiar the last few years, and the only winners are the bankers, who will make massive fees, and hedge fund managers that rapidly dump the stock in the terrible companies they leave behind.
2 – Doing more of the same is not innovative and does not create value – McDonald’s
McDonald’s has been losing market share to fast casual restaurants for over a decade. Yet, leadership insists on constantly maintaining its undying focus on the fast food success formula upon which the company was launched some 60 years ago.
As the number of customers continued declining, McDonalds kept closing more stores. Yet, sales per store remained weak even as the denominator grew smaller. Unwilling to actually update McDonald’s to make it fit modern trends, in 2015 leadership decided the path to growth was serving breakfast all-day. Really. It is still hard to believe. No new products, just the same McMuffins and sausage biscuits, but now offered for more hours.
Because of McDonald’s size and legacy the media covered this story heavily in 2015. Yet, as 2016 starts we all can look back and see that this was no story at all. Doing more of the same is not in any way innovative or revolutionary. Defending and extending an outdated success formula does not fix a company strategy that is out of date and rapidly losing relevancy.
3 – Hiring the wrong CEO is a BIG problem – Yahoo
We would like to think that Boards are really good at hiring CEOs. Unfortunately, we are regularly reminded they are not. The Board at Yahoo has spent a decade making bad CEO selections, and now the company’s core business is valueless.
In 2015 we saw that the decision by Yahoo’s board to hire a CEO based on political correctness (gender advantages), and limited experience with a well known company (a short Google career) rather than leadership capability could be deadly. Although Marissa Mayer was hired in 2012 amid much fanfare, we learned in 2015 that Yahoo is worth only the value of its Alibaba shareholdings, and no more. Yahoo as it was founded is now worth – nothing.
After 3 years of Mayer leadership it became clear that “there was no there, there” at Yahoo (to quote Gertrude Stein.) The value of the company’s “core” search and content accumulation businesses dropped to zero. Although 3 years have passed, practically no progress has been made toward developing a new business able to compete in the market shifted to social media and instant communications. Investors now realize Ms. Mayer has failed to grow future revenue and profits for the historical internet leader. Following a decade of incompetent CEOs, Yahoo has been left almost wholly irrelevant.
What was once Yahoo will soon be Alibaba USA, as the company gets rid of its old businesses – in some fashion, although who would want them is unclear – in order to allow shareholders to preserve their value in Alibaba stock purchased by Jerry Yang in 2005.
Yahoo has become irrelevant, replaced by its minority stake in Alibaba, largely due to a Board unable to identify and hire a competent CEO – ending with the wholly unqualified selection of Ms. Mayer, who will achieve at least a footnote in history for the outsized compensation package she received and the huge severance that will come her way, wildly out of proportion to her poor performance, when leaving Yahoo.
4 – Even 1 dumb leadership decision can devastate a company — Turing Pharmaceuticals and CEO Shkreli
In 2015 former hedge fund manager Martin Shkreli raised a lot of money, and obtained control of an anit-parasitic pharmaceutical product. Recognizing that his customers either paid up or died, and being young, naïve, enormously greedy and without much oversight he decided to raise product pricing 70-fold. This would leave his customers either dead, bankrupt or bankrupting the insurance companies paying for his product – but he infamously said he did not care.
Thumbing your nose at customers, and regulators, is never a good idea. And even if they could not roll back the price quickly, they could target the CEO and his company for further investigation. It didn’t take long until Mr. Shrkeli was indicted for stock manipulation, leaving Turing Pharmaceuticals in disrepair as it rapidly cut staff and tried to determine what it will do next. Now KaloBios Pharma, controlled by Turing, is forced to file bankruptcy.
Never forget that Al Capone did not go to prison for stealing, bribing police, bootlegging, number running, murder or other gangster behavior. He went to prison for tax evasion. The simple lesson is, when you think you are smarter than everyone else, can do whatever you want and thumb your nose at those with government powers you’ll soon find yourself under the microscope of investigation, and most likely in really big trouble. And in the desire to take down the unwise CEO corporations become mere fodder.
The pharma industry is a regular target of consumers and politicians. Now not only are the investors in Turing damaged by this foolishly incompetent CEO, but the entire industry will once again be under close scrutiny for its pricing practices. Arrogantly making brash decisions, based on ill-formed thinking and juvenile egotism, without careful, thoughtful consideration can create enormous damage.
5 – Putting short-term results above good business practice will hurt you very badly long-term – Volkswagen and Takata
VW cheated on its emissions tests. Takata sold deadly, exploding airbags. Both companies are large organizations with layers of management. How could judgemenetal errors so big, so costly and so deadly happen?
These outcomes did not happen because of just “one bad apple.” Cultural acceptance of lying takes years of leadership focused on short-term results, even when it means operating unethically or illegally, to be inculcated. It took years for layers of management to learn how to turn away from problems, falsify test results, fake outcomes, lie to customers and even lie to regulators. It took years to create a culture of tolerated deception and willful misrepresentation.
Unfortunately, the auto industry is a tough place to make money. There is a lot of regulation, and a lot of competition. When it becomes too hard to make money honestly, cheating can become far too easily accepted. Rather than trying to revolutionize the auto making process, or the product itself, it can be a lot easier to push managers all the way down to the front-line of procurement, manufacturing or sales to simply cheat.
“Make your numbers” becomes a mantra. If you want to keep your job, or even more importantly if you want to move up, do whatever it takes to tell those above you what they want to hear. And those above don’t ask too many questions, don’t try to figure out how results happen – just keep applying pressure to those below to do what’s necessary to make the numbers.
As VW and Takata showed us, eventually the company will be caught. And the consequences are severe. Now those companies, their customers, their employees and their shareholders are suffering. And industry regulations will tighten further to make it harder to cheat. Everyone loses when short-term results are the top goal, rather than building a sustainable long-term business.
Let’s hope for better leadership in 2016.
Marissa Mayer’s reign as head of Yahoo looks to be ending like her predecessors. With a serious flop. Only this may well be the last flop – and the end of the internet pioneer.
It didn’t have to happen this way, but an inability to manage Status Quo Risk doomed Ms. Mayer’s leadership – as it has too many others. And once again bad leadership will see a lot of people – investors, employees and even customers – pay the price.
Yahoo was in big trouble when Ms. Mayer arrived. Growth had stalled, and its market was being chopped up by Google and Facebook. It’s very relevancy was questionable as people no longer needed news consolidation sites – which had ended AOL, for example – and search had long gone to Google. The intense internet users were already clearly mobile social media fans, and Yahoo simply did not compete in that space.
In other words, Yahoo desperately needed a change of direction and an entirely new strategy the day Ms. Mayer showed up. Only, unfortunately, she didn’t provide either. Instead Ms. Meyer offered, at best, a series of fairly meaningless tactical actions. Changing Yahoo’s home page layout, cancelling the company’s work-from-home policy and hiring Katie Couric, amidst a string of small and meaningless acquisitions, were the business equivalent of fiddling while Rome burned. Tinkering with the tactics of an outdated success formula simply ignored the fact that Yahoo was already well on the road to irrelevancy and needed to change, dramatically, quickly.
The saving grace for Yahoo was when Alibaba went public. Suddenly a long-ago decision to invest in the Chinese company created a vast valuation increase for Yahoo. This was the opportunity of a lifetime to shift the business fast and hard into something new, different and much more relevant than the worn out Yahoo strategy. But, unfortunately, Ms. Mayer used this as a curtain to hide the crumbling former internet leader. She did nothing to make Yahoo relevant, as fights erupted over how to carve up the Alibaba windfall.
When it became public that Ms. Mayer had hired famed strategy firm McKinsey & Co. to decide what businesses to close in its next “restructuring” it lit up the internet with cries to possibly just get rid of the whole thing! After 3 years, and more than one layoff, it now appears that Ms. Mayer has no better idea for creating value out of Yahoo than doing another big layoff to, once again, improve “focus on core offerings.” Additional layoffs, after 3 years of declining sales, is not the way to grow and increase shareholder value.
Analysts are pointing out that Yahoo’s core business today is valueless. The company is valued at less than its remaining Alibaba stake. And this is not outrageous, since in the ad world Yahoo has become close to irrelevant. Nobody would build an on-line ad campaign ignoring Google or Facebook, and several other internet leaders. But ignoring Yahoo as a media option is increasingly common.
Investors are rightly worried that the IRS will take much of the remaining Alibaba value as taxes in any spinoff, leaving them with far less money. Giving up on the CEO, and its increasingly irrelevant “core business” they are asking if it wouldn’t be smarter to sell what we think of as Yahoo to Softbank so the Japanese company can obtain the rest of Yahoo Japan it does not already own. Ostensibly then Yahoo as it is known in the USA could simply start to disappear – like AOL and all the other on-line news consolidators.
It really did not have to happen this way. Yahoo’s troubles were clearly visible, and addressable. But CEO Mayer simply chose to keep doing more of the same, making small improvements to Yahoo’s site and search tool. By keeping Yahoo aligned with its historical Status Quo risk of irrelevance, obsolescence and failure grew quarter-by-quarter.
Now Status Quo Risk (the risk created by not adapting to shifting market needs) has most likely doomed Yahoo. Investors are no longer interested in waiting for a turn-around. They want their Alibaba valuation, and they could care less about Yahoo’s CEO, employees or customers. Many have given up on Ms. Mayer, and simply want an exit strategy so they can move on.
Ms. Mayer’s leadership has shown us some important leadership lessons:
- Hiring an executive from Google (or another tech company) does not magically mean success will emerge. Like Ron Johnson from Apple to JCP, Ms. Mayer showed that even tech execs often lack an ability to understand market trends and the skills to adapt an organization.
- It is incredibly easy for a new leader to buy into an historical success formula and keep tweaking it, rather than doing the hard work of creating a new strategy and adapting. The lure of focusing on tactics and hoping the strategy will take care of itself is remarkably easy fall into. But investors need to realize that tactics do not fix an outdated success formula.
- Youth is not the answer. Ms. Mayer was young, and identified with the youthfulness of Google and internet users. But, in the end, she woefully lacked the strategy and leadership skills necessary to turn around the deeply troubled Yahoo. Young, new and fresh is no substitute for critical thinking and knowing how to lead.
- Boards give CEOs too much time to fail. It was clear within months Ms. Mayer had no strategy for making Yahoo relevant. Yet, the Board did not recognize its mistake and replace the CEOs. There still are not sufficient safeguards to make sure Boards act when CEOs fail to lead effectively.
- CEOs too often have too much hubris. Ms. Mayer went from college to a rapid career acceleration in largely staff positions to CEO of Yahoo and a Board member of Wal-Mart. It is easy to develop hubris, and an over-abundance of self-confidence. Then it is easy to require your staff agree with you, and pledge so support you (as Ms. Mayer recently did.) All of this indicates a leader running on hubris rather than critical thinking, open discourse and effective decision-making. Hubris is not just a weakness of white male leaders.
Could there have been a different outcome. Of course. But for Yahoo’s employees, suppliers, customers and investors the company hired a string of CEOs that simply were not up to the job of redirecting the company into competitiveness. Each one fell victim to trying to maintain the Status Quo. And, unfortunately, Ms. Mayer will be seen as the most recent – and possibly last – CEO to lead Yahoo into failure. Ms. Mayer simply was not up to the job – and now a lot of people will pay the price.
Microsoft recently announced it was offering Windows 10 on xBox, thus unifying all its hardware products on a single operating system – PCs, mobile devices, gaming devices and 3D devices. This means that application developers can create solutions that can run on all devices, with extensions that can take advantage of inherent special capabilities of each device. Given the enormous base of PCs and xBox machines, plus sales of mobile devices, this is a great move that expands the Windows 10 platform.
Only it is probably too late to make much difference. PC sales continue falling – quickly. Q3 PC sales were down over 10% versus a year ago. Q2 saw an 11% decline vs year ago. The PC market has been steadily shrinking since 2012. In Q2 there were 68M PCs sold, and 66M iPhones. Hope springs eternal for a PC turnaround – but that would seem increasingly unrealistic.
The big market shift to mobile devices started back in 2007 when the iPhone began challenging Blackberry. By 2010 when the iPad launched, the shift was in full swing. And that’s when Microsoft’s current problems really began. Previous CEO Steve Ballmer went “all-in” on trying to defend and extend the PC platform with Windows 8 which began development in 2010. But by October, 2012 it was clear the design had so many trade-offs that it was destined to be an Edsel-like flop – a compromised product unable to please anyone.
By January, 2013 sales results were showing the abysmal failure of Windows 8 to slow the wholesale shift into mobile devices. Ballmer had played “bet the company” on Windows 8 and the returns were not good. It was the failure of Windows 8, and the ill-fated Surface tablet which became a notorious billion dollar write-off, that set the stage for the rapid demise of PCs.
And that demise is clear in the ecosystem. Microsoft has long depended on OEM manufacturers selling PCs as the driver of most sales. But now Lenovo, formerly the #1 PC manufacturer, is losing money – lots of money – putting its future in jeopardy. And Dell, one of the other top 3 manufacturers, recently pivoted from being a PC manufacturer into becoming a supplier of cloud storage by spending $67B to buy EMC. The other big PC manufacturer, HP, spun off its PC business so it could focus on non-PC growth markets.
And, worse, the entire OEM market is collapsing. For the largest 4 PC manufacturers sales last quarter were down 4.5%, while sales for the remaining smaller manufacturers dropped over 20%! With fewer and fewer sales, consolidation is wiping out many companies, and leaving those remaining in margin killing to-the-death competition.
Which means for Microsoft to grow it desperately needs Windows 10 to succeed on devices other than PCs. But here Microsoft struggles, because it long eschewed its “channel suppliers,” who create vertical market applications, as it relied on OEM box sales for revenue growth. Microsoft did little to spur app development, and rather wanted its developers to focus on installing standard PC units with minor tweaks to fit vertical needs.
Today Apple and Google have both built very large, profitable developer networks. Thus iOS offers 1.5M apps, and Google offers 1.6M. But Microsoft only has 500K apps largely because it entered the world of mobile too late, and without a commitment to success as it tried to defend and extend the PC. Worse, Microsoft has quietly delayed Project Astoria which was to offer tools for easily porting Android apps into the Windows 10 market.
Microsoft realized it needed more developers all the way back in 2013 when it began offering bonuses of $100,000 and more to developers who would write for Windows. But that had little success as developers were more keen to achieve long-term sales by building apps for all those iOS and Android devices now outselling PCs. Today the situation is only exacerbated.
By summer of 2014 it was clear that leadership in the developer world was clearly not Microsoft. Apple and IBM joined forces to build mobile enterprise apps on iOS, and eventually IBM shifted all its internal PCs from Windows to Macintosh. Lacking a strong installed base of Windows mobile devices, Microsoft was without the cavalry to mount a strong fight for building a developer community.
In January, 2015 Microsoft started its release of Windows 10 – the product to unify all devices in one O/S. But, largely, nobody cared. Windows 10 is lots better than Win8, it has a great virtual assistant called Cortana, and it now links all those Microsoft devices. But it is so incredibly late to market that there is little interest.
Although people keep talking about the huge installed base of PCs as some sort of valuable asset for Microsoft, it is clear that those are unlikely to be replaced by more PCs. And in other devices, Microsoft’s decisions made years ago to put all its investment into Windows 8 are now showing up in complete apathy for Windows 10 – and the new hybrid devices being launched.
AM Multigraphics and ABDick once had printing presses in every company in America, and much of the world. But when Xerox taught people how to “one click” print on a copier, the market for presses began to die. Many people thought the installed base would keep these press companies profitable forever. And it took 30 years for those machines to eventually disappear. But by 2000 both companies went bankrupt and the market disappeared.
Those who focus on Windows 10 and “universal windows apps” are correct in their assessment of product features, functions and benefits. But, it probably doesn’t matter. When Microsoft’s leadership missed the mobile market a decade ago it set the stage for a long-term demise. Now that Apple dominates the platform space with its phones and tablets, followed by a group of manufacturers selling Android devices, developers see that future sales rely on having apps for those products. And Windows 10 is not much more relevant than Blackberry.
This week McDonald’s and Microsoft both reported earnings that were higher than analysts expected. After these surprise announcements, the equities of both companies had big jumps. But, unfortunately, both companies are in a Growth Stall and unlikely to sustain higher valuations.
McDonald’s profits rose 23%. But revenues were down 5.3%. Leadership touted a higher same store sales number, but that is completely misleading.
McDonald’s leadership has undertaken a back to basics program. This has been used to eliminate menu items and close “underperforming stores.” With fewer stores, loyal customers were forced to eat in nearby stores – something not hard to do given the proliferation of McDonald’s sites. But some customers will go to competitors. By cutting stores and products from the menu McDonald’s may lower cost, but it also lowers the available revenue capacity. This means that stores open a year or longer could increase revenue, even though total revenues are going down.
Profits can go up for a raft of reasons having nothing to do with long-term growth and sustainability. Changing accounting for depreciation, inventory, real estate holdings, revenue recognition, new product launches, product cancellations, marketing investments — the list is endless. Further, charges in a previous quarter (or previous year) could have brought forward costs into an earlier report, making the comparative quarter look worse while making the current quarter look better.
Confusing? That’s why accounting changes are often called “financial machinations.” Lots of moving numbers around, but not necessarily indicating the direction of the business.
McDonald’s asked its “core” customers what they wanted, and based on their responses began offering all-day breakfast. Interpretation – because they can’t attract new customers, McDonald’s wants to obtain more revenue from existing customers by selling them more of an existing product; specifically breakfast items later in the day.
Sounds smart, but in reality McDonald’s is admitting it is not finding new ways to grow its customer base, or sales. The old products weren’t bringing in new customers, and new products weren’t either. As customer counts are declining, leadership is trying to pull more money out of its declining “core.” This can work short-term, but not long-term. Long-term growth requires expanding the sales base with new products and new customers.
Perhaps there is future value in spinning off McDonald’s real estate holdings in a REIT. At best this would be a one-time value improvement for investors, at the cost of another long-term revenue stream. (Sort of like Chicago selling all its future parking meter revenues for a one-time payment to bail out its bankrupt school system.) But if we look at the Sears Holdings REIT spin-off, which ostensibly was going to create enormous value for investors, we can see there were serious limits on the effectiveness of that tactic as well.
MIcrosoft also beat analysts quarterly earnings estimate. But it’s profits were up a mere 2%. And revenues declined 12% versus a year ago – proving its Growth Stall continues as well. Although leadership trumpeted an increase in cloud-based revenue, that was only an 8% improvement and obviously not enough to offset significant weakness in other markets:
It is a struggle to see the good news here. Office 365 revenues were up, but they are cannibalizing traditional Office revenues – and not fast enough to replace customers being lost to competitive products like Google OfficeSuite, etc.
Azure sales were up, but not fast enough to replace declining Windows sales. Further, Azure competes with Amazon AWS, which had remarkable results in the latest quarter. After adding 530 new features, AWS sales increased 15% vs. the previous quarter, and 78% versus the previous year. Margins also increased from 21.4% to 25% over the last year. Azure is in a growth market, but it faces very stiff competition from market leader Amazon.
We build our companies, jobs and lives around successful products and services. We want these providers to succeed because it makes our lives much easier. We don’t like to hear about large market leaders losing their strength, because it signals potentially difficult change. We want these companies to improve, and we will clutch at any sign of improvement.
As investors we behave similarly. We were told large companies have vast customer bases, strong asset bases, well known brands, high switching costs, deep pockets – all things Michael Porter told us in the 1980s created “moats” protecting the business, keeping it protected from market shifts that could hurt sales and profits. As investors we want to believe that even though the giant company may slip, it won’t fall. Time and size is on its side we choose to believe, so we should simply “hang on” and “ride it out.” In the future, the company will do better and value will rise.
As a result we see that Growth Stall companies show a common valuation pattern. After achieving high valuation, their equity value stagnates. Then, hopes for a turn-around and recovery to new growth is stimulated by a few pieces of good news and the value jumps again. Only after a few years the short-term tactics are used up and the underlying business weakness is fully exposed. Then value crumbles, frequently faster than remaining investors anticipated.
McDonald’s valuation rose from $62/share in 2008 to reach record $100/share highs in 2011. But valuation then stagnated. It is only this last jump that has caused it to reach new highs. But realize, this is on a smaller number of stores, fewer products and declining revenues. These are not factors justifying sustainable value improvement.
Microsoft traded around $25/share from March, 2003 through November, 2011 – 8.5 years. When the CEO was changed value jumped to $48/share by October, 2014. After dipping, now, a year later Microsoft stock is again reaching that previous valuation ($50/share). Microsoft is now valued where it was in December, 2002 (which is half its all-time high.)
The jump in value of McDonald’s and Microsoft happened on short-term news regarding beating analysts earnings expectations for one quarter. The underlying businesses, however, are still suffering declining revenue. They remain in Growth Stalls, and the odds are overwhelming that their values will decline, rather than continue increasing.