Chart courtesy of Felix Richter, Statista.com https://www.statista.com/chart/9454/retail-space-per-1000-people/
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 like 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.
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
In 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.
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.
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 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.
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.
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.
I’m a believer in Disruptive Innovation. For almost 100 years economists have written about “Creative Destruction,” in which new technologies come along making old technologies — and the companies built on them — obsolete. In the last 20 years, largely thanks to the insights of faculty at the Harvard Business School, we’ve seen a dramatic increase in understanding how new companies use new technologies to disrupt markets and wipe out the profitability of companies that were once clearly successful. In a large way, we’ve come to accept that Disruptive Innovation is good, and the concomitant Creative Destruction of the old players leads to more rapid growth for the economy, increasing jobs and the wherewithal of everyone. Creative Destruction, in the pursuit of progress, is good because it helps economies to grow.
But, not really everyone benefits from Creative Destruction. The trickle down benefits to lots of people can be a long time coming. When market shifts happen, and people lose jobs to new competitors — domestic or offshore — they only know that their life, at least short term, is a lot worse. As they struggle to pay a mortgage, and find a new job, they often learn their skills are outdated. There are new jobs, but these folks are often not qualified. As they take lesser jobs, their incomes dwindle, and they may well lose their homes. And their healthcare.
Economists call this workplace transition “temporary economic dislocation.” Fancy term. They claim that eventually folks do enter the workplace who are properly trained, and those folks make more money than the workers associated with the previous, now inferior, technology. And, eventually, everyone finds new work – at something.
A person learns to be a printer, or a printing plate maker, in the 1970s when they are 20-something. Good job, makes a great wage. Secure work, since printing demand just keeps rising. But then along comes the internet with PDF and JPEG documents that people read on a screen, and folks simply quit needing, or wanting, printed documents. In 2016, now age 50-something, this printer or plate-maker no longer has a job. Demand is down, and its really easy to send the printing to some offshore market like Thailand, Brazil or India where printing is cheaper.
What’s he or she to do now? Go back to school you may say. But to learn how to do what? Say it’s online (or digital) document production. OK, but since everyone in the 20s has been practicing this for over a decade it takes years to actually be skilled enough to be competitive. And then, what’s the pay for a starting digital graphic artist? A lot less than what they made as a printer. And who’s going to hire the 58-62 year old digital graphic artist, when there are millions of well trained 20-somethings who seem to be quicker, and more attuned to what the publishers want (especially when the boss ordering the work is 35-42, and really uncomfortable giving orders and feedback to someone her parents’ age.) Oh, and when you look around there are millions of immigrants who are able to do the work, and willing to do it for a whole lot less than anyone native born to your country.
In England last week these disaffected people made it a point to show their country’s leadership that their livelihoods were being “creatively destroyed.” How were they to keep up their standard of living with the flood of immigrants? And with the wealth of the country constantly shifting from the middle class to the wealthy business leaders and bankers? And with work going offshore to less developed countries? While folks who have done well the last 25 years voted overwhelmingly to remain in the EU (such as those who live in what’s called “The City”), those in the suburbs and outlying regions voted overwhelmingly to leave the EU. Sort of like their income gains, and jobs, left them.
A whole lot of anger. To paraphrase the famous line from the movie Network, they were mad as Hell and they weren’t going to take it any longer. Simply put, if they couldn’t participate in the wonderful economic growth of EU participation, they would take it away from those who did. The point wasn’t whether or not the currency might fall 10% or more, or whether stocks on the UK exchange would be routed. After all, these folks largely don’t go to Europe or America, so they don’t care that much what the Euro or dollar costs. And they don’t own stocks, because they aren’t rich enough to do so, so what does it hurt them if equities fall? If this all puts a lot of pain on the wealthy – well just maybe that is what they really wanted.
America is seeing this as well. It’s called the Donald Trump for president campaign. While unemployment is a remarkably low 5%, there are a lot of folks who are working for less money, or simply out of work entirely, because they don’t know how to get a job. They may laugh at Robert De Niro as a retired businessman now working for free in The Intern. But they really don’t think it’s funny. They can’t afford to work for free. They need more income to pay higher property taxes, sales taxes, health care and the costs of just about everything else. And mostly they know they are rapidly being priced out of their lifestyle, and their homes, and figuring they’ll be working well into their 70s just to keep from falling into poverty.
These people hate President Obama. They don’t care if the stock market has soared during his presidency – they don’t own stocks (and if they do in a 401K or similar program they don’t care because it does them no good today). They don’t care that he’s created more jobs than anyone since Reagan or Roosevelt, because they see their jobs gone, and they blame him if their recent college graduate doesn’t have a well-paying job. They don’t care if America is closing in on universal health care, because all they see is that health care is becoming ever more expensive – and often beyond their ability to pay. For them, their personal America is not as good as they expected it to be – and they are very, very angry. And the President is a very identifiable symbol they can blame.
Creative Destruction, and disruptive innovations, are great for the winners. But they can be wildly painful to the losers. And when the disruptive innovations are as big, and frequent, as what’s happened the last 30 years – globalized economy, nationwide and international super banks, outsourcing, offshoring and the entirety of the Internet of Things – it has left a lot of people really concerned about their future. As they see the top 1% live opulent lifestyles, they struggle to keep a 12 year old car running and pay the higher license plate fees. They really don’t care if the economy is growing, or the dollar is strong, or if unemployment is at near-record lows. They feel they are on the losing end of the stick. For them, well, America really isn’t all that great anymore.
So, hungry for revenge, they are happy to kill the goose for dinner that laid the golden eggs. They will take what they can, right now, and they don’t care if the costs are astronomical. They will let tomorrow sort out itself, in a bit of hyper-ignorance to evaluate the likely outcome of their own actions.
Despite their hard times, does this not sound at the least petty, and short-sighted? Doesn’t it seem rather selfish to damn everyone just because your situation isn’t so good? Is it really in the interest of your fellow man to create bad outcomes just because you’ve not done well?
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?
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:
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.
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.
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.
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.
“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.
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.
$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.
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.
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.
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.
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.
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.
The words “search” and “Google” are practically synonymous. We’ve even turned the name of the ubiquitous web application into a verb by telling people to “Google it.” And that’s good, because Alphabet’s revenue (that’s Google’s parent company) soared more than 25% in the last quarter, and over 90% of Alphabet’s revenue comes from Google AdWords. The more people search using Google, the more money Alphabet makes.
Chart courtesy of Martin Armstrong at Statista.com
But ever since Facebook came along, a new trend has started emerging. People often want answers to their questions within the context of their community. So “searches” are changing. People are going back to what they did before Google existed – they are asking for information from their friends. But online. And primarily using Facebook.
There is no doubt Google dominates keyword searching. But that type of searching has its shortcomings. How often have you found yourself doing multiple searches — adding words, adding phrases, dropping words, etc. trying to find what you were seeking? It’s a common problem, and we all know people who are better “Googlers” than others because of their skill at putting together key words to actually find what we want. And how often do we find ourselves lost in the initial batch of ads, but not finding the link we want? Or going through several pages of links in search of what we seek?
Context often matters. Take the classic problem of finding a place to eat. Googling an answer requires we enter the location, type of food, price point, and other info — which often doesn’t lead us to the desired information, but instead puts us into some kind of web site, or article, with restaurant review. What seems an easy question can be hard to answer when relying on key words.
But, we know how incredibly easy it is for a friend to answer this question. So when seeking a place to eat we use Facebook to ask our friends “hey, any ideas on where I should eat dinner?” Because they know us, and where we are, they fire back specific answers like “the Mexican place two blocks north is just for you,” or “spend the money to eat at that place across the street – pricey but worth it.” Your friends are loaded with context about you, your habits, your favorites and they can give great answers much faster than Google.
Think of these kind of referrals – for food, entertainment, directions, quick facts, local info — as “context based searches” rather than referrals. Instead of making a query with a string of key words, we use context to derive the answer — and our friends. Most people undertake far more of these kind of “searches” than keywords every day.
Even though Google is still growing incredibly fast, context searching — or referrals — pose a threat. People will use their network to answer questions. The web birthed on-line data, and we all quickly wanted engines to help us find that data. We were excited to use Excite, Lycos, InfoSeek, AltaVista and Ask Jeeves to name just a few of the early search engines. We gravitated toward Google because it was simply better. But with the growth of Facebook today we can ask our friends a question faster, and easier, than Google — and often we obtain better results.
Both Google and Facebook rely on ads for most of their revenue. But if consumer goods companies, event promoters, apparel manufacturers and other “core advertisers” realize that people are using Facebook to ask for information, rather than searching Google, where do you think they will spend their on-line ad dollars? Isn’t it better to have an ad for diapers on the screen when someone asks “what diapers do you like best?” than relying on someone to search for diaper reviews?
This is why Google+ with its Groups and Google Hangouts was such a big deal. Google+ allows users to come together in discussions much like Facebook. But Plus, Groups and Hangouts never really caught on, and Plus isn’t nearly as popular as Facebook discussions, or Instagram picture sharing or WhatsApp messaging. Today, when it comes to referral traffic Facebook has eclipsed Google. Five years ago most people would have guessed this would never happen.
I’m not saying that Google searches will decline, nor am I saying Google will stop growing, nor am I saying that Google’s other revenue generators, like YouTube, won’t grow. I am saying that Facebook as a platform is growing incredibly fast, and becoming an ever more powerful tool for users and advertisers. Possibly a lot more powerful than Google as people use it for more and more information gathering — and referrals. The more people make referrals on Facebook, the more it will attract advertisers, and potentially take searches away from Google.
By comparison, this moment may be like the late 1980s when PC sales finally edged ahead of Apple Mac sales. At the time it didn’t look deadly for Apple. But it didn’t take long for the Wintel platform to dominate the market, and the Mac began its slide toward being a submarket favorite.
Amazon.com is now worth about the same as Berkshire Hathaway. Amazon has had an amazing run-up in value. The stock is up 17% year to date, and 46% over the last 12 months. By comparison, Berkshire has risen 3.1% this year and Microsoft has risen 5.6% —while the S&P 500 is up 5.8%. Due to this greater value increase, Jeff Bezos has become the second richest man in the world, jumping past Warren Buffett while Bill Gates remains No. 1.
Obviously, it wouldn’t take much of a slip in Amazon, or a jump in Berkshire, to reverse the positions of the companies and their CEOs. But it is important to recognize what is happening when a barely profitable company that sells general merchandise, technology products (Kindles, Fires and Echos) and technology services (AWS) eclipses one of the most revered financial minds and successful investment managers of all time.
When Buffett started his magical machine he realized that capital was often in short supply. Companies had to ration capital, unable to build the means of production they desired. Banks were unwilling to lend when they perceived any risk, even when the risk was not that great. Simultaneously investment banks were highly inefficient. The industry was unwilling to support companies prior to going public, often uninterested in taking companies public, and poor at allocating additional capital to the highest return opportunities. By the time you were big enough to use an investment bank you really didn’t need them to raise capital – they just organized the transactions.
Berkshire Hathaway was a big winner at mastering finance during the industrial era. By putting money in the right place, at the right time, tremendous gains could be made. Berkshire didn’t have to be a manufacturer, it could make a higher rate of return by understanding how to deploy capital to industrial companies in a marketplace where capital was rationed. In other words, give people money when they need it and Berkshire could generate outsized returns.
It was a great strategy for supporting companies in the Industrial Age. And a great way to make money when capital was hard to come by.
But the world has changed. Two important things happened First, capital became a lot easier to acquire. Deregulation and a vast expansion of financial services led to a greater willingness to lend by banks, larger secondary markets for bank-originated products that carried risk, the creation of venture capital and private equity firms willing to invest in riskier opportunities, and a dramatic growth in investment banking globally making it far easier to go public and raise equity. Capital became vastly more available, and the cost of capital dropped dramatically.
This made finding opportunities for outsized returns just based on investing considerably more difficult. And thus every year it has become harder for Berkshire Hathaway to find investment opportunities that exceed market rates of return. Berkshire isn’t doing poorly, but it now competes in a world of many competitors who have driven down returns for everyone. Thus, Berkshire’s returns increasingly move toward the market norm.
The Industrial Era is dead — usher in the Information Era. Second, we are no longer in the Industrial Age. Sometime in the 1990s (economic historians will pin it to a specific date eventually) the world transitioned into the Information Age. In the Information Age assets are no longer worth as much as they previously were. Instead, information has become much more valuable. What a business knows about customers, markets and supply chains is worth more than the buildings, machines and trucks that actually make up the physical economy. The value from having information has become much higher than the value of things — or of providing capital to purchase things.
In the Information Era, few companies have mastered the art of information management better than Amazon.com. Amazon doesn’t succeed because it has great retail stores, or great product inventory or even great computers. Amazon’s success is based on knowing things about markets and its customers. Amazon has piles and piles of data, and Amazon monetizes that information into sales.
By studying customer habits, every time they buy something, Amazon has been able to make the company more valuable to customers. Often Amazon is able to tell a customer what they need before they realize they need it. And Amazon is able to predict the flow of new product introductions, and predict sales for manufacturers with great accuracy. Amazon is able to understand what media customers want, and when they’ll want it. Amazon is able to predict a business’ “cloud needs” before that business knows – and predict the customer’s likely future services needs long before the customer knows.
In the Information Age, Amazon is one of the very, very best information companies out there. It knows how to obtain information, analyze those mounds of “big data” to determine and predict needs, then connect customers with things they want to buy. Being great at information means that Amazon, even with its relatively poor current profits, is positioned to capitalize on its intellectual property for years to come. Not without competition. But with a tremendous competitive lead.
So, how is your portfolio allocated? Are you invested in assets, or information? Accumulating assets is a very hard way to make high rates of return. But creating sales, and profits, out of information is far easier today. The relative change in the value of Amazon and Berkshire is telling investors that it is now smarter to be long information rich companies than asset rich companies.
If you’re long GE, GM, 3M and Walmart how well will you do in an economy where information is more valuable than assets? If you don’t own data rich, analytically intensive companies like Amazon, Facebook, Alphabet/Google and Netflix how would you expect to make above-average rates of return?
And where is your business investing? Are you still putting most of your attention on how you allocate capital, in a world where capital is abundant and cheap? Are you focusing your attention on getting the most out of what you know about markets, customers and suppliers, or just making and selling more stuff? Do you invest in projects to give you insights competitors don’t have, or in making more of the products you have — or launching product version X?
And are you being smart about how you manage your most important information tool — your talented employees? Information is worthless without insight. It is critical companies today do all they can to help employees develop insights, and then rapidly deploy those insights to grow sales. If you spend a few hours pouring over expenses to find dimes, consider letting that activity go in order to spend hours brainstorming how to find new markets and new product opportunities that can generate a lot more revenue dollars.
Howard Schultz is one of those CEO legends. Like Steve Jobs, Larry Ellison, Jeff Bezos and Mark Zuckerberg, he turned a startup into a huge, mega-billion dollar company – and in the process created an entirely new market. This isn’t easy to do, and that’s why business acolytes and the media turn these people into heroes.
But, is it right to hand-wring over Schultz’s departure as CEO? After all, things have not been pretty for investors since Mr. Jobs turned over Apple to his hand-picked successor Tim Cook. However, could this change mean something better is in store for shareholders?
First, let’s address the very popular myth that when Mr. Schultz left Starbucks in 2000 his successors nearly destroyed the company – and Starbucks was saved only by Mr. Schultz returning with his tremendous creativity and servant leadership. While it is great propaganda for making the Schultz as hero story more appealing, it isn’t exactly accurate.
His successor, Orin Smith, far outperformed Mr. Schultz, more than tripling the chain to over 9,000 stores and expanding revenue to over $5 billion in just four years! He expanded the original model internationally, began adding many new varieties of coffee and other drinks, and even added food. These enhancements were tremendously successful at bringing in additional revenue, even if the average store revenue fell as smaller stores were added in places like airports, hotels and entertainment venues.
In 2007 Starbucks fourth quarter saw 22% revenue increase, and for the year 21% growth. Comparable store sales grew 5%. International margins expanded, and net earnings grew over 19% from $564 million to $673 million.
Starbucks’ stock, from 2000 when Mr. Schultz departed into 2006 rose 375%, from $4 to just under $19 per share. Not the ruination that some seem to think was happening.
But Mr. Schultz did not like the diversification, even if it produced more revenue and profit. He joined the chorus of analysts that beat down the P/E ratio, and the stock price, as the company expanded beyond its “core” coffee store business.
When the Great Recession hit, and people realized they could live without $4 per cup of coffee and a $50 per day habit, revenues plummeted, as they did for many restaurants and retailers. Mr. Schultz seized the opportunity to return to his old job as CEO. That the downturn in Starbucks had far more to do with the greatest economic debacle since the 1930s was overlooked as Mr. Schultz blamed everything on the previous CEO and his leadership team – firing them all.
What returning CEO Schultz did was far from creative. He simply stopped all the projects that didn’t fit his definition of the “core” Starbucks he created. And he closed 600 stores in 2009 then 300 more in 2010 – making the chain smaller as new store openings stopped. Although the popular myth is that Starbucks stagnated under Mr. Schultz successors, the opposite was true. The chain expanded both its “core” and new incremental revenues from 2000 though 2008. But as Mr. Schultz returned as CEO from 2008 through 2011 Starbucks actually did stagnate , with virtually no growth.
Since 2012 Starbucks has returned to doing what it did prior to 2000 – opening more stores. Growing from 17,000 to 25,000 stores. Refocused on its very easy to understand, if dated, business model analysts loved the simpler company and bid up the P/E to over 30 – creating a trough (2008) to peak (2016) increase in adjusted stock price from $4 to $60 – an incredible 15 times!
But, more realistically one should compare the price today to that of 2006, before the entire market crashed and analysts turned negative on the profitable Starbucks diversification and business model expansion. That gain is a more modest 300% – basically a tripling over a decade – far less a gain for investors than happened under the 2000-2006 era of Mr. Schultz’s successors.
Mr. Schultz succeeded in returning Starbucks to its “core.” But now he’s leaving a much more vulnerable company. As my fellow Forbes contributor Richard Kestenbaum has noted, retail success requires innovation. Starbucks is now almost everywhere, leaving little room for new store expansion. Yet it has abandoned other revenue opportunities pioneered under Messrs. Smith and Donald. And competition has expanded dramatically – both via direct coffee store competitors and the emergence of new gathering spots like smoothie stores, tech stores and fast casual restaurants that are attracting people away from a coffee addiction.
At some point Starbucks and its competition will saturate the market. And tastes will change. And when that happens, growth will be a lot harder to find. As McDonald’s and WalMart have learned, business models grow tired and customers switch . Exciting new competitors emerge, like Starbucks once was, and Amazon.com is increasingly today.
Mr. Schultz has said he is vastly more confident in this change of leadership than he was the last time he left – largely because he feels this hand-picked team (as if he didn’t pick the last team, by the way) will continue to remain tightly focused on defending and extending Starbucks “core” business. This approach sounds all too familiar – like Jobs selection of Cook – and the risks for investors are great.
A focus on the core has real limits. Diminishing returns do apply. And P/E compression (from the very high 30+ today) could cause Starbucks to lose any investor upside, possibly even cause the stock to decline. If Mr. Schultz’s departure was opening the door for more innovation, new business expansion and a change to new trends that sparked growth one could possibly be excited. But there is real reason for concern – just as happened at Apple.
In early August Tesla announced it would be buying SolarCity. The New York Times discussed how this combination would help CEO Elon Musk move toward his aspirations for greater clean energy use. But the Los Angeles Times took the companies to task for merging in the face of tremendous capital needs at both, while Tesla was far short of hitting its goals for auto and battery production.
Since then the press has been almost wholly negative on the merger. Marketwatch’s Barry Randall wrote that the deal makes no sense. He argues the companies are in two very different businesses that are not synergistic – and he analogizes this deal to GM buying Chevron. He also makes the case that SolarCity will likely go bankrupt, so there is no good reason for Tesla shareholders to “bail out” the company. And he argues that the capital requirements of the combined entities are unlikely to be fundable, even for its visionary CEO.
Fortune quotes legendary short seller Jim Chanos as saying the deal is “crazy.” He argues that SolarCity has an uneconomic business model based on his analysis of historical financial statements. And now Fortune is reporting that shareholder lawsuits to block the deal could delay, or kill, the merger.
But short-sellers are clearly not long-term investors. And there is a lot more ability for this deal to succeed and produce tremendous investor returns than anyone could ever glean from studying historical financial statements of both companies.
GM buying Chevron is entirely the wrong analogy to compare with Tesla buying SolarCity. Instead, compare this deal to what happened in the creation of television after General Sarnoff, who ran RCA, bought what he renamed NBC.
The world already had radio (just as we already have combustion powered cars.) The conundrum was that nobody needed a TV, especially when there were no TV programs. But nobody would create TV programs if there were no consumers with TVs. General Sarnoff realized that both had to happen simultaneously – the creation of both demand, and supply. It would only be by the creation, and promotion, of both that television could be a success. And it was General Sarnoff who used this experience to launch the first color televisions at the same time as NBC launched the first color programming – which fairly quickly pushed the industry into color.
Skeptics think Mr. Musk and his companies are in over their heads, because there are manufacturing issues for the batteries and the cars, and the solar panel business has yet to be profitable. Yet, the older among us can recall all the troubles with launching TV.
Early sets were not only expensive, they were often problematic, with frequent component failures causing owners to take the TV to a repairman. Often reception was poor, as people relied on poor antennas and weak network signals. It was common to turn on a set and have “snow” as we called it – images that were far from clear. And there was often that still image on the screen with the words “Technical Difficulties,” meaning that viewers just waited to see when programming would return. And programming was far from 24×7 – and quality could be sketchy. But all these problems have been overcome by innovation across the industry.
Yes, the evolution of electric cars will involve a lot of ongoing innovation. So judging its likely success on the basis of recent history would be foolhardy. Today Tesla sells 100% of its cars, with no discounts. The market has said it really, really wants its vehicles. And everybody who is offered electric panels with (a) the opportunity to sell excess power back to the grid and (b) financing, takes the offer. People enjoy the low cost, sustainable electricity, and want it to grow. But lacking a good storage device, or the inability to sell excess power, their personal economics are more difficult.
Electricity production, electricity storage (batteries) and electricity consumption are tightly linked technologies. Nobody will build charging stations if there are no electric cars. Nobody will build electric cars if there are not good batteries. Nobody will make better batteries if there are no electric cars. Nobody will install solar panels if they can’t use all the electricity, or store what they don’t immediately need (or sell it.)
This is not a world of an established marketplace, where GM and Chevron can stand alone. To grow the business requires a vision, business strategy and technical capability to put it all together. To make this work someone has to make progress in all the core technologies simultaneously – which will continue to improve the storage capability, quality and safety of the electric consuming automobiles, and the electric generating solar panels, as well as the storage capabilities associated with those panels and the creation of a new grid for distribution.
This is why Mr. Musk says that combining Tesla and SolarCity is obvious. Yes, he will have to raise huge sums of money. So did such early pioneers as Vanderbilt (railways,) Rockefeller (oil,) Ford (autos,) and Watson (computers.) More recently, Steve Jobs of Apple became heroic for figuring out how to simultaneously create an iPhone, get a network to support the phone (his much maligned exclusive deal with AT&T,) getting developers to write enough apps for the phone to make it valuable, and creating the retail store to distribute those apps (iTunes.) Without all those pieces, the ubiquitous iPhone would have been as successful as the Microsoft Zune.
It is fair for investors to worry if Tesla can raise enough money to pull this off. But, we don’t know how creative Mr. Musk may become in organizing the resources and identifying investors. So far, Tesla has beaten all the skeptics who predicted failure based on price of the cars (Tesla has sold 100% of its production,) lack of range (now up to nearly 300 miles,) lack of charging network (Tesla built one itself) and charging time (now only 20 minutes.) It would be shortsighted to think that the creativity which has made Tesla a success so far will suddenly disappear. And thus remarkably thoughtless to base an analysis on the industry as it exists today, rather than how it might well look in 3, 5 and 10 years.
The combination of Tesla and SolarCity allows Tesla to have all the components to pursue greater future success. Investors with sufficient risk appetite are justified in supporting this merger because they will be positioned to receive the future rewards of this pioneering change in the auto and electric utility industries.