President Trump has been bashing Amazon of late. And Amazon is down about 12.5% since peaking on March 12, 2018. Simultaneously the DJIA fell 10% from 1/26/18 thru 4/3/18, so it is hard to discern if Amazon’s pullback has more to do with market conditions and trade war fears or Presidential bashing. Amazon’s performance has been only slightly worse than the Dow. Anyway, one would think that if the President is right and Amazon plays unfairly, the future would bode well for Walmart.
That is very unlikely. Since peaking on January 29, just after the Dow, Walmart crashed 32% by April 3. Over the last month the stock has stabilized, but unfortunately the signs are not good for Walmart investors.
Walmart leadership has never shown a keen understanding of e-commerce, nor a commitment to making Walmart a leading market competitor. You might counter that Walmart’s acquisition of Jet.com showed a strong commitment. But we now know that amidst the minimalistic hype, Walmart actually cheated when providing its e-commerce results. And when Walmart hired a former Tesco executive to lead Jet.com’s grocery sales effort, the news was not splashed front page. Rather it was hidden in an internal email discovered by Reuters and given almost no coverage. Like Walmart was afraid to let people know it was incompetent and hiring an outsider.
Investors, and customers, need to admit that it is a LOT easier for Amazon to learn about traditional store operations by purchasing Whole Foods than it is for Walmart to learn how to succeed in e-commerce. Traditional grocery “excellence” is easy to come by, after all there are thousands of experienced grocery store executives. So Amazon can buy Whole Foods and gain what knowledge it needs overnight, while adapting Whole Foods to the tremendous e-commerce insight embedded in Amazon. But Walmart is struggling to add compete with Amazon in e-commerce, where knowledge is a lot, lot tougher to come by.
Telltale’s are strips of cloth used by sailors to provide early tips about wind direction and speed. Good sailors “read” the telltale strips to plot their sail use for maximum performance. We can read the “telltales” in business as well. The “telltales” at Walmart have long been bad signals for investors. After 3 years of recovery from a 2014 collision created by an overworked Walmart driver, comedian Tracy Morgan recently returned to television with a new show. The overworked driver was a worrisome telltale of how Walmart pressured its employees to attempt competing against much lower cost e-commerce. By February, 2016 there were 10 very obvious telltales of Walmart’s inability to cope with Amazon and the market shift to e-commerce.
Understanding e-commerce is worth a whole lot more than being good at running a tight retail operation. As I pointed out in May, 2016, knowing that trend is what makes Amazon worth so much more than the much bigger, and asset rich, Walmart. And the Walton family knows this, that’s why it became clear by October, 2017 that they were cashing out of the traditional Walmart business. As I’ve said before, if the Walton’s aren’t putting their money in Walmart (or shopping in the stores) why should you?
On February 20, 2018 Walmart’s stock had its biggest price drop ever. And the second biggest percentage decline ever. Even though same store sales improved, investors sold off the stock in droves. And after a pretty healthy recent valuation run-up.
What happened? Simply put, Walmart said its on-line sales slowed and its cost of operations rose, slowing growth and cramping margins. In other words, even though it bought Jet.com Walmart is still a long, long way from coming close to matching the customer relationship and growth of Amazon.com. And (surprise, surprise) margins in on-line aren’t an easy thing — as Amazon’s thin margins for 15 years have demonstrated.
In other words, this was completely to be expected. Walmart is a behemoth with no adaptability. For decades the company has been focused on how to operate its warehouses and stores, and beat up its suppliers. Management had to be drug, kicking and screaming, into e-commerce. And failing regularly it finally made an acquisition. But to think that Jet.com was going to change WalMart’s business model into a growing, high profit operation any time soon was foolish. Management still wants people in the store, first and foremost, and really doesn’t understand how to do anything else.
All the way back in 2005, I wrote that Walmart was too big to learn, and was unwilling to create white space teams to really explore growing e-commerce (hence the belated Jet-com acquisition.) In 2007, I wrote that calling Walmart a “mature” competitor with huge advantages was the wrong way to view the company already under attack by all the e-commerce players. In July, 2015 Amazon’s market cap exceeded Walmart’s, showing the importance of retail transformation on investor expectations. By February, 2016 there were 10 telltale signs Walmart was in big trouble by a changing retail market. And by October, 2017 it was clear the Waltons were cashing out of Walmart, questioning why any investor should remain holding the stock.
It really is possible to watch trends and predict future markets. And that can lead to good predictions about the fates of companies. The signs were all there that Walmart shouldn’t be going up in value. Hope had too many investors thinking that Walmart was too big to stumble – or fail. But hope is not how you should invest. Not for your portfolio, and not for your business. Walmart should have dedicated huge sums to e-commerce 15 years ago, now it is playing catch up with Amazon.com, and that’s a race it simply won’t win. Are you making the right investment decisions for your business early enough? Or will you stumble like Walmart?
Business Insider is projecting a “tsunami” of retail store closings in 2018 — 12,000 (up from 9,000 in 2017.) Also, the expect several more retailers will file bankruptcy, including Sears.
Duh. Nothing surprising about those projections. In mid-2016, Wharton Radio interviewed me about Sears, and I made sure everyone clearly understood I expect it to fail. Soon. In December, 2016 I overviewed Sears’ demise, predicted its inevitable failure, and warned everyone that all traditional retail was going to get a lot smaller. I again recommended dis-investing your portfolio of retail. By March, 2017 the handwriting was so clear I made sure investors knew that there were NO traditional retailers worthy of owning, including Walmart. By October, 2017 I wrote about the Waltons cashing out their Walmart ownership, indicating nobody should be in the stock – or any other retailer.
The trend is unmistakable, and undeniable. The question is – what are you going to do about it? In July, 2015 Amazon became more valuable than Walmart, even though much smaller. I explained why that made sense – because the former is growing and the latter is shrinking. Companies that leverage trends are always worth more. And that fact impacts YOU! As I wrote in February, 2017 the “Amazon Effect” will change not only your investments, but how you shop, the value of retail real estate (and thus all commercial real estate,) employment opportunities for low-skilled workers, property and sales tax revenues for all cities impacting school and infrastructure funding, and all supply chain logistics. These trends are far-reaching, and no business will be untouched.
Don’t just say “oh my, retailers are crumbling” and go to the next web page. You need to make sure your strategy is leveraging the “Amazon Effect” in ways that will help you grow revenues and profits. Because your competition is making plans to use these trends to hurt your business if you don’t make the first move. Need help?
Companies, like aircraft, stall when they don’t have enough “power” to continue to climb.
Everybody wants to be part of a winning company. As investors, winners maximize portfolio returns. As employees winners offer job stability and career growth. As communities winners create real estate value growth and money to maintain infrastructure. So if we can understand how to avoid the losers, we can be better at picking winners.
It has been 20 years since we recognized the predictive power of Growth Stalls. Growth Stalls are very easy to identify. A company enters a Growth Stall when it has 2 consecutive quarters, or 2 successive quarters vs the prior year, of lower revenues or profits. What’s powerful is how this simple measure indicates the inability of a company to ever grow again.
Only 7% of the time will a company that has a Growth Stall ever grow at greater than 2%/year. 93% of these companies will never achieve even this minimal growth rate. 38% will trudge along with -2% to 2% growth, losing relevancy as it develops no growth opportunities. But worse, 55% of companies will go into decline, with sales dropping at 2% or more per year. In fact 20% will see sales drop at 6% or more per year. In other words, 93% of companies that have a Growth Stall simply will not grow, and 55% will go into immediate decline.
Growth Stalls happen because the company is somehow “out of step” with its marketplace. Often this is a problem with the product line becoming less desirable. Or it can be an increase in new competitors. Or a change in technology either within the products or in how they are manufactured. The point is, something has changed making the company less competitive, thus losing sales and/or profits.
Unfortunately, leadership of most companies react to a Growth Stall by doubling down on what they already do. They vow to cut costs in order to regain lost margin, but this rarely works because the market has shifted. They also vow to make better products, but this rarely matters because the market is moving toward a more competitive product. So the company in a Growth Stall keeps doing more of the same, and fortunes worsen.
But, inevitably, this means someone else, some company who is better aligned with market forces, starts doing considerably better.
This week analysts at Goldman Sachs lowered GM to a sell rating. This killed a recent rally, and the stock is headed back to $40/share, or lower, values it has not maintained since recovering from bankruptcy after the Great Recession. GM is an example of a company that had a Growth Stall, was saved by a government bailout, and now just trudges along, doing little for employees, investors or the communities where it has plants in Michigan.
Tesla- enough market power to gain share “uphill”?
By understanding that GM, Ford and Chrysler (now owned by Fiat) all hit Growth Stalls we can start to understand why they have simply been a poor place to invest one’s resources. They have tried to make cars cheaper, and marginally better. But who has seen their fortunes skyrocket? Tesla. While GM keeps trying to make a lot of cars using outdated processes and technologies Tesla has connected with the customer desire for a different auto experience, selling out its capacity of Model S sedans and creating an enormous backlog for Model 3. Understanding GM’s Growth Stall would have encouraged you to put your money, career, or community resources into the newer competitor far earlier, rather than the no growth General Motors.
This week, JCPenney’s stock fell to under $3/share. As JCPenney keeps selling real estate and clearing out inventory to generate cash, analysts now say JCPenney is the next Sears, expecting it to eventually run out of assets and fail. Since 2012 JCP has lost 93% of its market value amidst closing stores, laying off people and leaving more retail real estate empty in its communities.
In 2010 JCPenney entered a Growth Stall. Hoping to turn around the board hired Ron Johnson, leader of Apple’s retail stores, as CEO. But Mr. Johnson cut his teeth at Target, and he set out to cut costs and restructure JCPenney in traditional retail fashion. This met great fanfare at first, but within months the turnaround wasn’t happening, Johnson was ousted and the returning CEO dramatically upped the cost cutting.
The problem was that retail had already started changing dramatically, due to the rapid growth of e-commerce. Looking around one could see Growth Stalls not only at JCPenney, but at Sears and Radio Shack. The smart thing to do was exit those traditional brick-and-mortar retailers and move one’s career, or investment, to the huge leader in on-line sales, Amazon.com. Understanding Growth Stalls would have helped you make a good decision much earlier.
This recent quarter Chipotle Mexican Grill saw analysts downgrade the company, and the stock took another hit, now trading at a value not seen since the end of 2012. Chipotle leadership blamed bad results on higher avocado prices, temporary store closings due to hurricanes, paying out damages due to a “one time event” of hacking, and public relations nightmares from rats falling out of a store ceiling in Texas and a norovirus outbreak in Virginia. But this is the typical “things will all be OK soon” sorts of explanations from a leadership team that failed to recognize Chipotle’s Growth Stall.
Prior to 2015, Chipotle was on a hot streak. It poured all its cash into new store openings, and the share price went from $50 from the 2006 IPO to over $700 by end of 2015; a 14x improvement in 9 years. But when it was discovered that ecoli was in Chipotle’s food the company’s sales dropped like a stone. It turned out that runaway growth had not been supported by effective food safety processes, nor effective store operations processes that would meet the demands of a very large national chain.
But ever since that problem was discovered, management has failed to recognize its Growth Stall required a significant set of changes at Chipotle. They have attacked each problem like it was something needing individualized attention, and could be rectified quickly so they could “get back to normal.” And they hoped to turn around public opinion by launching nationwide a new cheese dip product in 2017, despite less than good social media feedback on the product from early customers. They kept attempting piecemeal solutions when the Growth Stall indicated something much bigger was engulfing the company.
What’s needed at Chipotle is a recognition of the wholesale change required to meet customer demands amidst a shift to more growth in independent restaurants, and changing millennial tastes. From the menu options, to app ordering and immediate delivery, to the importance of social media branding programs and customer testimonials as well as demonstrating commitment to social causes and healthier food Chipotle has fallen out-of-step with its marketplace. The stock has now lost 66% of its value in just 2 years amidst sales declines and growth stagnation.
We don’t like to study losers. But understanding the importance of Growth Stalls can be very helpful for your career and investments. If you identify who is likely to do poorly you can avoid big negatives. And understanding why the market shifted can lead you to finding a job, or investing, where leadership is headed in the right direction.
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Monitor displays General Electric Co. (GE) at the New York Stock Exchange (NYSE) October, 2017. Photographer: Michael Nagle/Bloomberg
For years I have been negative on GE’s leadership. CEO Immelt led the dismantling of the once-great GE, making it a smaller company and one worth quite a bit less. The process has been devastating to many employees who lost their jobs, pensioners who have seen their benefits shrivel, communities with GE facilities that have suffered from investment atrophy, suppliers that have been squeezed out or displaced and investors that have seen the value of GE shares plummet.
But now there is a new CEO, a new leadership team and even some new faces on the Board of Directors. Some readers have informed me that it is easier to attack a weak leader than recommend a solution, and they have inquired as to what I think GE should do now. I do not see the GE situation as hopeless. The company still has an enormous revenue base, and vast assets it can use to fund a directional shift. And that’s what GE must do – make a serious shift in how it allocates resources.
Step 1 – Apply the First Rule of Holes
The first rule of holes is “when you find yourself in a hole, stop digging.” (Will Rogers, 1911) This seems simple. But far too many companies have their resourcing process on auto-pilot. Businesses that have not been growing, and often are not producing good returns on investment, continue to receive funding. Possibly because they are a legacy business that nobody wants to stop. Or possibly because leadership remains ever hopeful that tomorrow will somehow look like yesterday and the next round of money, or hiring, will change things to the way they were.
In fact, these businesses are in a hole, and spending more on them is continuing to dig. The investment hole just keeps getting bigger. The smart thing to do is just stop. Quit adding resources to a business that’s not adding value to the market capitalization. Just stop investing.
When Steve Jobs took over Apple he discontinued several Macintosh models, and cut funding for Macintosh development. The Mac was not going to save Apple’s declining fortunes. Apple needed new products for new markets, and the only way to make that happen was to stop putting so much money into the Mac business.
When streaming emerged CEO Reed Hastings of Netflix quit spending money on the traditional DVD/Video distribution business even though Netflix dominated it. He even raised the price. Only by stopping investments in traditional distribution could he turn the company toward streaming.
Step 2 – Identify the Trend that will Guide Your Strategy
All growth strategies build on trends. After receiving funding from Microsoft to avoid bankruptcy in 2000, Apple spent a year deciding its future lied in building on the trend to mobile. Once the trend was identified, all product development, and new product introductions, were targeted at being a leader in the mobile trend.
When the internet emerged GE CEO Jack Welch required all business units to create “DestroyYourBusiness.com” teams. This forced every business to look at the impact the internet would have on their business, including business model changes and emergence of new competitors. By focusing on the internet trend GE kept growing even in businesses not inherently thought of as “internet” businesses.
GE has to decide what trend it will leverage to guide all new growth projects. Given its large positions in manufacturing and health care it would make sense to at least start with IoT opportunities, and new opportunities to restructure America’s health care system. But even if not these trends, GE needs to identify the trend that it can build upon to guide its investments and grow.
Step 3 – Place Your Bets and Monetize
When Facebook CEO Mark Zuckerberg realized the trend in communications was toward pictures and video he took action to keep users on the company platform. First he bought Instagram for $1 billion, even though it had no revenues. Two years later he paid $19 billion for WhatsApp, gaining many new users as well as significant OTT technology. Both seemed very expensive acquisitions, but Facebook rapidly moved to increase their growth
and monetize their markets. Leaders of the acquired companies were given important roles in Facebook to help guide growth in users, revenues and profits.
Netflix leads the streaming war, but it has tough competition. So Netflix has committed spending over $6billion on new original content to keep customers from going to Amazon Prime, Hulu and others. This large expenditure is intended to allow ongoing subscriber growth domestically and internationally, as well as raise subscription prices.
This week CVS announced it is planning to acquire Aetna Health for $66 billion. On the surface it is easy to ask “why?” But quickly analysts offered support for the deal, ranging from fighting off Amazon in prescription sales to restructuring how health care costs are paid and how care is delivered. The fact that analysts see this acquisition as building on industry trends gives support to the deal and expectations for better future returns for CVS.
During the Immelt era, there were attempts to grow, such as in the “water business.” But the investments were not consistent, and there was insufficient effort placed on understanding how to monetize the business short- and long-term. Leadership did not offer a compelling vision for how the trends would turn into revenues and profits. Acquisitions were made, but lacking a strong vision of how to grow revenues, and an outsider’s perspective on how to lead the trend, very quickly short-term financial metrics built into GE’s review process led to bad decisions crippling these opportunities for growth. And today the consensus is that GE will likely sell its healthcare businessrather than make the necessary investments to grow it as CVS is doing.
Successful leadership means moving beyond traditional financial management to invest for growth
In the Welch era, GE made dozens of acquisitions. These were driven by a desire to build on trends. Welch did not fear investing in growth businesses, and he held leaders’ feet to the fire to produce successful results. If they didn’t achieve goals he let the people and/or the business go. Hence his nickname “Neutron Jack.”
For example, although GE had no background in entertainment, GE bought NBC at a time when viewership was growing and ad prices were growing even faster. This led to higher revenues and market cap for GE. On the other hand, when leaders at CALMA did not anticipate the shift in CAD/CAM from dedicated workstations to PCs, Welch saw them overly tied to old technology and unable to recognize the trend, so he immediately sold the business. He invested in businesses that added to valuation, and sold businesses that lacked a clear path to building on trends for higher value.
Being a caretaker, or steward, is no longer sufficient for business leadership. Competitors, and markets, shift too quickly. Leaders must anticipate trends, reduce investments in products, services and projects that are off the trend, and put resources to work where growth can create higher returns.
This is all possible at GE – if the new leadership has a vision for the future and starts allocating resources effectively. For now, all we can do is wait and see……
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Employees restock shelves of school supplies at a Walmart Stores Inc. location in Burbank, CA. Bloomberg
Last week there was a lot of stock market excitement regarding WalMart. After a “favorable” earnings report analysts turned bullish and the stock jumped 4% in one day, WMT’s biggest rally in over a year, making it a big short-term winner. But the leadership signals indicate WalMart is probably not the best place to put your money.
WalMart has limited growth plans
WalMart is growing about 3%/year. But leadership acknowledged it was not growing its traditional business in the USA, and only has plans to open 25 stores in the next year. It hopes to add about 225 internationally, predominantly in Mexico and China, but unfortunately those markets have been tough places for WalMart to grow share and make profits. And the company has been plagued with bribery scandals, particularly in Mexico.
And, while WalMart touts its 40%+ growth rate on-line, margins online (including the free delivery offer) are even lower than in the traditional Wal-Mart stores, causing the company’s gross margin percentage to decline. The $11.5 billion on-line revenue projection for next year is up, but it is 2.5% of Walmart’s total, and a mere 7-8% of Amazon’s retail sales. Amazon remains the clear leader, with 62% of U.S. households having visited the company in the second quarter. And it is not a good sign that WalMart’s greatest on-line growth is in groceries, which amount to 26% of on-line salesalready. WalMart is investing in 1,000 additional at-store curb-side grocery pick-uplocations, but this effort to defend traditional store sales is in the products where margins are clearly the lowest, and possibly nonexistent.
It is not clear that WalMart has a strategy for competing in a shrinking traditional brick-and-mortar market where Costco, Target, Dollar General, et.al. are fighting for every dollar. And it is not clear WalMart can make much difference in Amazon’s giant on-line market lead. Meanwhile, Amazon continues to grow in valuation with very low profits, even as it grows its presence in groceries with the Whole Foods acquisition. In the 17 months from May 10, 2016 through October 10, 2017 WalMart’s market cap grew by $24 billion (10%,) while Amazon’s grew by $174 billion (57%.)
Even after recent gains for WalMart, its market capitalization remains only 53% of its much smaller on-line competitor. This creates a very difficult pricing problem for WalMart if it has to make traditional margins in order to keep analysts, and investors, happy.
Leadership is not investing to compete, but rather cashing out the business
To understand just how bad this growth problem is, investors should take a look at where WalMart has been spending its cash. It has not been investing in growing stores, growing sales per store, nor really even growing the on-line business. From 2007-2016 WalMart spent a whopping $67.3 billion in share buybacks. That is over 20 times what it spent on Jet.com. And it was 45% of total profits during that timeframe. Additionally WalMart paid out $51.2 billion in dividends, which amounted to 34% of profits. Altogether that is $118.5 billion returned to shareholders in the last decade. And a staggering 79% of profits. It shows that WalMart is really not investing in its future, but rather cashing out the company by returning money to shareholders.
So very large investors, who control huge voting blocks, recognize that things are not going well at WalMart. But, because of the enormity of the share buybacks, the Walton family now controls over half of WalMart stock. That makes it tough for an activist to threaten shaking up the company, and lets the Waltons determine the company’s future.
Buybacks signal Strategy
There will be marginal enhancements. But the vast majority of the money is being returned to them, via $20 billion in share repurchases and $1.5 billion in cash dividends annually.
Amazon spends nothing on share repurchases. Nor does it distribute cash to shareholders via dividends. Amazon’s largest shareholder, Jeff Bezos, invests all the company money in new growth opportunities. These nearly cover the retail landscape, and increasingly are in other growth markets like cloud services, software-as-a-service and entertainment. Comparing the owners of these companies, quite clearly Bezos has faith in Amazon’s ability to invest money for profitable future growth. But the Waltons are far less certain about the future success of WalMart, so they are pulling their money off the table, allowing investors to put their money in ventures outside WalMart.
Investing your money, do you think it is better to invest where the owner believes in the future of his company?
Or where the owners are cashing out?
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(Photo by Scott Olson/Getty Images)
Traditional retailers just keep providing more bad news. Payless Shoes said it plans to file bankruptcy next week, closing 500 of its 4,000 stores. Most likely it will follow the path of Radio Shack, which hasn’t made a profit since 2011. Radio Shack filed bankruptcy and shut a gob of stores as part of its “turnaround plan.” Then in February Radio Shack filed its second bankruptcy — most likely killing the chain entirely this time.
Sears Holdings finally admitted it probably can’t survive as a going concern this week. Sears has lost over $10 billion since 2010 — when it last showed a profit — and owes over $4 billion to its creditors. Retail stocks cratered Monday as the list of retailers closing stores accelerated: Sears, KMart, Macy’s, Radio Shack, JCPenney, American Apparel, Abercrombie & Fitch, The Limited, CVS, GNC, Office Depot, HHGregg, The Children’s Place and Crocs are just some of the household names that are slowly (or not so slowly) dying.
None of this should be surprising. By the time CEO Ed Lampert merged KMart with Sears the trend to e-commerce was already pronounced. Anyone could build an excel spreadsheet that would demonstrate as online retail grew, brick-and-mortar retail would decline. In the low margin world of retail, profits would evaporate. It would be a blood bath. Any retailer with any weakness simply would not survive this market shift — and that clearly included outdated store concepts like Sears, KMart and Radio Shack which long ago were outflanked by on-line shopping and trendier storefronts.
Yet, not everyone is ready to give up on some retailers. Walmart, for example, still trades at $70 per share, which is higher than it traded in 2015 and about where it traded back in 2012. Some investors still think that there are brick-and-mortar outfits that are either immune to the trends, or will survive the shake-out and have higher profits in the future.
And that is why we have to be very careful about business myths. There are a lot of people that believe as markets shrink the ultimate consolidation will leave one, or a few, competitors who will be very profitable. Capacity will go away, and profits will return. In the end, they believe if you are the last buggy whip maker you will be profitable — so investors just need to pick who will be the survivor and wait it out. And, if you believe this, then you have justified owning Walmart.
Only, markets don’t work that way. As industries consolidate they end up with competitors who either lose money or just barely eke out a small profit. Think about the auto industry, airlines or land-line telecom companies.
Two factors exist which effectively forces all the profits out of these businesses and therefore make it impossible for investors to make money long-term.
First, competitive capacity always remains just a bit too much for the market need. Management, and often investors, simply don’t want to give up in the face of industry consolidation. They keep hoping to reach a rainbow that will save them. So capacity lingers and lingers — always pushing prices down even as costs increase. Even after someone fails, and that capacity theoretically goes away, someone jumps in with great hopes for the future and boosts capacity again. Therefore, excess capacity overhangs the marketplace forcing prices down to break-even, or below, and never really goes away.
Given the amount of retail real estate out there and the bargains being offered to anyone who wants to open, or expand, stores this problem will persist for decades in retail.
Second, demand in most markets keeps declining. Hopefuls project that demand will “stabilize,” thus balancing the capacity and allowing for price increases. Because demand changes aren’t linear, there are often plateaus that make it appear as if demand won’t go down more. But then something changes — an innovation, regulatory change, taste change — and demand takes another hit. And all the hope goes away as profits drop, again.
It is not a successful strategy to try being the “last man standing” in any declining market. No competitor is immune to these forces when markets shift. No matter how big, when trends shift and new forms of competition start growing every old-line company will be negatively affected. Whether fast, or slow, the value of these companies will continue declining until they eventually become worthless.
Nor is it successful long-term to try and segment the business into small groupings which management thinks can be protected. When Xerox brought to market photocopying, small offset press manufacturers (ABDick and Multigraphics ) said not to worry. Xeroxing might be OK in some office installations, but there were customer segments that would forever use lithography. Even as demand shrunk, well into the 1990s, they said that big corporations, industrial users, government entities, schools and other segments would forever need the benefits of lithography, so investors were safe. Today the small offset press market is a tiny fraction of its size in the 1960s. ABDick and Multigraphics both went through rounds of bankruptcies before disappearing. Xerography, its child desktop publishing, and its grandchild electronic screens, killed offset for almost all applications.
So don’t be lured into false hopes by retailers who claim their segment is “protected.” Short-term things might not look bad. But the market has already shifted to e-commerce and this is just round one of change. More and more innovations are coming that will make the need for traditional stores increasingly unnecessary.
Many readers have expressed their disappointment in my chronic warnings about Walmart. But those warnings are no different than my warnings about Sears Holdings. It’s just that the timing may be different. Both companies have been over-investing in assets (brick-and-mortar stores) that are declining in value as they have attempted to defend and extend their old business model. Both radically under-invested in new markets which were cannibalizing their old business. And, in the end, both will end up with the same results.
And this is true for all retailers that depend on traditional brick-and-mortar sales for their revenues and profits — it’s only a matter of when things will go badly, not if. So traditional retail is nowhere that any investor wants to be.
(Photo: JOHN MACDOUGALL/AFP/Getty Images)
Amazon.com has become an important part of the American economy, and the lives of people globally. But, far too few people still understand the repercussions of Amazon’s success on retailers, consumer goods manufacturers, real estate – and ultimately everyone’s lives. The implications are enormous. Smart leaders, and investors, will plan for these implications and take advantage of the market shift.
Invest in ecommerce, divest traditional retailers.
The first implication is just thinking about investing in Amazon and/or its competitors in retail. In May, 2016 I compared the market value of Wal-Mart, the world’s largest retailer, with Amazon. At the time Wal-Mart was worth $216 billion, and Amazon was worth $332 billion. The difference could be explained by realizing that Wal-Mart was the leader at brick-and-mortar sales, which were shrinking, while Amazon was the leader in e-commerce, which is growing. Since then Wal-Mart’s value has increased to $222 billion – up $6 billion, 2.8%. Meanwhile Amazon’s value has increased to $403 billion- up $71 billion, 21.4%. Over three years (starting 3/3/14) Wal-Mart’s per share value has declined from $74 to $71 (down 4%,) while Amazon’s has risen from $370 to $845 (up 128%.)
To put it mildly, investing in Amazon, which is the leader in e-commerce, has created a great return. Contrastingly that value increase has been fueled by declines in traditional retailers. The Amazon Effect has caused shares in companies like Sears Holdings, JCPenney, Kohl’s, Macy’s and many other stalwarts of the bygone era to be crushed. Over the last year investors in XRT (the retail industry spider) have increased 1.6%, while the S&P 500 spider has jumped 22%. The number of retailers with debt rated at Moody’s most distressed level has tripled since 2009 – and Moody’s predicts this list will worsen over the next five years.
There is vastly too much retail space, and nobody knows what to do with it.
And this has an impact on real estate. As online sales come to over 11% of all holiday sales in 2016, and Amazon accounts for 40% of all those sales, it is clear people just don’t go to stores any more anywhere near the way they once did. Historically prime retail real estate was considered valuable – and in 2007 many people thought Sears real estate was worth more than Sears as a retailer. But no longer. According to Morningstar, Sears store closings alone could cause 200 malls to close.
It is apparent the Amazon Effect has left America with far more storefronts than needed. Stand-alone stores are being shuttered, with no alternative use for most buildings. Malls and shopping centers go begging as traffic drops, tenants leave, lease rates collapse and the facilities end up wholly or nearly empty. This means you don’t want to invest in retail real estate REITs. But it also means that neighborhoods, and sometimes entire towns, will be impacted as these empty buildings reduce interest in housing and push down residential prices.
Tax receipts will fall, and nobody knows how to replace them.
For a long time governments gave handouts to retailers in the form of tax breaks to build stores or locate their headquarters. But as stores close the property tax receipts decline, putting a greater burden on homeowners to pay for schools and infrastructure. Same with sales taxes which disappear from the local government coffers. And tax breaks once given to hold onto jobs – like the ones the village of Hoffman Estates and state of Illinois, gave Sears in 2011 to not move its headquarters, look far less justified. In short, the Amazon Effect has an enormous impact on the local tax base – and those missing dollars will inevitably have to come from residents – or a significant curtailing of services.
The impact on job eliminations will be staggering.
The Amazon Effect also has an impact on jobs. Amazon’s growth keeps escalating, from 19% in 2014 to 20% in 2015 to 28% in 2016, which takes the jobs away from traditional retailers. Macy’s plans to shed 10,000 workers as it shrinks and streamlines. JCPenney will eliminate 6,000 employees via early retirement completely separate from its store closings, and HHGregg is shedding 1,500 jobs as stores close. And thousands more are being lost across traditional retail in stores, supply chain positions and headquarters facilities.
Traditional retail employs about 16.5 million Americans – nearly 10% of the entire workforce. 6.2 million are in the prime product lines targeted by e-commerce (GAFO – General, Apparel, Furniture and Other.) The Amazon Effect will continue to eliminate these positions. Over the next five years it is not unlikely that the decline of brick-and-mortar will cause 16% of GAFO jobs to disappear, which is almost 1 million jobs. Simultaneously this could easily cause 10% of the non-GAFO jobs (10.3 million) to disappear – which is another 1 million. This likely scenario would cause the loss of 2 million jobs in just five years, which is the entirety of all lost manufacturing jobs to China. The Trump administration has more employment concerns to face than just the return of manufacturing.
The Amazon Effect is changing grocery shopping, without even being a major competitor in that sector. Because Wal-Mart has lost so much general merchandise sales to e-commerce, the company has amped up grocery sales – which are now 56% of total revenue. To continue growing groceries Wal-Mart is undertaking a massive price war pitting itself against the long-running low cost grocer Aldi. This is creating even more intense profit pressure on Wal-Mart, which last year saw gross margins drop by eight points, as net income fell 18%. Such intense price competition is creating the need for even more cost cutting among all grocers – which means investors beware – and we can expect even more job cutting as the spiral downward continues.
Consumer Goods manufacturers, and their suppliers, will be stressed.
Of course this pushes the Amazon Effect onto consumer goods companies that supply grocery retailers. Wal-Mart has held meetings with P&G, Unilever, Conagra, Coca-Cola and other big name companies demanding across-the-board 15% price reductions at wholesale. And Wal-Mart expects these suppliers to help Wal-Mart beat its head-to-head competitors on price 8o% of the time. This will cause consumer goods manufacturers to cut their own costs, including jobs, as well as pressure their raw material suppliers to further reduce their costs – leading to an ongoing spiral of cost cutting, job eliminations and additional pressures for change.
The internet gave us e-commerce, and that birthed Amazon.com. Few predicted the enormous implications this would have on retail, and society. Every single American is affected by the Amazon Effect, which is now inescapable. The only remaining question is whether your business, your government leaders and you are planning for this and preparing for the inevitable changes which will continue coming?
(Photo by Andrew Burton/Getty Images)
Apple’s stock is on a tear. After languishing for well over a year, it is back to record high levels. Once again Apple is the most valuable publicly traded company in America, with a market capitalization exceeding $700 billion. And pretty overwhelmingly, analysts are calling for Apple’s value to continue rising.
But today’s Apple, and the Apple emerging for the future, is absolutely not the Apple which brought investors to this dance. That Apple was all about innovation. That Apple identified big trends – specifically mobile – then created products that turned the trend into enormous markets. The old Apple knew that to create those new markets required an intense devotion to product development, bringing new capabilities to products that opened entirely new markets where needs were previously unmet, and making customers into devotees with really good quality and customer service.
That Apple was built by Steve Jobs. Today’s Apple has been remade by Tim Cook, and it is an entirely different company.
Today’s Apple – the one today’s analysts love – is all about making and selling more iPhones. And treating those iPhone users as a “loyal base” to which they can sell all kinds of apps/services. Today’s Apple is about using the company’s storied position, and brand leadership, to milk more money out of customers that own their devices, and expanding into adjacent markets where the installed base can continue growing.
UBS likes Apple because they think the services business is undervalued. After noting that it today would stand alone as a Fortune 100 company, they expect those services to double in four years. Bernstein notes services today represents 11% of revenue, and should grow at 22% per year. Meanwhile they expect the installed base of iPhones to expand by 27% – largely due to offshore sales – adding further to services growth.
Analysts further like Apple’s likely expansion into India – a previously almost untapped market. CEO Cook has led negotiations to have Foxxcon and Wistron, the current Chinese-based manufacturers, open plants in India for domestic production of iPhones. This expansion into a new geographic market is anticipated to produce tremendous iPhone sales growth. Do you remember when, just before filing for bankruptcy, Krispy Kreme was going to keep up its valuation by expanding into China?
Of course, with so many millions of devices, it is expected that the apps and services to be deployed on those devices will continue growing. Likely exponentially. The iOS developer community has long been one of Apple’s great strengths. Developers like how quickly they can deploy new apps and services to the market via Apple’s sales infrastructure. And with companies the size of IBM dedicated to building enterprise apps for iOS the story heard over and again is about expanding the installed base, then selling the add-ons.
Gee, sounds a lot like the old “razors lead to razor blade sales” strategy – business innovation circa 1966.
Overall, doesn’t this sound a lot like Microsoft? Bill Gates founded a company that revolutionized computing with low-cost software on low-cast hardware that did just about anything you would want. Windows made life easy. Microsoft gave users office automation, databases and all the basic work tools. And when the internet came along Microsoft connected everyone with Internet Explorer – for free! Microsoft created a platform with Windows upon which hordes of developers could build special applications for dedicated markets.
Once this market was created, and pretty much monopolized by Microsoft CEO Gates turned the reigns over to CEO Steve Ballmer. And Mr. Ballmer maximized these advantages. He invested constantly in developing updates to Windows and Office which would continue to insure Microsoft’s market share against emerging competitors like Unix and Linux. The money was so good that over a decade money was poured into gaming, even though that business lost more money than it made in revenue – but who cared? There were occasional investments in products like tablets, hand-helds and phones, but these were merely attractions around the main show. These products came and went and, again, nobody really cared.
Ballmer optimized the gains from Microsoft’s installed base. And a lot – a lot – of money was made doing this. nvestors appreciated the years of ongoing profits, dividends – and even occasional special dividends – as the money poured in. Microsoft was unstoppable in personal computing. The only thing that slowed Microsoft down was the market shift to mobile, which caused the PC market to collapse as unit sales have declined for six straight years (PC sales in 2016 barely managed levels of 2006). But, for a goodly while, it was a great ride!
Today all one hears about at Apple is growing the installed base. Maximizing sales of iPhones. And then selling everyone services. Oh yeah, the Apple Watch came out. Sort of flopped. Nobody really seemed to care much. Not nearly as much as they cared about 2 quarters of sales declines in iPhones. And whatever happened to AppleTV? ApplePay? iBeacons? Beats? Weren’t those supposed to be breakthrough innovations to create new markets? Oh well, nobody seems to much care about those things any longer. Attractions around the main event – iPhones!
So now analysts today aren’t put in the mode of evaluating breakthrough innovations and trying to guess the size of brand new, never before measured markets. That was hard. Now they can be far more predictable forecasting smartphone sales and services revenue, with simulations up and down. And that means they can focus on cash flow. After all, Apple makes more cash than it makes profit! Apple has a $246 billion cash hoard. Most people think Berkshire Hathaway, led by famed investor Warren Buffett, spent $6.6 billion on Apple stock in 2016 because Berkshire sees Apple as a cash generation machine – sort of like a railroad! And if those meetings between CEO Cook and President Trump can yield a tax change allowing repatriation at a low rate then all that cash could lead to a big one time dividend!
And, most likely, the stock will go up. Most likely, a lot. Because for at least a while Apple’s iPhone business is going to be pretty good. And the services business is going to grow. It will be a lot like Microsoft – at least until mobile changed the business. Or, maybe like Xerox giving away copiers to obtain toner sales – until desktop publishing and email cratered the need for copiers and large printers. Or, going all the way back into the 1950s and 60s, when Multigraphics and AB Dick practically gave away small printers to get the ink and plate sales – until xerography crushed that business. Of course you couldn’t go wrong investing in Sears for years, because they had the store locations, they had the brands (Kenmore, Craftsman, et.al.,) they had the credit card services – until Wal-Mart and Amazon changed that game.
You see, that’s the problem with all of these sort of “milk the base” businesses. As the focus shifts to grow the base and add-on sales the company loses sight of customer needs. Innovation declines, then evaporates as everything is poured into maximizing returns from the “core” business. Optimization leads to a focus on costs, and price reductions. Arrogance, based on market leadership, emerges and customer service starts to wane. Quality falters, but is not considered as important because sales are so large.
These changes take time, and the business looks really good as profits and cash flow continue, so it is easy to overlook these cultural and organizational changes, and their potential negative impact. Many applaud cost reductions – remember the glee with which analysts bragged about the cost savings when Dell moved its customer service to India some 20 years ago?
Today we’re hearing more stories about long-term Apple customers who aren’t as happy as they once were.
Genius bar experiences aren’t always great. In a telling AdAge column one long-time Apple user discusses how he had two iPhones fail, and Apple could not replace them leaving the customer with no phone for two weeks – demonstrating a lack of planning for product failures and a lack of concern for customer service. And the same issues were apparent when his corporate Macbook Pro failed. This same corporate customer bemoans design changes that have led to incompatible dongles and jacks, making interoperability problematic even within the Apple line.
Meanwhile, over the last four years Apple has spent lavishly on a new corporate headquarters befitting the country’s most valuable publicly traded company. And Apple leaders have been obsessive about making sure this building is built right! Which sounds well and good, except this was a company that once put customers – and unearthing their hidden needs, wants and wishes – first. Now, a lot of attention is looking inward. Looking at how they are spending all that money from milking the installed base. Putting some of the best managers on building the building – rather than creating new markets.
Who was that retailer that was so successful that it built what was, at the time, the world’s tallest building? Oh yeah, that was Sears.
Markets always shift. Change happens. Today it happens faster than ever in history. And nowhere does change happen faster than in technology and consumer electronics. CEO Cook is leading like CEO Ballmer. He is maximizing the value, and profitability, of the Apple’s core product – the iPhone. And analysts love it. It would be wise to disavow yourself of any thoughts that Apple will be the innovative market creating Jobs/Ives organization it once was.
How long will this be a winning strategy? Your answer to that should determine how long you would like to be an Apple investor. Because some day something new will come along.
Sears recently announced it is closing another big batch of stores. Yawn. Who cares? Sears losses since 2010 are nearly $10 billion, with a $.75 billion loss in just the third quarter. As revenue fell another 13% overall and comparable store sales declined 7.4% investors have fled the stock for years.
Five years ago Sears had 3,510 stores. Now it has 1,687. It has 750 with leases expiring in the next five years and CFO Jason Hollar has said 550 of those are short-term enough they will let those close.
What’s striking about this statement is that Sears is a perfect candidate to file bankruptcy, renegotiate those leases, and start with a new plan for the future. Unless it has no plan. Lacking a plan to make its business successful and return those stores to profitability, the CFO is admitting the company has no choice but to keep shrinking assets as Sears simply disappears. Investors should view Sears as a microcosm of trends in traditional brick-and-mortar retailing across the industry. The business is shrinking. Fast
A closed retail store is viewed in Manhattan. (Photo by Spencer Platt/Getty Images)
Just look at retail employment. Amidst another strong jobs report for November, retail employment actually shrank. This previously only happened in recessions – and 2016 is definitely not a recession year. And all the losses were in traditional store retailing. Kohl’s said it is hiring almost 13% fewer seasonal workers, and Macy’s says it is hiring 2.4% fewer.
Of course, Amazon seasonal hiring is up 20%.
In January, 2015 I wrote how the trend to e-commerce had taken hold, and traditional retailing would never again be the same. For the 2014 holiday season online retail grew 17%, but brick-and-mortar sales actually declined. This was a pivotal event. It clearly indicated a sea change in the marketplace, and it was clear valuations would be shifting accordingly. Surprising many, but not those who really understood the trends and market shifts, six months later (July, 2015) Amazon’s market cap exceeded that of much larger Wal-Mart.
ALL trends (including mobile use) reinforce on-line growth, brick and mortar decline.
The 2016 holiday season is further reinforcing this trend. The National Retail Federation reported that on black Friday 99 million people went to stores. 108.5million shopped online. Black Friday online sales jumped 21.6%.
And this . E-commerce apps are making the on-line experience constantly better. On Thanksgiving day 70% of all on-line retail traffic was mobile, and for the first time ever 53% of on-line orders were from mobile devices – exceeding the orders placed on PCs. With this kind of access, and easy shopping, the need to travel to physical stores accelerates their decline.
Sears is beyond rescue. Unfortunately, there are a number of retailers already so challenged by the on-line competition that they are “the walking dead.” They will falter, and fail, just like the former Dow Jones Industrial retailing giant. They will not make the shift to on-line effectively. They are unwilling to dramatically change their business model, unwilling to cannibalize store sales to create an aggressively competitive on-line business. Expect bad things at JCPenney, Kohl’s, Pier 1 – and weakness at giants Wal-Mart and even Target.
Christmas used to be the time when investors in traditional retail cheered. Results for the quarter could create great gains in stock values. But that time is long gone – passed during the 2014 inflection when traditional started declining while e-commerce continued double digit growth. One can understand the Scrooge-like mentality of those investors, who dread seeing the shift in customers, and valuation, away from their companies and toward the Amazon’s who embrace trends and market shifts.