Chart courtesy of Felix Richter, Statista.com https://www.statista.com/chart/9454/retail-space-per-1000-people/
GE Chairman and CEO Jeff Immelt walks off stage after being interviewed during the Washington Ideas Forum at the Harmon Center for the Arts September 28, 2016 in Washington, DC. A proud Republican, Immelt said it would hurt the United States and cripple President Barack Obama — and the next president of the U.S. — not to agree to trade deals like theTrans Pacific Partnership (Photo by Chip Somodevilla/Getty Images)
Readers of this column know I’m not a fan of General Electric’s CEO, Jeffrey Immelt. In May, 2012 I listed CEO Immelt as the 4th worst CEO of a large publicly traded American company. Unfortunately, his continued tenure since then did nothing to help make GE a stronger, or more valuable company. GE’s lead director says this is the culmination of a transition plan first developed in 2011. One can only wonder why it took the board so incredibly long to replace the feckless CEO, and why they allowed GE’s leadership to continue destroying shareholder value.
The longer back you look, the worse Immelt’s performance appears.
Few company analysts can say they’ve followed a company for 3 years. Fewer yet can say 5 years. Nearly none can say a decade. Yet, CEO Immelt was in his job for 16 years – much longer than almost all business analysts or writers have followed GE. Therefore, their lack of long-term memory often leaves them unable to give a proper overview of the company’s fortunes under the long-lived CEO.
I have followed GE closely for almost 35 years. Ever since I graduated from HBS class of 1982 along with Mr. Immelt. Several fellow alumni worked at GE, and a large number of my BCG (Boston Consulting Group) colleagues joined GE in senior positions during the mid-1980s as GE grew exponentially. I have followed several of these alumni as the years passed allowing me to take the “long view” on GE’s performance, during Welch’s leadership and more recently since Mr. Immelt took the top job.
I was very pleased to include a positive case study of GE’s business practices in my book “Create Marketplace Distruption – How to Stay Ahead of the Competition” (Financial Times Press, 2007.) CEO Welch used a number of internal processes to help GE leaders identify disruptive opportunities to change industries – whether markets where GE already competed or new markets. He relentlessly encouraged entering new businesses where GE could bring something new to the game, and he put GE’s money to good use growing revenues, and market cap, enormously. No other CEO in American history made as much value for shareholders as Jack Welch. His leadership pushed GE to the top position in most industries, and his relentless focus on growth helped even rank-and-file employees build million dollar IRAs to go with well funded pension and retiree benefit plans.
GE’s performance could not have changed more dramatically than it has under Mr. Immelt. But there are now a number of apologists who would say GE’s smaller size, and lower valuation, are due to market conditions which were out of Mr. Immelt’s control. They contend CEO Immelt was a good steward of the company during difficult market conditions, and the results of his tenure – notably lower revenues, lower valuation, fewer markets, fewer employees and lower community involvement – are not his fault. They argue he did a good job, all things considered.
Balderdash. Immelt was a terrible CEO
There is an overall reluctance to say bad things about any huge American icon, and its CEO. After all, columnists and analysts who are non-congratulatory don’t usually get called by the company to be consultants, or advisors. Or to be on the board. And publishers of columnists who say negative things about big companies and their execs risk having ad dollars moved to more favorable journals, and often unfriendly relationships with their ad departments and agencies. So it is far easier, and more acceptable, to sugar coat bad strategy, bad leadership and bad results.
But we should move beyond that bias. Mr. Immelt was the CEO of the ONLY company on the Dow Jones Industrial Average (DJIA) to have been on that list since it was created. He inherited the most successful company at creating shareholder value during the 1980s and 1990s. He surely should be held to the highest of comparative bars.
Those who say CEO Immelt was “set up to fail” are somehow making the case that Immelt would have been more successful if he had inherited a company with a bad brand image, weak history, and inadequate performance. They are rewriting history to say Jack Welch was not a good CEO, and his outsized gains destined GE to do poorly under his successor. That simply defies the facts – and logic.
Looking at the last 16 years of “difficult times,” when GE has struggled under Immelt’s leadership, one should ask “why did so many other companies do so well?” After all, the DJIA has more than doubled. The S&P 500 has almost doubled. The Russell 2000 has almost tripled. Overall, far more companies have gone up in value than down. Why were Immelt’s circumstances so difficult that all of those CEOs did so much better? They dealt with the same financial meltdown, same Great Recession, same increase in regulations, same federal reserve, same government administration – yet they were able to adapt their companies, grow and increase value.
Yes, GE was huge in financial services when Immelt took the reigns, and financial services saw a major crash. But look at the performance of JPMorganChase under CEO Jamie Dimon (also a classmate of Mr. Immelt.) JPM is stronger today than ever, growing and gaining market share and increasing its value to shareholders. Prior to the crash, in spring 2007, GE was trading at $41/share, and now it is $29 – a decline of ~30%. Back then JPM was trading at $53, and now it is $93 – a gain of ~75%. There obviously was a strategy to adapt to market conditions and do well. Just not at GE.
Immelt reacted to market events, poorly, rather than having a prepared, proactive strategy
Let’s not rewrite history. Prior to the banking crash CEO Immelt was more than happy for GE to be in the “easy money” world of finance. Welch had created GE Capital, and Immelt had furthered its growth when lending was easy and profitable. And he supported the enormous growth in GE’s real estate division. When this industry faced the crash, GE faced a near-bankruptcy not because of Welch, but because of Immelt’s leadership during the over 6 years he had been CEO. If there were risks in the system CEO Immelt had ample time to re-arrange the portfolio, reduce lending, offload financial assets and reduce exposure to real estate and mortgages. But Immelt did not do those things. He did not prepare for a reversal in the markets, and he did not prepare the balance sheet for a significant change of events. It was his leadership that left GE exposed.
As GE shares fell to $7 Immelt made a famous deal with Berkshire Hathaway’s CEO Warren Buffet to increase GE’s capital base in order to stave off demise. And this deal saved GE. But this was an extremely sweet deal for Buffett, giving Berkshire very good interest (10%) on the preferred shares and warrants allowing Buffett to buy future shares of GE at a fixed price. Berkshire made a profit, over and above the interest, of $260M on the deal, and overall at least $1.2B. By being prepared Buffett saved GE and made a lot of money. GE’s investors paid the price for a CEO that was unprepared.
But the changes brought about by the crash, and Dodd-Frank, were more than CEO Immelt could manage. Thus GE exited the business selling many assets at fire sale prices. This “turn tale and run” strategy was sold to the public as a way for GE to “focus” on its “core manufacturing business.” Rather, it was a failure of leadership to understand how to manage this business to future success in changed markets. Where Welch’s GE had grasped for disruption as opportunity, Immelt’s GE gasped at disruption and fled, destroying billions in GE value.
Immelt could not grow GE’s businesses, so he divested GE of many.
GE was to be the “industrial internet giant.” GE was to be a leader in the internet-of-things (IoT) where sensors, the cloud and remote devices created greater productivity. And, to be sure, companies like Apple, Google and Samsung have made huge gains in this market. Even small companies, like Nest, were able to jump on this technology shift with new products for the residential market. But name one market where GE is the dominant IoT player. During 16 years the internet and remote services markets have exploded, yet GE is not the market leader. Rather it is barely recognized.
Rather than growing GE with disruptive innovations and visionary products in emerging technology markets, Immelt’s GE was primarily shrinking via divestitures. In dismantling GE Capital he eliminated the lending and real estate operations. After decades as a leader in appliances, that division was sold. Welch built the extremely successful entertainment division around NBC/Universal, which Immelt sold.
The water business that was to be a world leader under Immelt’s vision, likewise sold – and largely to make sure GE could close the deal on selling its oil & gas unit. Even the famed electrical distribution business, going back to the start of GE, is now close to being sold.
And what happened to all this money? Well, about $50B went into share buybacks – which ostensibly would help shareholders. Only it didn’t, because GE is still worth less than when buybacks started. So the money just disappeared. At least Immelt could have paid it to shareholders as a dividend – but then that would not have boosted his bonuses.
GE’s website says Mr. Immelt wanted to create a “simpler, more valuable industrial company.” Mr. Immelt is definitely leaving behind a simpler, much smaller and weaker company. The brand is gone from consumer products, and severely tarnished in commercial products. GE lacks a great product pipeline, and even a strong development pipeline due to the rampant divestitures. When Mr. Flannery takes over as CEO he will not inherit a powerhouse company. He will inherit a company that is shrinking and rudderless, and disconnected from most growth markets with almost no product, technology or brand advantages. And he will report to the Chairman that created this mess, Mr. Immelt.
The most likely outcome is that Mr. Peltz and his firm, Trian Partners, will buy more GE shares and seek directorships on the board. Then, in a move not unlike the deaths of DuPont and Dow, there will be a massive cost cutting effort to bring expenses in-line with the shrunken GE business. R&D will be discontinued, as will product development. Support groups will be shredded. Customer service will be downsized. Then the remaining pieces will be sold off to buyers, or taken public, leaving GE a dismantled piece of history.
While that may work for the capital markets, and some short-term investors will share in the higher valuation, what about the people? People who dedicated their careers to GE, and are pensioners or current employees? What about cities and counties where GE has been a major employer, and civic contributor? What about customers that bought GE industrial products, only to see those products dropped due to low profitability, or little growth opportunity? What about suppliers that invested in developing new technologies or products for GE to take to market? What will happen to the people who once relied on GE as America’s largest diversified industrial company?
These people all have an ax to grind with the very wealthy, and now departing, CEO Immelt. He inherited what may well have been the most successful company on earth. He leaves behind a far weaker company that may not survive.
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.
Last week Microsoft announced its new Surface Pro 5 tablet would be available June 15. Did you miss it? Do you care?
Do you remember when it was a big deal that a major tech company released a new, or upgraded, device? Does it seem like increasingly nobody cares?
Non-phone device sales are declining, while smartphone sales accelerate
This chart compares IDC sales data, and forecasts, with adjustments to the forecast made by the author. The adjustments offer a fix to IDC’s historical underestimates of PC and tablet sales declines, while simultaneously underestimating sales growth in smartphones.
Since 2010 people are buying fewer desktops and laptops. And after tablet sales ramped up through 2013, tablet purchases have declined precipitously as well. Meanwhile, since 2014 sales of smartphones have doubled, or more, sales of all non-phone devices. And it’s also pretty clear that these trends show no signs of changing.
Why such a stark market shift? After all desktop and laptop sales grew consistently for some 3 decades. Why are they in such decline? And why did the tablet market make such a rapid up, then down movement? It seems pretty clear that people have determined they no longer need large internal hard drives to work locally, nor big keyboards and big screens of non-phone devices. Instead, they can do so much with a phone that this device is becoming the only one they need.
Today a new desktop starts at $350-$400. Laptops start as low as $180, and pretty powerful ones can be had for $500-$700. Tablets also start at about$180, and the newest Microsoft Surface 5 costs $800. Smartphones too start at about $150, and top of the line are $600-$800. So the purchase decision today is not based on price. All devices are more-or-less affordable, and with a range of capabilities that makes price not the determining factor.
Smartphones let most people do most of what they need to do
Every month the Internet-of-Things (IoT) is putting more data in the cloud. And developers are figuring out how to access that data from a smartphone. And smartphone apps are making it increasingly easy to find data, and interact with it, without doing a lot of typing. And without doing a lot of local processing like was commonplace on PCs. Instead, people access the data – whether it is financial information, customer sales and order data, inventory, delivery schedules, plant performance, equipment performance, maintenance specs, throughput, other operating data, web-based news, weather, etc. — via their phone. And they are able to analyze the data with apps they either buy, or that their companies have built or purchased, that don’t rely on an office suite.
Additionally, people are eschewing the old forms of connecting — like email, which benefits from a keyboard — for a combination of texting and social media sites. Why type a lot of words when a picture and a couple of emojis can do the trick?
And nobody listens to CD-based, or watches DVD-based, entertainment any longer. They either stream it live from an app like Pandora, Spotify, StreamUp, Ustream, GoGo or Facebook Live, or they download it from the cloud onto their phone.
To obtain additional insight into just how prevalent this shift to smartphones has become look beyond the USA. According to IDC there are about 1.8 billion smartphone users globally. China has nearly 600M users, and India has over 300 million users — so they account for at least half the market today. And those markets are growing by far the fastest, increasing purchases every quarter in the range of 15-25% more than previous years.
Chinese manufacturers are rapidly catching up to Apple and Samsung – there will be losers
Clayton Christensen often discusses how technology developers “overshoot” user needs. Early market leaders keep developing enhancements long after their products do all people want, producing upgrades that offer little user benefit. And that has happened with PCs and most tablets. They simply do more than people need today, due to the capabilities of the cloud, IoT and apps. Thus, in markets like China and India we see the rapid uptake of smartphones, while demand for PCs, laptops and tablets languish. People just don’t need those capabilities when the smartphone does what they want — and provides greater levels of portability and 24x7 access, which are benefits greatly treasured.
And that is why companies like Microsoft, Dell and HP really have to worry. Their “core” products such as Windows, Office, PCs, laptops and tablets are getting smaller. And these companies are barely marginal competitors in the high growth sales of smartphones and apps. As the market shifts, where will their revenues originate? Cloud services, versus Amazon AWS? Game consoles?
Even Apple and Samsung have reasons to worry. In China Apple has 8.4% market share, while Samsung has 6%. But the Chinese suppliers Oppo, Vivo, Huawei and Xiaomi have 58.4%. And as 2016 ended Chinese manufacturers, including Lenovo, OnePlus and Gionee, were grabbing over 50% of the Indian market, while Samsung has about 20% and Apple is yet to participate. How long will Apple and Samsung dominate the global market as these Chinese manufacturers grow, and increase product development?
When looking at trends it’s easy to lose track of the forest while focusing on individual trees. Don’t become mired in the differences, and specs, comparing laptops, hybrids, tablets and smartphones. Recognize the big shift is away from all devices other than smartphones, which are constantly increasing their capabilities as cloud services and IoT grows. So buy what suits your, and your company’s, needs — without “overbuying” because capabilities just keep improving. And keep your eyes on new, emerging competitors because they have Apple and Samsung in their sites.
Writing on trends, I frequently profile tech companies that use trends to outperform competitors. But using trends is not restricted to tech companies.
By following trends, since 1998 Alexandria Real Estate Equities has tripled the performance of the NASDAQ, quadrupled returns of the S&P 500, and quintupled the Russell 2000. Alexandria has even outperformed technology stalwart Microsoft, and investment guru Berkshire Hathaway by 230%.
Although you probably never heard of it, Alexandria has trounced its real estate peers. Over the last three years Alexandria has returned double the FTSE NAREIT Equity Office Index, and double the SNL US REIT Office Index. Alexandria’s value has almost doubled during this time, and produced returns 2.3 times better than such well known competitors as Vornado Realty Trust and Boston Properties.
In 1983, Joel Marcus was a lawyer in the IPO market when he noticed the high value launch of biotech firms like Amgen and Genentech. He began tracking the growth of biotechs to see what kind of opportunity might appear to serve these high growth companies.
By 1994 Marcus realized that these companies were struggling to find appropriate real estate to serve their unique needs for laboratory space, and the infrastructure these labs require. It was a classic under-served market, and it was growing fast.
Jacobs Engineering (NYSE:JEC) was serving some of these companies’ needs, including erecting structures for them. But Jacobs did not own any buildings or consider itself a real estate developer. So Marcus approached Jacobs about starting a company to meet the real estate needs of this high growth biotech industry. Marcus put up some money, Jacobs put up some money, and other friends/associates combined to raise $19 million. There was no professionally managed money involved – and no real estate developers.
Focusing on the rapidly expanding biotech scene in San Diego, the newly created Alexandria bought 4 buildings. They refocused the buildings on the unserved needs of local biotech companies and did a quick flip, breaking even on the transaction. With just a bit of money Alexandria had proven that the market existed, the trend was real and users were under-served.
But, like any idea based on an emerging trend, growing was not easy. Using their first transaction as “proof of concept” CEO Marcus and his team set out to raise $100 million. Quickly Paine Webber (now UBS) secured $75 million in debt financing. But moving forward required raising $25 million in equity.
Over the next few weeks Alexandria pitched a slew of nay-sayers. From GE Capital to CALPERS investors felt that their first deal was a “1-trick pony,” and this “niche market” was not a sustainable business. Finally, after 29 failed pitches, the AEW pension fund, an early stage real estate investor, saw the trend and invested.
The Alexandria team realized that fast client growth meant there was no time to develop from ground up. They focused on high growth geographies for biotech, places where the trend was more pronounced, and bought 11 existing properties:
Realizing that companies needing labs tended to cluster, leadership focused on finding locations where clusters were likely to emerge. They bought land in San Francisco, San Diego, New York and Worcester, MA. What looked like risky locations to others looked like profitable opportunities to Alexandria due to their superior trend research.
Historically pharma companies built their headquarters, and labs, in suburban locations where development was easy, and labs were welcome. Alexandria realized the new trend for emerging companies was to be near universities in urban environments, and although land was costly — and development more difficult — this was the right place to leverage the trend.
Today Alexandria is the bona fide market leader in labs and tech facilities in the USA. By seeing the trend early they bought land which is now so expensive it is practically untouchable – even for $1 billion. Their development pipeline includes Mission Bay, Kendall Square, the Manhattan borough of New York City and RTP (Research Triangle Park.) Today companies want to be where the lab is — and frequently the lab space is now owned, or being developed, by Alexandria.
This didn’t happen by accident. Not at the beginning nor as Alexandria plans its future growth. The company maintains a team of 13 researchers studying market trends in technology, and under-served real estate needs. They constantly track employers of tech/research people, competitors, historical and emerging customers — and identify prospective tech tenants who will need specialized real estate. A few of the leading trends Alexandria follows include:
Alexandria’s historical and ongoing successes relied first and foremost on using trends to understand underserved markets where needs will soon be the greatest. This is an important lesson for all businesses. No matter what you do, what you sell, or your industry you can generate higher returns, outperform your peers, and outperform the market rewarding investors by identifying trends and investing in them.
Thanks to Joel Marcus for providing an interview to explain the history and current practices at Alexandria.
General Electric stock had a small pop recently when investors thought CEO Jeffrey Immelt might be pushed out. Obviously more investors hope the CEO leaves than stays. And it appears clear that activist investor Nelson Peltz of Trian Partners thinks it is time for a change in CEO atop the longest running member of the Dow Jones Industrial Average (DJIA.)
You can’t blame investors, however. Since he took over the top job at General Electric in 2001 (16 years ago) GE’s stock value has dropped 38%. Meanwhile, the DJIA has almost doubled. Over that time, GE has been the greatest drag on the DJIA, otherwise the index would be valued even higher! That is terrible performance — especially as CEO of one of America’s largest companies.
But, after 16 years of Immelt’s leadership, there’s a lot more wrong than just the CEO at General Electric these days. As the JPMorgan Chase analyst Stephen Tusa revealed in his analysis, these days GE is actually overvalued, “cash is weak, margins/share of customer wallet are already at entitlement, the sum of the parts valuation points to a low 20s stock price.” He goes on to share his pessimism in GE’s ability to sell additional businesses, or create cost lowering synergies or tax strategies.
What went so wrong under Immelt? Go back to 1981. GE installed Jack Welch as its new CEO. Over the next 20 years there wasn’t a business Neutron Jack wouldn’t buy, sell or trade. CEO Welch understood the importance of growth. He bought business after business, in markets far removed from traditional manufacturing, building large positions in media and financial services. He expanded globally, into all developing markets. After businesses were acquired the pressure was relentless to keep growing. All had to be no. 1 or no. 2 in their markets or risk being sold off. It was growth, growth and more growth.
Under Welch, GE was in the rapids of growth. Welch understood that good operating performance was not enough. GE had to grow. Investors needed to see a path to higher revenues in order to believe in long term value creation. Immediate profits were necessary but insufficient to create value, because they could be dissipated quickly by new competitors. So Welch kept the headquarters team busy evaluating opportunities, including making some 600 acquisitions. They invested in things that would grow, whether part of historical GE, or not.
Jeff Immelt as CEO took a decidedly different approach to leadership. During his 16 year leadership GE has become a significantly smaller company. He sold off the plastics, appliances and media businesses — once good growth providers — in the name of “refocusing the company.” Plans currently exist to sell off the electrical distribution/grid business (Industrial Solutions) and water businesses, eliminating another $5 billion in annual revenue. He has dismantled the entire financial services and real estate businesses that created tremendous GE value, because he could not figure out how to operate in a more regulated environment. And cost cutting continues. In the GE Transportation business, which is supposed to remain, plans have been announced to double down on cost cutting, eliminating another 2,900 jobs.
Under Immelt GE has focused on profits. Strategy turned from looking outside, for new growth markets and opportunities, to looking inside for ways to optimize the company via business sales, asset sales, layoffs and other cost cutting. Optimizing the business against some sense of an historical “core” caused nearsighted — and shortsighted — quarterly actions, financial gyrations and transactions rather than building a sustainable, growing revenue stream. Under Immelt sales did not just stagnate, sales actually declined while leadership pursued higher margins.
By focusing on the “core” GE business (as defined by Immelt) and pursuing short term profit maximization, leadership significantly damaged GE. Nobody would have ever imagined an activist investor taking a position in Welch’s GE in an effort to restructure the company. Its sales growth was so good, its prospects so bright, that its P/E (price to earnings) multiple kept it out of activist range.
But now the vultures see the opportunity to do an even bigger, better job of whacking up GE — of tearing it into small bits while killing off all R&D and innovation — like they did at DuPont. Over 16 years Immelt has weakened GE’s business — what was the most omnipresent industrial company in America, if not the world – to the point that it can be attacked by outsiders ready to chop it up and sell it off in pieces to make a quick buck.
Thomas Edison, one of the world’s great inventors, innovators and founder of GE, would be appalled. That GE needs now, more than ever, is a leader who understands you cannot save your way to prosperity, you have to invest in growth to create future value and increase your equity valuation.
In May, 2012 (five years ago) I warned investors that Immelt was the wrong CEO. I listed him as the fourth worst CEO of a publicly traded company in America. While he steered GE out of trouble during the financial crisis, he also simply steered the company in circles as it used up its resources. Then was the time to change CEOs, and put in place someone with the fortitude to develop a growth strategy that would leverage the resources, and brand, of GE. But, instead, Immelt remained in place, and GE became a lot smaller, and weaker.
At this point, it is probably too late to save GE. By losing sight of the need to grow, and instead focusing on optimizing the old business while selling assets to raise cash for reorganizations, Immelt has destroyed what was once a great innovation engine. Now that the activists have GE in their sites it is unlikely they will let it ever return to the company it once was – creating whole new markets by developing new technologies that people never before imagined. The future looks a lot more like figuring out how to maximize the value of each piece of meat as it’s carved off the GE carcass.
It’s been over a decade since the Internet transformed print media.
Very quickly the web’s ability to rapidly disseminate news, and articles, made newspapers and magazines obsolete. Along with their demise went the ability for advertisers to reach customers via print. What was once an “easy buy” for the auto or home section of a paper, or for magazines targeting your audience, simply disappeared. Due to very clear measuring tools, unlike print, Internet ads were far cheaper and more appealing to advertisers – so that’s where at least some of the money went.
While this trend was easy enough to predict, few expected the unanticipated consequences.
1. First was the trend to automated ad buying. Instead of targeting the message to groups, programmatic buying tools started targeting individuals based upon how they navigated the web. The result was a trolling of web users, and ad placements in all kinds of crazy locations.
2. Which led to the next unanticipated consequence, the rising trend of bad – and even fake – journalism.
Now anybody, without any credentials, could create their own web site and begin publishing anything they want. The need for accuracy is no longer as important as the willingness to do whatever is necessary to obtain eyeballs. Learning how to “go viral” with click-bait keywords and phrases became more critical than fact checking. Because ads are bought by programs, the advertiser is no longer linked to the content or the publisher, leaving the world awash in an ocean of statements – some accurate and some not. Thus, what were once ads that supported noteworthy journals like the New York Times now support activistpost.com.
3. The next big trend is the continuing rise of paid entertainment sites that are displacing broadcast and cable TV.
Netflix is now spending $6 billion per year on original content. According to SymphonyAM’s measurement of viewership, which includes streaming as well as time-shifted viewing, Netflix had the no. 1 most viewed show (Orange is the New Black) and three of the top four most viewed shows in 2016.
Increasingly, purchased streaming services (Netflix, Hulu, et.al.) are displacing broadcast and cable, making it harder for advertisers to reach their audience on TV. As Barry Diller, founder of Fox Broadcasting, said at the Consumer Electronics Show, people who can afford it will buy content – and most people will be able to afford it as prices keep dropping. Soon traditional advertisers will “be advertising to people who can’t afford your goods.”
4. And, lastly, there is the trend away from radio.
Radio historically had an audience of people who listened to their favorite programming at home or in their car. But according to BuzzAngle that too is changing quickly. Today the trend is to streaming audio programming, which jumped 82.6% in 2016, while downloading songs and albums dropped 15-24%. With Apple, Amazon and Google all entering the market, streaming audio is rapidly displacing real-time radio.
Declining free content will affect all consumers and advertisers.
Thus, the assault on advertisers which began with the demise of print continues. This will impact all consumers, as free content increasingly declines. Because of these trends, users will have a lot more options, but simultaneously they will have to be much more aware of the source of their content, and actively involved in selecting what they read, listen to and view. They can’t rely on the platforms (Facebook, etc.) to manage their content. It will require each person select their sources.
Meanwhile, consumer goods companies and anyone who depends on advertising will have to change their success formulas due to these trends. Built-in audiences – ready made targets – are no longer a given. Costs of traditional advertising will go up, while its effectiveness will go down. As the old platforms (print, TV, radio) die off these companies will be forced to lean much, much heavier on social media (Facebook, Snapchat, etc.) and sites like YouTube as the new platforms to push their product message to potential customers.
There will be big losers, and winners, due to these trends.
These market shifts will favor those who aggressively commit early to new communications approaches, and learn how to succeed. Those who dally too long in the old approach will lose awareness, and eventually market share. Lack of ad buying scale benefits, which once greatly favored the very large consumer goods companies (Kraft, P&G, Nestle, Coke, McDonalds) means it will be harder for large players to hold onto dominance. Meanwhile, the easy access and low cost of new platforms means more opportunities will exist for small market disrupters to emerge and quickly grow.
And these trends will impact the fortunes of media and tech companies for investors The decline in print, radio and TV will continue, hurting companies in all three media. When Gannet tried to buy Tronc the banks balked at the price, killing the deal, fearing that forecasted revenues would not materialize.
Just as print distributors have died off, cable’s role as a programming distributor will decline as customers opt for bandwidth without buying programming. Thus trends put the growth prospects of companies such as Comcast and DirecTV/AT&T at peril, as well as their valuations.
Privatized content will benefit Netflix, Amazon and other original content creators. While traditionalists question the wisdom of spending so much on original content, it is clearly the trend and attracts customers. And these trends will benefit streaming services that deliver paid content, like Apple, Amazon and Google. It will benefit social media networks (Facebook and Alphabet) who provide the new platforms for reaching audiences.
Media has changed dramatically from the business it was in 2000. And that change is accelerating. It will impact everyone, because we all are consumers, altering what we consume and how we consume it. And it will change the role, placement and form of advertising as the platforms shift dramatically. So the question becomes, is your business (and your portfolio) ready?
2016 was an election year, and Americans were inundated with talk. Unfortunately, a lot of it was pure hubris.
President-elect Donald Trump inspired people to “make America great again.” In doing so, he developed the theme that the reason America wasn’t so great had to do with too much work being done offshore, rather than onshore. And that there were far too many immigrants, which harmed the economy and the country. This became rather popular with a significant voting block, led in particular by white males – and within that group those lacking higher education. These people expressed, with their votes and with their words at many rallies, that they were economically depressed by America’s policies allowing work to be completed by people not born in America.
Oh, if it was only so simple.
Any time something is manufactured offshore there is a cost to supply the raw materials, often the equipment, and frequently the working capital. These are added costs, not incurred by U.S. manufacturing. The reason manufacturing jobs went offshore had everything to do with (1) Americans unwilling to work at jobs for the pay offered, and (2) an unwillingness for Americans to invest in their skill sets so they could do the work.
Since the 1980s America has lost some five million manufacturing jobs (from about 17.5 million to 12.5million). That sounds terrible, until you realize that the amount of goods manufactured in America is near an all-time. While it may sound backwards, the honest truth is that automation has greatly improved the output of plant and equipment with less labor. America isn’t making less stuff. Productivity more than doubled between 1985 and 2009. As the Great Recession has abated, output is again back to all-time highs. It just doesn’t take nearly as many people as it once did.
Manufacturing today isn’t about sweat shops. Not in the USA, and not in Mexico, China or India. The plants in all these countries are equally high-tech, sophisticated and automated. Just look at the images of workers at the Chinese Foxconn plants, or the Mexican auto parts plants, and you’ll see something that could just as easily be in the USA. The reality is that those plants are in those countries because the workers in those countries train themselves to be very productive, and they make great products at very high quality.
And don’t blame regulations and unions for creating offshoring.
For almost all U.S. companies, their offshore plants comply with the U.S. regulations. Most require the same level of safety and working conditions globally.
Union membership has been declining for 75 years. Fifty years ago one in three workers was in a union. Today, it’s less than one in 10. In 2015 the Bureau of Labor reported that only 6.7% of private sector workers were unionized – an all time modern era low. Unions are almost unimportant today. It hasn’t been union obstructionism that has driven jobs oversees – it’s largely been an inability to hire qualified workers.
Much was made the last few years of a lower labor participation rate. Many Trump followers said that the Obama administration was failing to create jobs, so people stayed home. But that simply was not true. While the economy was recovering, the unemployment rate fell to its lowest level since the super-heated economy of 2001. To find this low level of unemployment prior to that you have to go all the way back to 1970!
There are plenty of jobs. The issue is getting people trained to do the work.
And here is the real rub. You can’t sit home complaining and moping, you have to study hard and train. Before today’s level of computerization and automation, when work was a lot more manual, it didn’t matter how much education you had, nor how well you could read and do math and science. But today, work is not manual. It takes minimal manual skill to operate equipment. Today it takes computer programming skills, engineering skills and math skills.
Trump appealed to those who have let their skills lapse, and shown an unwillingness to study hard to make themselves more employable. He took the Lake Wobegon approach of claiming that U.S. workers were like the people of that famous fictional city – “where all the women are strong, all the men are good looking and all the children are above average.” As much as these “angry white men” who voted for Trump would like to think they are smarter and better trained than immigrants and offshore workers – that just is not true. The problem is not “them.” To the extent there is an American problem, it is U.S.
The Organization for Economic Cooperation and Development (OECD) does an annual Program for International Student Assessment (PISA) study. This looks at test scores across the world to see where students fair best. Of course, economically displaced Americans are sure that Americans are at the top of these test results – because it is easy to assume so.
Americans are in the bottom half of the planet’s educational performance .
The 2015 results are here, and in reading, science and math America doesn’t even crack the top 10. In fact, the poorest 10% of Vietnamese students did better than the average American teen. In all three categories, the USA scored below the global average. American’s are not above average – they are now below average.
American’s have simply gotten lazy. For far too long, when somebody did poorly Americans have blamed the teacher, blamed the test, blamed the “system” — blamed everyone and everything except the person themselves. It has become unacceptable to tell someone they are doing a below-average job. It is unacceptable to tell someone their skills don’t match up to the needs of the job. Instead, we simply give out trophies for participation to everyone, imply that everyone is good, nobody is bad and let mediocrity blossom.
Instead of forcing people to work hard – really hard – and expecting that each and every person will work hard to compete in a global economy – just to keep up – the expectation has developed that hard work is not necessary, and everyone should do really well. Instead of thinking that hard mental effort, ongoing education and additional training are the minimal acceptable standards to maintaining a job, it is expected that high paying jobs should just be there for everyone – even if they lack the skills to perform. American no longer want to admit that someone is being outperformed.
In 1988 Nike set the company on a growth trajectory with their trademarked phrase “Just Do It.” Just get up off the couch and do it. Quit complaining about being out of shape – just do it.
And that’s my wish for America in 2017. Quit blaming foreigners for working harder at school than we do. Quit blaming immigrants for being better trained, and harder working, than Americans. Quit pretending like the problem with the labor participation rate is some kind of problem created by the government. Quit finger-pointing and blaming someone else for being better than us.
Instead, get up off the couch and do it. Go back to school and study hard – harder than the competition. Grades matter. Learn geometry, trigonometry and calculus so you can make things – or operate equipment that makes things. Gain some engineering skills so you can learn to program, in order to improve productivity with a mobile device – or even a personal computer. Become facile in more than one language so you can operate and compete in a global economy.
Hey Americans, instead of blaming everyone else for workers lacking a job, or a higher income, quit talking about the problems. If you want to “make America great again” quit complaining and just do it.
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.
McDonald’s has been trying for years to re-ignite growth. But, unfortunately for customers and investors alike, leadership keeps going about it the wrong way. Rather than building on new trends to create a new McDonald’s, they keep trying to defend extend the worn out old strategy with new tactics.
Recently McDonald’s leadership tested a new version of the Big Mac,first launched in 1967. They replaced the “special sauce” with Sriracha sauce in order to make the sandwich a bit spicier. They are now rolling it out to a full test market in central Ohio with 128 stores. If this goes well – a term not yet defined – the sandwich could roll out nationally.
This is a classic sustaining innovation. Take something that exists, make a minor change, and offer it as a new version. The hope is that current customers keep buying the original version, and the new version attracts new customers. Great idea, if it works. But most of the time it doesn’t.
People who are still eating Big Macs know exactly what they want. And it’s the old Big Mac, not a new one. Thus the initial test results were “mixed” – with many customers registering disgust at the new product. Just like the failure of New Coke, a New Big Mac isn’t what customers are seeking.
After 50 years, times and trends have changed. Fewer people are going to McDonald’s, and fewer are eating Big Macs. Many new competitors have emerged, and people are eating at Panera, Panda Express, Zaxby’s, Five Guys and even beleaguered Chipotle. Customers are looking for a very different dining experience, and different food. While a version two of the Big Mac might have driven incremental sales in 1977, in 2017 the product has grown tired and out of step with too many people and there are too many alternative choices.
Similarly, McDonald’s CEO’s effort to revitalize the brand by adding ordering kiosks and table service in stores, in a new format labeled the “Experience of the Future,” will not make much difference. Due to the dramatic reconfiguration, only about 500 stores will be changed – roughly 3.5% of the 14,500 McDonald’s. It is an incremental effort to make a small change when competitors are offering substantially different products and experiences.
When a business, brand or product line is growing it is on a trend. Like McDonald’s was in the 1960s and 1970s, offering quality food, fast and at a consistent price nationwide at a time when customers could not count on those factors across independent cafes. At that time, offering new products – like a Big Mac – that are variations on the theme that is riding the trend is a good way to expand sales.
But over time trends change, and adding new features has less and less impact. These sustaining innovations, as Clayton Christensen of Harvard calls them, have “diminishing marginal returns.” That’s an academic’s fancy way of saying that you have to spend ever greater amounts to create the variations, but their benefits keep having less and less impact on growing, or even maintaining, sales. Yet, most leaders keep right on trying to defend & extend the old business by investing in these sustaining measures, even as returns keep falling.
Over time a re-invention gap is created between the customer and the company. Customers want something new and different, which would require the business re-invent itself. But the business keeps trying to tweak the old model. And thus the gap. The longer this goes on, the bigger the re-invention gap. Eventually customers give up, and the product, or company, disappears.
Think about portable hand held AM radios. If someone gave you the best one in the world you wouldn’t care. Same for a really good portable cassette tape player. Now you listen to your portable music on a phone. Companies like Zenith were destroyed, and Sony made far less profitable, as the market shifted from radios and cathode-ray televisions to more portable, smarter, better products.
Motorola, one of the radio pioneers, survived this decline by undertaking a “strategic pivot.” Motorola invested in cell phone technology and transformed itself into something entirely new and different – from a radio maker into a pioneer in mobile phones. (Of course leadership missed the transition to apps and smart phones, and now Motorola Solutions is a ghost of the former company.)
McDonald’s could have re-invented itself a decade ago when it owned Chipotle’s. Leadership could have stopped investing in McDonald’s and poured money into Chipotle’s, aiding the cannibalization of the old while simultaneously capturing a strong position on the new trend. But instead of pivoting, leadership sold Chipotle’s and used the money to defend & extend the already tiring McDonald’s brand.
Strategic pivots are hard. Just look at Netflix, which pivoted from sending videos in the mail to streaming, and is pivoting again into original content. But, they are a necessity if you want to keep growing. Because eventually all strategies become out of step with changing trends, and sustaining innovations fail to keep customers.
McDonald’s needs a very different strategy. It has hit a growth stall, and has a very low probability of ever growing consistently at even 2%. The company needs a lot more than sriracha sauce on a Big Mac if it is to spice up revenue and profit growth.
Apple AAPL -0.72% announced sales and earnings yesterday. For the first time in 15 years, ever since it rebuilt on a strategy to be the leader in mobile products, full year sales declined. After three consecutive down quarters, it was not unanticipated. And Apple’s guidance for next quarter was for investors to expect a 1% or 2% improvement in sales or earnings. That’s comparing to the disastrous quarter reported last January, which started this terrible year for Apple investors.
Yet, most analysts remain bullish on Apple stock. At a price/earnings (P/E) of 13.5, it is by far the cheapest tech stock. iPad sales are stagnant, iPhone sales are declining, Apple Watch sales dropped some 70% and Chromebook breakout sales caused a 20% drop in Mac Sales. Yet most analysts believe that something will improve and Apple will get its mojo back.
Only, the odds are against Apple. As I pointed out last January, Apple’s value took a huge hit because stagnating sales caused the company to completely lose its growth story. And, the message that Apple doesn’t know how to grow just keeps rolling along. By last quarter – July – I wrote Apple had fallen into a Growth Stall. And that should worry investors a lot.
Companies that hit growth stalls almost always do a lot worse before things improve – if they ever improve. Seventy-five percent of companies that hit a growth stall have negative growth for several quarters after a stall. Only 7% of companies grow a mere 6%. To understand the pattern, think about companies like Sears, Sony, RIM/Blackberry, Caterpillar Tractor. When they slip off the growth curve, there is almost always an ongoing decline.
And because so few regain a growth story, 70% of the companies that hit a growth stall lose over half their market capitalization. Only 5% lose less than 25% of their market cap.
Why? Because results reflect history, and by the time sales and profits are falling the company has already missed a market shift. The company begins defending and extending its old products, services and business practices in an effort to “shore up” sales. But the market shifted, either to a competitor or often a new solution, and new rev levels do not excite customers enough to create renewed growth. But since the company missed the shift, and hunkered down to fight it, things get worse (usually a lot worse) before they get better.
Think about how Microsoft MSFT -0.42% missed the move to mobile. Too late, and its Windows 10 phones and tablet never captured more than 3% market share. A big miss as the traditional PC market eroded.
Right now there is nothing which indicates Apple is not going to follow the trend created by almost all growth stalls. Yes, it has a mountain of cash. But debt is growing faster than cash now, and companies have shown a long history of burning through cash hoards rather than returning the money to shareholders.
Apple has no new products generating market shifts, like the “i” line did. And several products are selling less than in previous quarters. And the CEO, Tim Cook, for all his operational skills, offers no vision. He actually grew testy when asked, and his answer about a “strong pipeline” should be far from reassuring to investors looking for the next iPhone.
Will Apple shares rise or fall over the next quarter or year? I don’t know. The stock’s P/E is cheap, and it has plenty of cash to repurchase shares in order to manipulate the price. And investors are often far from rational when assessing future prospects. But everyone would be wise to pay attention to patterns, and Apple’s Growth Stall indicates the road ahead is likely to be rocky.