There is a definite trend to raising the minimum wage. Regardless your political beliefs, the pressure to increase the minimum wage keeps growing. The important question for business leaders is, “Are we prepared for a $12 or $15 minimum wage?”
Whether the economic case is provable, it appears that public sentiment is greatly in favor of a much higher minimum wage. And it will not affect all companies the same. Those that depend upon low priced labor, such as retailers like Wal-Mart and fast food companies like McDonald’s have a much higher concern. As should their employees, suppliers and investors.
The implications for businesses that use low-priced labor are clear. It is time to change the business model – to adapt for a different future. A higher minimum wage does not doom McDonald’s – but it will force the company to adapt. If McDonald’s (and Burger King, Wendy’s, Subway, Dominos, Pizza Hut, and others) doesn’t adapt the future will be very ugly for their customers and the company. But if these companies do adapt there is no reason the minimum wage will hurt them particularly hard.
The chains that replaced McDonald’s closed stores were Five Guys, Chick-fil-A and Chipotle. You might remember that in 1998 McDonald’s started investing in Chipotle, and by 2001 McDonald’s owned the chain. And Chipotle’s grew rapidly, from a handful of restaurants to over 500. But then in 2006 McDonald’s sold all its Chipotle stock as the company went IPO, and used the proceeds to invest in upgrading McDonald’s stores and streamlining the supply chain toward higher profits on the “core” business.
Now, McDonald’s is shrinking while Chipotle is growing. Bloomberg/BusinessWeek headlined “Chipotle: The One That Got Away From McDonalds” (Oct. 3, 2013.) Investors were well served to trade in McDonald’s stock for Chipotle’s. And franchisees have suffered through sales problems as they raised prices off the old “dollar menu” while suffering higher food costs creating shrinking margins. Meanwhile Chipotle’s franchisees have been able to charge more, while keeping customers very happy, and maintain margins while paying higher wages. In a nutshell, Chipotle’s (and similar competitors) has captured the lost McDonald’s business as trends favor their business.
So McDonald’s obviously made a mistake. But that does not mean “game over.” All McDonald’s, Burger King and Wendy’s need to do is adapt. Fighting the higher minimum wage will lead to a lot of grief. There is no doubt wages will go up. So the smart thing to do is figure out what these stores will look like when minimum wages double. What changes must happen to the menu, to the store look, to the brand image in order for the company to continue attracting customers profitably.
This will undoubtedly include changes to the existing brands. But, these companies also will benefit from revisiting the kind of strategy McDonald’s used in the 1990s when buying Chipotle’s. Namely, buying chains with a different brand and value proposition which can flourish in a higher wage economy. These old-line restaurants don’t have to forever remain dominated by the old brands, but rather can transition along with trends into companies with new brands and new products that are more desirable, and profitable, as trends change the game. Like The Limited did when selling its stores and converting into L Brands to remain a viable company.
Now is the time to take action. Waiting until forced to take action will be too late. If McDonald’s and its brethren (and Wal-Mart and its minimum-wage-paying retail brethren) remain locked-in to the old way of doing business, and do everything possible to defend-and-extend the old success formula, they will follow Howard Johnson’s, Bennigan’s, Circuit City, Sears and a plethora of other companies into brand, and profitability, failure. Fighting trends is a route to disaster.
However, by embracing the trend and taking action to be successful in a future scenario of higher labor these companies can be very successful. There is nothing which dictates they have to follow the road to irrelevance while smarter brands take their place. Rather, they need to begin extensive scenario planning, understand how these competitors succeed and take action to disrupt their old approach in order to create a new, more profitable business that will succeed.
Disruptions happen all the time. In the 1970s and 1980s gasoline prices skyrocketed, allowing offshore competitors to upend the locked-in Detroit companies that refused to adapt. On-line services allowed Google Maps to wipe out Rand-McNally, Travelocity to kill OAG and Wikipedia to kill bury Encyclopedia Britannica. These outcomes were not dictated by events. Rather, they reflect an inability of an existing leader to adapt to market changes. An inability to embrace disruptions killed the old competitors, while opening doors for new competitors which embraced the trend.
Now is the time to embrace a higher minimum wage. Every business will be impacted. Those who wait to see the impact will struggle. But those who embrace the trend, develop future scenarios that incorporate the trend and design new business opportunities can turn this disruption into a big win.
Last week we learned that there is no doubt, the world is warming. A U.N. report affirmed by some 1,000 scientists asserted 95% confidence as to the likely outcomes, as well as the cause. We must expect more volatility in weather, and that the oceans will continue rising.
Incredibly, for those of us who don't live and work in Florida, there was CNN news footage of daily flooding in Miami's streets due to current sea levels which have risen over last 50 years. Given that we can now predict the oceans will rise between 1 and 6 feet in the next 50 years, it is possible to map the large areas of Miami streets which are certain to be flooded.
There is just no escaping the fact that the long-term trend of global warming will have a remarkable impact on everyone. It will affect transportation, living locations, working locations, electricity generation and distribution, agriculture production, textile production – everything will be affected. And because it is happening so slowly, we actually can do lots of modeling about what will happen.
Yet, I never hear any business leaders talk about how they are planning for global warning. No comments about how they are making changes to keep their business successful. Nor comments about the new opportunities this will create. Even though the long-term impacts will be substantial, the weather and how it affects us is treated like the status quo.
America has known for decades that its healthcare system was dysfunctional; to be polite. It was incredibly expensive (by all standards) and yet had no better outcomes for citizens than other modern countries. For over 20 years efforts were attempted to restructure health care. Yet as the morass of regulations ballooned, there was no effective overhaul that addressed basic problems built into the system. Costs continued to soar, and more people joined the ranks of those without health care, while other families were bankrupted by illness.
Finally, amidst enormous debate, the Affordable Care Act was passed. Despite wide ranging opinions from medical doctors, nurses, hospital and clinic administrators, patient advocacy groups, pharmaceutical companies, medical device companies and insurance companies (to name just some of those with a vested interest and loud, competing, viewpoints) Congress passed the Affordable Care Act which the President signed.
Like most such things in America, almost nobody was happy. No one got what they wanted. It was one of those enormous, uniquely American, compromises. So, like unhappy people do in America, we sued! And it took a few years before finally the Supreme Court ruled that the legislation was constitutional. The Affordable Care Act would be law.
But, people remain who simply do not want to accept the need for health care change. So, in a last ditch effort to preserve the status quo, they are basically trying to kidnap the government budget process and hold it hostage until they get their way. They have no alternative plan to replace the Affordable Care Act. They simply want to stop it from moving forward.
What global warming and the government shut down have in common are:
Very long-term problems
No quick solution for the problem
No easy solution for the problem
If you do nothing about the problem today, you have no immediate calamity
Doing anything about the problem affects almost everyone
Doing anything causes serious change
So, in both cases, people have emerged as the Status Quo Police. They take on the role of stopping change. They will do pretty much anything to defend & extend the status quo:
Ignore data that is contradictory to the best analytical views
Claim that small probability outcomes (that change may not be necessary) justifies doing nothing
Delay, delay, delay taking any action until a disaster requires action
Constantly claim that the cost of change is not justified
Claim that the short-term impact of change is more deleterious than the long-term benefits
Assume that the status quo will somehow resolve itself favorably – with no supporting evidence or analysis
Undertake any action that preserves the status quo
Threaten a "scorched earth policy" (that they will create big, immediate problems if forced to change the status quo)
The earth is going to become warmer. The oceans will rise, and other changes will happen. If you don't incorporate this in your plans, and take action, you can expect this trend will harm you.
U.S. health care is going to be reformed. How it will happen is just starting. How it will evolve is still unclear. Those who create various scenarios in their plans to prepare for this change will benefit. Those who do nothing, hoping it goes away, will find themselves struggling.
The Status Quo Police, trying their best to encourage people to ignore the need for change – the major, important trends – are helping nobody. By trying to preserve the status quo they inhibit effective planning, and action, to prepare for a different (better) future.
Does your organization have Status Quo Police? Are their functions, groups or individuals who are driven to defend and extend the status quo – even in the face of trends that demonstrate change is necessary? Can they stop conversations around substantial change? Are they allowed to stop future planning for scenarios that are very different from the past? Can they enforce cultural norms that stop considering new alternatives? Can they control resources resulting in less innovation and change?
Let's learn from these 2 big issues. Change is inevitable. It is even necessary. Trying to preserve the status quo is costly, and inhibits taking long-term effective action. Status Quo Police are obstructionists who keep us from facing, and solving, difficult problems. They don't help our organizations create a new, more successful future. Only by overcoming them can we reach our full potential, and create opportunities out of change.
Just over a week after Microsoft announces plans to replace CEO Steve Ballmer the company announced it will spend $7.2B to buy the Nokia phone/tablet business. For those looking forward to big changes at Microsoft this was like sticking a pin in the big party balloon!
Everyone knows that Microsoft's future is at risk now that PC sales are declining globally at nearly 10% – with developing markets shifting even faster to mobile devices than the USA. And Microsoft has been the perpetual loser in mobile devices; late to market and with a product that is not a game changer and has only 3% share in the USA.
But, despite this grim reality, Microsoft has doubled-down (that's doubled its bet for non-gamblers) on its Windows 8 OS strategy, and continues to play "bet the company". Nokia's global market share has shriveled to 15% (from 40%) since former Microsoft exec-turned-Nokia-CEO Stephen Elop committed the company to Windows 8. Because other Microsoft ecosystem companies like HP, Acer and HP have been slow to bring out Win 8 devices, Nokia has 90% of the miniscule market that is Win 8 phones. So this acquisition brings in-house a much deeper commitment to spending on an effort to defend & extend Microsoft's declining O/S products.
As I predicted in January, the #1 action we could expect from a Ballmer-led Microsoft is pouring more resources into fighting market leaders iOS and Android – an unwinnable war. Previously there was the $8.5B Skype and the $400M Nook, and now a $7.2B Nokia. And as 32,000 Nokia employees join Microsoft losses will surely continue to rise. While Microsoft has a lot of cash – spending it at this rate, it won't last long!
Some folks think this acquisition will make Microsoft more like Apple, because it now will have both hardware and software which in some ways is like Apple'siPhone. The hope is for Apple-like sales and margins soon. But, unfortunately, Google bought Motorola months ago and we've seen that such revenue and profit growth are much harder to achieve than simply making an acquisition. And Android products are much more popular than Win8. Simply combining Microsoft and Nokia does not change the fact that Win8 products are very late to market, and not very desirable.
Some have postulated that buying Nokia was a way to solve the Microsoft CEO succession question, positioning Mr. Elop for Mr. Ballmer's job. While that outcome does seem likely, it would be one of the most expensive recruiting efforts of all time. The only reason for Mr. Elop to be made Microsoft CEO is his historical company relationship, not performance. And that makes Mr. Elop is exactly the wrong person for the Microsoft CEO job!
In October, 2010 when Mr. Elop took over Nokia I pointed out that he was the wrong person for that job – and he would destroy Nokia by making it a "Microsoft shop" with a Microsoft strategy. Since then sales are down, profits have evaporated, shareholders are in revolt and the only good news has been selling the dying company to Microsoft! That's not exactly the best CEO legacy.
Mr. Elop's job today is to sell more Win8 mobile devices. Were he to be made Microsoft CEO it is likely he would continue to think that is his primary job – just as Mr. Ballmer has believed. Neither CEO has shown any ability to realize that the market has already shifted, that there are two leaders far, far in front with brand image, products, apps, developers, partners, distribution, market share, sales and profits. And it is impossible for Microsoft to now catch up.
It is for good reason that short-term traders pushed down Microsoft's share value after the acquisition was announced. It is clear that current CEO Ballmer and Microsoft's Board are still stuck fighting the last war. Still trying to resurrect the Windows and Office businesses to previous glory. Many market anallysts see this as the last great effort to make Ballmer's bet-the-company on Windows 8 pay off. But that's a bet which every month is showing longer and longer odds.
Microsoft is not dead. And Microsoft is not without the ability to turn around. But it won't happen unless the Board recognizes it needs to steer Microsoft in a vastly different direction, reduce (rather than increase) investments in Win8 (and its devices,) and create a vision for 2020 where Microsoft is highly relevant to customers. So far, we're seeing all the wrong moves.
Sears has performed horribly since acquired by Fast Eddie Lampert's KMart in 2005. Revenues are down 25%, same store sales have declined persistently, store margins have eroded and the company has recently taken to reporting losses. There really hasn't been any good news for Sears since the acquisition.
Bloomberg Businessweek made a frontal assault on CEO Edward Lampert's leadership at Sears this week. Over several pages the article details how a "free market" organization installed by Mr. Lampert led to rampant internal warfare and an inability for the company to move forward effectively with programs to improve sales or profits. Meanwhile customer satisfaction has declined, and formerly valuable brands such as Kenmore and Craftsman have become industry also-rans.
Because the Lampert controlled hedge fund ESL Investments is the largest investor in Sears, Mr. Lampert has no risk of being fired. Even if Nobel winner Paul Krugman blasts away at him. But, if performance has been so bad – for so long – why does the embattled Mr. Lampert continue to lead in the same way? Why doesn't he "fire" himself?
By all accounts Mr. Lampert is a very smart man. Yale summa cum laude and Phi Beta Kappa, he was a protege of former Treasury Secretay Robert Rubin at Goldman Sach before convincing billionaire Richard Rainwater to fund his start-up hedge fund – and quickly make himself the wealthiest citizen in Connecticut.
If the problems at Sears are so obvious to investors, industry analysts, economics professors, management gurus and journalists why doesn't he simply change?
Mr. Lampert, largely because of his success, is a victim of BIAS. Deep within his decision making are his closely held Beliefs, Interpretations, Assumptions and Strategies. These were created during his formative years in college and business. This BIAS was part of what drove his early success in Goldman, and ESL. This BIAS is now part of his success formula – an entire set of deeply held convictions about what works, and what doesn't, that are not addressed, discussed or even considered when Mr. Lampert and his team grind away daily trying to "fix" declining Sears Holdings.
This BIAS is so strong that not even failure challenges them. Mr. Lampert believes there is deep value in conventional retail, and real estate. He believes strongly in using "free market competition" to allocate resources. He believes in himself, and he believes he is adding value, even if nobody else can see it.
Mr. Lampert assumes that if he allows his managers to fight for resources, the best programs will reach the top (him) for resourcing. He assumes that the historical value in Sears and its house brands will remain, and he merely needs to unleash that value to a free market system for it to be captured. He assumes that because revenues remain around $35B Sears is not irrelevant to the retail landscape, and the company will be revitalized if just the right ideas bubble up from management.
Mr. Lampert inteprets the results very different from analysts. Where outsiders complain about revenue reductions overall and same store, he interprets this as an acceptable part of streamlining. When outsiders say that store closings and reduced labor hurt the brand, he interprets this as value-added cost savings. When losses appear as a result of downsizing he interprets this as short-term accounting that will not matter long-term. While most investors and analysts fret about the overall decline in sales and brands Mr. Lampert interprets growing sales of a small integrated retail program as a success that can turn around the sinking behemoth.
Mr. Lampert's strategy is to identify "deep value" and then tenaciously cut costs, including micro-managing senior staff with daily calls. He believes this worked for Warren Buffett, so he believes it will continue to be a successful strategy. Whether such deep value continues to exist – especially in conventional retail – can be challenged by outsiders (don't forget Buffett lost money on Pier 1,) but it is part of his core strategy and will not be challenged. Whether cost cutting does more harm than good is an unchallenged strategy. Whether micro-managing staff eats up precious resources and leads to unproductive behavior is a leadership strategy that will not change. Hiring younger employees, who resemble Mr. Lampert in quick thinking and intellect (if not industry knowledge or proven leadership skills) is a strategy that will be applied even as the revolving door at headquarters spins.
The retail market has changed dramatically, and incredibly quickly. Advances in internet shopping, technology for on-line shopping (from mobile devices to mobile payments) and rapid delivery have forever altered the economics of retailing. Customer ease of showrooming, and desire to shop remotely means conventional retail has shrunk, and will continue to shrink for several years. This means the real challenge for Sears is not to be a better Sears as it was in 2000 — but to become something very different that can compete with both WalMart and Amazon – and consumer goods manufacturers like GE (appliances) and Exide (car batteries.)
There is no doubt Mr. Lampert is a very smart person. He has made a fortune. But, he and Sears are a victim of his BIAS. Poor results, bad magazine articles and even customer complaints are no match for the BIAS so firmly underlying early success. Even though the market has changed, Mr. Lampert's BIAS has him (and his company) in internal turmoil, year after year, even though long ago outsiders gave up on expecting a better result.
Even if Sears Holdings someday finds itself in bankruptcy court, expect Mr. Lampert to interpret this as something other than a failure – as he defends his BIAS better than he defends its shareholders, employees, suppliers and customers.
What is your BIAS? Are you managing for the needs of changing markets, or working hard to defend doing more of what worked in a bygone era? As a leader, are you targeting the future, or trying to recapture the past? Have market shifts made your beliefs outdated, your interpretations of what happens around you faulty, your assumptions inaccurate and your strategies hurting results? If any of this is true, it may be time you address (and change) your BIAS, rather than continuing to invest in more of the same. Or you may well end up like Sears.
It is an unfortunate fact that small businesses fail at a higher rate than large businesses. While we've come to accept this, it somewhat flies in the face of logic. After all, small businesses are run by owners who can achieve entrepreneurial returns rather than managerial bonuses, so incentive is high. Conventional wisdom is that small businesses have fewer, and closer relationships to customers (think Ace Hardware franchisees vs. Home Depot.) And lacking layers of overhead and embedded management they should be more nimble.
Yet, they fail. From as high as 9 out of 10 for restaurants to 4 out of 10 in more asset intensive business-to-business ventures. That is far higher than large companies.
Why? Despite conventional wisdom most small businesses are run by leaders committed to a single, narrow success formula. Most are wedded to their core ideology, based on personal history, and unwilling to adapt until the business completely fails. Most reject new technologies and other emerging innovations as long as possible, trying to conserve cash and wait for "more proof" change will pay off. Additionally, most spend little time investing time, or money, in innovation at all as they pour everything into defending and extending their historical business approach.
Take for example the major trend to digital marketing. Everyone knows that digital is the only growing ad market, while print is fast dying: Chart republished with permission of Jay Yarow, Business Insider 3/19/2013
Digital marketing is one of the few places where ads can be purchased for as little as $100. Digital ads are targeted at users based upon their searches and pages viewed, thus delivered directly to likely buyers. And digital ads consistently demonstrate the highest rate of return. That's why it's growing at over 20%/year!
Yet, small businesses continue to put most of their money into local newspapers and direct mail circulars. The least targeted of all advertising, and increasingly the least read! While print ad spending has declined over 80% the last few years, to 1950 levels (adjusted for inflation,) smarter businesses have abandoned the media. At large companies in 2012 38% of advertising is on digital, second only to TV's 42% – and rapidly moving into first place!
A second major trend is the move to mobile and app usage. In the last 2 years mobile users have grown and shown a distinct preference for apps over mobile web sites. App use is growing while mobile web sites have stalled: Chart republished with permission of Alex Cocotas, Business Insider 3/20/13
Even though there are over 1million apps available for iPhone and Android users, the vast majority of small businesses have no apps aligned with their business and customers. Most small businesses, late to the game in digital marketing, are content to try and add mobile capability to their already existing web site – hoping that it will be sufficient for future growth. Meanwhile, customers are going directly for apps in accelerating numbers every month! Chart republished with permission of Alex Cocotas, Business Insider 1/8/13
Rather than act like market leaders, using customer intimacy and nimbleness to jump ahead of lumbering giants, small business leaders complain they are unsure of app value – and keep spending money on historical artifacts (like their web site) rather than invest in higher return innovation opportunities. Many small businesses are spending $20k+/year on printed brochures, coupons and newspaper or magazine PR when a like amount spent on an app could connect them much more tightly with customers, add higher value and expand their base more quickly and more profitably!
The trend to digital marketing – including the explosive growth in mobile app use – is proven. And due to very low relative up-front cost, as well as low variable cost, both trends are a wonderful boon for small businesses ready to adopt, adapt and grow. But, unfortunately, the vast majoritiy of small business leaders are behaving oppositely! They remain wedded to outdated marketing and customer relationship processes that are too expensive, with lower yield!
The opportunity is greater now than during most times for smaller competitors to be disruptive. They can seize new innovations faster, and leverage them before larger competitors. But as long as they cling to old practices and processes, and beliefs about historical markets, they will continue to fail, smashed under the heal of slower moving, bureaucratic large companies who have larger resources when they do finally take action.
Microsoft needed a great Christmas season. After years of product stagnation, and a big market shift toward mobile devices from PCs, Microsoft's future relied on the company seeing customers demonstrate they were ready to jump in heavily for Windows8 products – including the new Surface tablet.
Looking deeper, for the 4th quarter PC sales declined by almost 5% according to Gartner research, and by almost 6.5% according to IDC. Both groups no longer expect a rebound in PC shipments, as they believe homes will no longer have more than 1 PC due to the mobile device penetration – the market where Surface and Win8 phones have failed to make any significant impact or move beyond a tiny market share. Users increasingly see the complexity of shifting to Win8 as not worth the effort; and if a switch is to be made consumer and businesses now favor iOS and Android.
These trends mean nothing short of the ruin of Microsoft. Microsoft makes more than 75% of its profits from Windows and Office. Less than 25% comes from its vaunted servers and tools. And Microsoft makes nothing from its xBox/Kinect entertainment division, while losing vast sums on-line (negative $350M-$750M/quarter). No matter how much anyone likes the non-Windows Microsoft products, without the historical Windows/Office sales and profits Microsoft is not sustainable.
So what can we expect at Microsoft:
Ballmer has committed to fight to the death in his effort to defend & extend Windows. So expect death as resources are poured into the unwinnable battle to convert users from iOS and Android.
As resources are poured out of the company in the Quixotic effort to prolong Windows/Office, any hope of future dividends falls to zero.
Expect enormous layoffs over the next 3 years. Something like 50-60%, or more, of employees will go away.
Expect closure of the long-suffering on-line division in order to conserve resources.
The entertainment division will be spun off, sold to someone like Sony or even Barnes & Noble, or dramatically reduced in size. Unable to make a profit it will increasingly be seen as a distraction to the battle for saving Windows – and Microsoft leadership has long shown they have no idea how to profitably grow this business unit.
As more and more of the market shifts to competitive cloud businesses Apple, Amazon and others will grow significantly. Microsoft, losing its user base, will demonstrate its inability to build a new business in the cloud, mimicking its historical experiences with Zune (mobile music) and Microsoft mobile phones. Microsoft server and tool sales will suffer, creating a much more difficult profit environment for the sole remaining profitable division.
Missing the market shift to mobile has already forever tarnished the Microsoft brand. No longer is Microsoft seen as a leader, and instead it is rapidly losing market relevancy as people look to Apple, Google, Amazon, Samsung, Facebook and others for leadership. The declining sales, and lack of customer interest will lead to a tailspin at Microsoft not unlike what happened to RIM. Cash will be burned in what Microsoft will consider an "epic" struggle to save the "core of the company."
But failure is already inevitable. At this stage, not even a new CEO can save Microsoft. Steve Ballmer played "Bet the Company" on the long-delayed release of Win8, losing the chance to refocus Microsoft on other growing divisions with greater chance of success. Unfortunately, the other players already had enough chips to simply bid Microsoft out of the mobile game – and Microsoft's ante is now long gone – without holding a hand even remotely able to turn around the product situation.
Game over. Ballmer loses. And if you keep your money invested in Microsoft it will disappear along with the company.
Many people equate spending on R&D with investing in innovation. The logic goes that R&D spending is lab spending, and out of labs come innovations. Hence, those that spend a lot on R&D are innovative.
That is faulty logic.
This chart shows R&D spending from the top 20 companies in 2011:
Think of your own list of companies that are providing innovations which change your work, or life. Would you include Apple? Amazon? Facebook? Google? Genentech? (Here's the link to Fast Company's 50 most innovative for 2012). Note that none of these companies appear on the list of top R&D spenders.
On the other hand, as you look at the big spender list some things might be apparent:
Microsoft is #5, spending $9B and nearly 13% of revenue. Yet, for this money in 2012 the world received updates to their aging operating system and office automation software. Both of which failed to register favorable reviews by industry gurus, and are considered far from innovative. And Nokia, which is so floundering some consider it a likely bankruptcy candidate soon, is #7! Despite spending nearly $8B on R&D Nokia is now completely reliant on Microsoft if it is to even survive.
Autos make up a big part of the group. Toyota, GM, Volkswagen, Honda and Daimler are all on the list, spending a whopping $36B. Yet, even though they give us improvements nobody considers them (especially GM) very innovative. That award would go to little Tesla Motors. Or maybe Tata Motors in India.
Pharmaceuticals make up the dominant industry. Novartis, Roche, Pfizer, Merck, Johnson & Johnson, Sanofi, GlaxoSmithKline and AstraZeneca are all here – spending a cumulative $54B! Yet, they have all failed to give the world any incredible new drugs, all have profit struggles, and the industry is rife with discussions about weak product pipelines. The future of modern medicine increasingly is shifting to genetic solutions, biologics and more specific alternatives to the historical drug regimes from these aging pharma R&D programs.
Do you see the obvious pattern? Most big R&D spenders are not really seeking innovations. They are spending money on historical programs, following historical patterns and trying to defend and extend the historical business. In other words, they are spending vast sums attempting to sustain (or recapture) historical success. And, as the list shows, largely doing a pretty lousy job of it.
If you were given $10,000 to invest would you select these top 20 R&D spenders – or would you look for other, more innovative companies. From a profitability, rate of return and trend perspective, most of these companies look weak – or downright horrible.
Innovators don't focus on what they spend, but where they spend it.
The companies most known for innovation don't keep spending money year after year on their old business. Instead of digging deeper into what they already know, they invest laterally. They spend money putting the pieces together in new, unique ways. They try to find new solutions to old problems, using new – even fringe – technologies. They try to develop disruptive solutions that actually change the marketplace, rather than trying to make something that already exists better, faster or cheaper.
Lots of people like to think there is "scale" in research. Bigger is better. What's more important, for investors, is that there is "diminishing returns." The more you research an area the more you have to spend to find anything new. The costs keep escalating, as the gains shrink. After investing for a while, continuing to research an area is not a good investment (although it may be very intellectually interesting.)
Most of the companies on this list would be smarter to scrap their existing R&D programs, cut the budget in half (at least,) and then invest it somewhere very different. Instead of looking deeper, they need to look wider – broader. They need to investigate alternative solutions, rather than more of the same. They need to be putting more money on fringe opportunities, and a lot less into the core.
Until they do, few on this list are very good investment bets. You'll do better investing like, and in, the real innovators.
There was a time, before primaries, when each party's platform was really important. Voters didn't pick a candidate, the party did. Then voters read what policies the party planned to implement should it control the executive branch, and possibly a legislative majority. It was the policies that drew the most attention – not the candidates.
Digging deeper than shortened debate-level headlines, there is a considerable difference in the recommended economic policies of the two dominant parties. The common viewpoint is that Republicans are good for business, which is good for the economy. Republican policies – and the more Adam Smith, invisible hand, limited regulation, lassaiz faire the better – are expected to create a robust, healthy, growing economy. Meanwhile, the common view of Democrat policies is that they too heavily favor regulation and higher taxes which are economy killers.
Right?
Well, for those who feel this way it may be time to review the last 80 years of economic history, as Bob Deitrick and Lew Godlfarb have done in a great, easy to read book titled "Bulls, Bears and the Ballot Box" (available at Amazon.com) Their heavily researched, and footnoted, text brings forth some serious inconsistency between the common viewpoint of America's dominant parties, and the reality of how America has performed since the start of the Great Depression.
"Reason and facts are sacrificed to opinion and myth. Demonstrable
falsehoods are circulated and recycled as fact. Narrow minded opinion
refuses to be subjected to thought and analysis. Too many now subject
events to a prefabricated set of interpretations, usually provided by a
biased media source. The myth is more comfortable than the often
difficult search for truth."
Senator Daniel Patrick Moynihan is attributed with saying "everyone is
entitled to his own opinion, but not his own facts." So even though we
may hold very strong opinions about parties and politics, it is
worthwhile to look at facts. This book's authors are to be commended for spending several years, and many thousands of student research assistant man-days, sorting out economic performance from the common viewpoint – and the broad theories upon which much policy has been based. Their compendium of economic facts is the most illuminating document on economic performance during different administrations, and policies, than anything previously published.
Startling Results
Chart reproduced by permission of authors
The authors looked at a range of economic metrics including inflation, unemployment, growth in corporate profits, performance of the stock market, change in household income, growth in the economy, months in recession and others. To their surprise (I had the opportunity to interview Mr. Goldfarb) they discovered that laissez faire policies had far less benefits than expected, and in fact produced almost universal negative economic outcomes for the nation!
From this book loaded with statistical fact tidbits and comparative charts, here are just a few that caused me to realize that my long-term love affair with Milton Friedman's theories and recommended policies in "Free to Choose" were grounded in a theory I long admired, but that simply have proven to be myths when applied!
Personal disposable income has grown nearly 6 times more under Democratic presidents
Corporate profits have grown over 16% more per year under Democratic presidents (they actually declined under Republicans by an average of 4.53%/year)
Average annual compound return on the stock market has been 18 times greater under Democratic presidents (If you invested $100k for 40 years of Republican administrations you had $126k at the end, if you invested $100k for 40 years of Democrat administrations you had $3.9M at the end)
Republican presidents added 2.5 times more to the national debt than Democratic presidents
The two times the economy steered into the ditch (Great Depression and Great Recession) were during Republican, laissez faire administrations
The "how and why" of these results is explained in the book. Not the least of which revolves around the velocity of money and how that changes as wealth moves between different economic classes.
The book is great at looking at today's economic myths, and using long forgotten facts to set the record straight. For example, in explaining President Reagan's great economic recovery of the 1980s it is often attributed to the stimulative impact of major tax cuts. But in reality the 1981 tax cuts backfired, leading to massive deficits and a weaker economy with a double dip recession as unemployment soared. So in 1982 Reagan signed (TEFRA) the largest peacetime tax increase in our nation's history. In his tenure Reagan signed 9 tax bills – 7 of which raised taxes!
The authors do not come down on the side of any specific economic policies. Rather, they make a strong case that a prosperous economy occurs when a president is adaptable to the needs of the country at that time. Adjusting to the results, rather than staunchly sticking to economic theory. And that economic policy does not stand alone, but must be integrated into the needs of society. As Dwight Eisenhower said in a New Yorker interview
"I despise people who go to the gutter on either the right or the left and hurl rocks at those in the center."
The book covers only Presidents Hoover through W. Bush. But as we near this election I asked Mr. Goldfarb his view on the incumbent Democrat's first 4 years. His response:
"Obama at this time would rank on par with Reagan
Corporate profits have risen under Obama more than any other president
The stock market has soared 14.72%/year under Obama, second only to Clinton — which should be a big deal since 2/3 of people (not just the upper class) have a 401K or similar investment vehicle dependent upon corporate profits and stock market performance"
As to the challenging Republican party's platform, Mr. Goldfarb commented:
"The platform is the inverse of what has actually worked to stimulate economic growth
The recommended platform tax policy is bad for velocity, and will stagnate the economy
Repealing the Affordable Care Act (Obamacare) will have a negative economic impact because it will force non-wealthy individuals to spend a higher percentage of income on health care rather than expansionary products and services
Economic disaster happens in America when wealth is concentrated at the top, and we are at an all time high for wealth concentration. There is nothing in the platform which addresses this issue."
There are a lot of reasons to select the party for which you wish to vote. There is more to America than the economy. But, if you think like the Democrats did in 1992 and "it's about the economy" then you owe it to yourself to read this book. It may challenge your conventional wisdom as it presents – like Joe Friday said – "just the facts."
McDonald’s is in a Growth Stall. Even though the stock is less than 10% off its recent 52 week high (which is about the same high it’s had since the start of 2012,) the odds of McDonald’s equity going down are nearly 10x the odds of it achieving new highs.
A Growth Stall occurs when a company has 2 consecutive quarters of declining sales or earnings, or 2 consecutive quarters of lower sales or earnings than the previous year. And our research, in conjunction with The Conference Board, proved that when this happens the future becomes fairly easy to predict.
Growth Stalls are Deadly
When companies hit a growth Stall, 93% of the time they are unable to maintain even a 2% growth rate. 55% fall into a consistent revenue decline of more than 2%. 1 in 5 drop into a negative 6%/year revenue slide. 69% of Growth Stalled companies will lose at least half their market capitalization in just a few years. 95% will lose more than 25% of their market value.
While McDonald’s has been saying that Asian store revenue growth had offset the USA declines, we now can see that the USA drop is the key signal of a stall. There was no specific program in Asia to indicate that offshore revenues could create a renewed uptick in USA sales. Now with offshore sales plummeting we can see that McDonald’s American performance is the lead indicator of a company with serious performance issues.
Growth Stalls are a great forecasting tool because they indicate when a company has become “out of step” with its marketplace. While management, and in fact many analysts, will claim that this performance deficit is a short term aberration which will be repaired in coming months, historical evidence — and a plethora of case stories – tell us that in fact by the time a Growth Stall shows itself (especially in a company as large as McDonald’s) the situation is far more dire (and systemic) than management would like investors to believe.
Something fundamental has happened in the marketplace, and company leadership is busy trying to defend its historical business in the face of a major change that is pulling customers toward substitute solutions. Frequently this defend & extend approach exacerbates the problems as retrenchment efforts further hurt revenues.
McDonald’s has reached this inflection point as the result of a long string of leadership decisions which have worked to submarine long-term value.
Back in 2006 McDonald’s sold its fast growing Chipotle chain in order to raise additional funds to close some McDonald’s stores, and undertake an overhaul of the supply chain as well as many remaining stores. This one-time event was initially good for McDonald’s, but it hurt shareholders by letting go of an enormously successful revenue growth machine.
The McDonald’s CEO is somewhat “under seige” due to the poor revenue and earnings reports. Yet, the company continues to ascribe its Growth Stall to short-term problems such as a meat processing scandal in China. But this inverts the real situation. Such scandals are not the cause of current poor results. Rather, they are the outcome of actions taken to meet goals set by leadership pushing too hard, trying to achieve too much, by defending and extending an outdated success formula desperately in need of change to meet new competitive market conditions.
Application of Growth Stall analysis has historically been very valuable. In May, 2009 I reported on the Growth Stall at Motorola which threatened to dramatically lower company value. Subsequently Motorola spun off its money losing phone business, sold other assets and businesses, and is now a very small remnant of the business prior to its Growth Stall; which was brought on by an overwhelming market shift to smartphones from 2-way radios and traditional cell phones.
In February, 2008 a Growth Stall at General Electric indicated the company would struggle to reach historical performance for long-term investors. The stock peaked at $57.80 in 2000, then at $41.40 in July, 2007. By January, 2009 (post Stall) the company had crashed to only $10, and even recent higher valuations ($28 in 10/2013) are still far from the all-time highs – or even highs in the last decade.
In May, 2008 the Growth Stall at AIG portended big problems for the Dow Jones Industrial (DJIA) giant as financial markets continued to shift radically and quickly. By the end of 2008 AIG stock cratered and the company was forced to wipe out shareholders completely in a government-backed restructuring.
Perhaps the most compelling case has been Microsoft. By February, 2010 a Growth Stall was impending (and confirmed by May, 2011) warning of big changes for the tech giant. Mobile device sales exploded, sending Apple and Google stocks soaring, while Microsoft’s primary, core market for PCs (and software for PCs) has fallen into decline. Windows 8 subsequently had a tepid market acceptance, and gained no traction in mobile devices, causing Microsoft to write-off its investment in the Surface tablet. Recent announcements about enormous lay-offs, with vast cuts in the acquired Nokia handheld unit, do not bode well for long-term revenue growth at the decaying (yet cash rich) giant.
As the Dow has surged to record highs, it has lifted all boats. Including those companies which are showing serious problems. It is easy to look at the ubiquity of McDonald’s stores and expect the chain to remain forever dominant. But, the company is facing serious strategic problems with its products, service and business model which leadership has shown no sign of addressing. The recent Growth Stall serves as a key long-term indicator that McDonald’s is facing serious problems which will most likely seriously jeopardize investors’ (as well as employees’, suppliers’ and supporting communities’) potential returns.
This happens one day after the Board of Directors fired the CEO at Supervalu, parent company of such large grocery chains as Albertson's, Jewel-Osco, ACME, Shaw's and Star Markets. Apparently this pleased most everyone, since the company has lost 85% of its equity value since he was brought in from Wal-Mart while simultaneously killing bonuses and even free employee coffee. Even though just last week he was paid a retention bonus by the same Board to remain in his job!
And even thought the Chairman at Wal-Mart was clearly in the thick of bribing Mexican officials to open stores south of the border, there is no sign of any changes expected in Wal-Mart's leadership team.
What is sparking such bizarre behavior in retail? Quite simply, industry leadership that is so stuck in the past it has no idea how to grow or make money in a dramatically changed marketplace. They keep trying to do more of the same, while growth goes elsewhere.
Everyone, and I mean everyone, outside of retail knows that the game has changed – permanently. Since 2000 on-line sales of everything, and I mean everything, has increased. Sure, there were some collosal flops in early on-line retail (remember Pets.com?) But every year sales of products on-line increase at double digit rates. It's rare to walk through a store – and I mean any store – and not see at least one customer comparison shopping the product on the shelf with an on-line vendor.
What 15 years ago was a niche seller of non-stock books, Amazon.com, has become the industry vanguard selling everything from apple juice to zombie memorabilia. Even though most industry analysts don't clump it as a direct competitor to Best Buy, Sears, and Wal-Mart – holding it aside in its own "internet retail" category – everyone knows Amazon is growing and changing shopping habits, and reducing demand in traditional stores.
The signs of this shift are everywhere. From the complete collapse of Circuit City and Sharper Image to the flat sales, reduced number of U.S. outlets and falling per-store numbers at Wal-Mart.
Across America drivers are accustomed to seeing retail outlets boarded up, and strip malls full of empty window space. You don't have to be a fancy analyst to notice how many malls would be knocked down entirely if they weren't being converted to low-cost office space for lawyers, tax preparers, dentists, veterinarians and emergency clinics – demonstrably non-retail businesses. Or to recognize an old Sears or superstore location converted into an evangelical nondenominational church.
It is not impossible to make money in retail. But you can't do it the way it was done in the past. The answer isn't as simple as "location, location, location;" or even inventory. As the new, and struggling, CEO at JC Penney has learned the hard way, it's not about "every day low price." Or even low price at all, as the former WalMart exec just fired at Supervalu learned – along with all their employees.
Today traditional retail store success requires you have unique products, unique merchandising, sales assistance that meets immediacy needs, strong trend connectivity and effective pricing. Just look at IKEA, Lululemon, Sephora, Whole Foods, Trader Joe's and PetSmart – for example.
Of course there will be grocery stores. Traditional retail will not disappear. But that doesn't mean it will be profitable. And trying to chase profits by constantly beating down costs gets you – well – Circuit City, Toys R Us, Drug Emporium, Pay N Save, Crazy Eddie, Egghead Software, Bradlee's, Korvette's, TG&Y, Wickes, Skagg's, Payless Cashways, Musicland — and Supervalu. There is more to business than price, something the vast, vast majority of retailers keep forgetting.
Fifty years ago if you wanted a TV you went to a television store where they not only sold you a TV, they repaired it! You selected from tube-based machines made by Zenith, RCA, Philco and Magnavox. The TV shop owner made some money on the TV, but he also made money on the service. And if you wanted a washer or refrigerator you went to an "appliance store" for the same reason. But the world changed, and the need for those stores disappeared. Almost none changed to what people wanted – they simply failed.
Now the world has changed again. The customer value proposition in retail is shifting from location and inventory to information. And it is extremely hard to have salespeople – or shelf tags – with comparable information to a web page, which have not only product and price info but competitive comparisons on everything. There simply isn't enough profit in a TV, stereo, PC, CD or DVD to cover the overhead of salespeople, check-out clerks, on-hand inventory and the building.
And that's why Best Buy had to shutter 50 stores in March. On its way to the same ending as Polk Brothers, Grant's Appliance and Circuit City.
Don't expect a 70 year old retailer to understand what retail markets will look like in 2020. Or anyone trained in traditional retail at Wal-Mart. Or anyone who thinks they can save a traditional "retail brand" like Sears. The world has already shifted – and those are stories from last decade (or long before.)
If you are interested in retail go where the growth is – and that is all about on-line leadership. Sell Best Buy and put your money in Amazon. You'll sleep better.
