The Waltons Are Cashing Out Of Walmart — And You Should Be, Too

The Waltons Are Cashing Out Of Walmart — And You Should Be, Too

Employees restock shelves of school supplies at a Walmart Stores Inc. location in Burbank, CA.  Bloomberg

Last week there was a lot of stock market excitement regarding WalMart. After a “favorable” earnings report analysts turned bullish and the stock jumped 4% in one day, WMT’s biggest rally in over a year, making it a big short-term winner.  But the leadership signals indicate WalMart is probably not the best place to put your money.

WalMart has limited growth plans

WalMart is growing about 3%/year.  But leadership acknowledged it was not growing its traditional business in the USA, and only has plans to open 25 stores in the next year.  It hopes to add about 225 internationally, predominantly in Mexico and China, but unfortunately those markets have been tough places for WalMart to grow share and make profits.  And the company has been plagued with bribery scandals, particularly in Mexico.

And, while WalMart touts its 40%+ growth rate on-line, margins online (including the free delivery offer) are even lower than in the traditional Wal-Mart stores, causing the company’s gross margin percentage to decline.  The $11.5 billion on-line revenue projection for next year is up, but it is 2.5% of Walmart’s total, and a mere 7-8% of Amazon’s retail sales.  Amazon remains the clear leader, with 62% of U.S. households having visited the company in the second quarter.  And it is not a good sign that WalMart’s greatest on-line growth is in groceries, which amount to 26% of on-line salesalready.  WalMart is investing in 1,000 additional at-store curb-side grocery pick-uplocations, but this effort to defend traditional store sales is in the products where margins are clearly the lowest, and possibly nonexistent.

It is not clear that WalMart has a strategy for competing in a shrinking traditional brick-and-mortar market where Costco, Target, Dollar General, et.al. are fighting for every dollar.  And it is not clear WalMart can make much difference in Amazon’s giant on-line market lead.  Meanwhile, Amazon continues to grow in valuation with very low profits, even as it grows its presence in groceries with the Whole Foods acquisition.  In the 17 months from May 10, 2016 through October 10, 2017 WalMart’s market cap grew by $24 billion (10%,) while Amazon’s grew by $174 billion (57%.)

Even after recent gains for WalMart, its market capitalization remains only 53% of its much smaller on-line competitor.  This creates a very difficult pricing problem for WalMart if it has to make traditional margins in order to keep analysts, and investors, happy.

Leadership is not investing to compete, but rather cashing out the business

To understand just how bad this growth problem is, investors should take a look at where WalMart has been spending its cash.  It has not been investing in growing stores, growing sales per store, nor really even growing the on-line business.  From 2007-2016 WalMart spent a whopping $67.3 billion in share buybacks.  That is over 20 times what it spent on Jet.com.  And it was 45% of total profits during that timeframe.  Additionally WalMart paid out $51.2 billion in dividends, which amounted to 34% of profits.  Altogether that is $118.5 billion returned to shareholders in the last decade.  And a staggering 79% of profits.  It shows that WalMart is really not investing in its future, but rather cashing out the company by returning money to shareholders.

 “Say on pay” votes are often seen as a measure of how happy investors are with a company.  The average disapproval level on executive pay is 4.3%.  At Target, Macy’s and Kroger the disapproval is 6.1%, 6.3% and 6.9%.  Investors, however, disapprove of the compensation for WalMart’s leaders at a whopping 16.7%; nearly 4x the average and 2.5x its competition.
So very large investors, who control huge voting blocks, recognize that things are not going well at WalMart.  But, because of the enormity of the share buybacks, the Walton family now controls over half of WalMart stock.  That makes it tough for an activist to threaten shaking up the company, and lets the Waltons determine the company’s future.

Buybacks signal Strategy

Walmart annual meeting 2014, walmart.com

With WalMart’s announcement last week that it intends to spend another $20 billion on additional share repurchases, the Walton family’s strategy is clear.  They are cashing out the business.  As money comes in they are going to continue spending little on the traditional business, and in no way do they intend to invest at a level to really chase Amazon on-line.

There will be marginal enhancements.  But the vast majority of the money is being returned to them, via $20 billion in share repurchases and $1.5 billion in cash dividends annually.

Amazon spends nothing on share repurchases.  Nor does it distribute cash to shareholders via dividends.  Amazon’s largest shareholder, Jeff Bezos, invests all the company money in new growth opportunities.  These nearly cover the retail landscape, and increasingly are in other growth markets like cloud services, software-as-a-service and entertainment.  Comparing the owners of these companies, quite clearly Bezos has faith in Amazon’s ability to invest money for profitable future growth.  But the Waltons are far less certain about the future success of WalMart, so they are pulling their money off the table, allowing investors to put their money in ventures outside WalMart.

Investing your money, do you think it is better to invest where the owner believes in the future of his company?

Or where the owners are cashing out?

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The Case For Trian’s Nelson Peltz Joining P&G’s Board

The Case For Trian’s Nelson Peltz Joining P&G’s Board

Months ago Trian’s Nelson Peltz began buying Procter & Gamble (P&G) shares.  He invested about $3.5 billion, making Trian’s ownership 1.5%.  Since then he has been lobbying, unsuccessfully, for a seat on P&G’s board of directors.  He has said that although P&G already has 10 outside directors on its 11 member board, adding him would make a tremendous difference increasing P&G’s market valuation.  P&G is now the largest company ever to engage in a proxy battle between the existing board and an outside investor.

Today, Peltz offered his plan to change P&G, continuing his attack on management, saying that P&G has not sufficiently cut costs, nor has it created growth via innovation – citing no new innovation platform since Swiffer was introduced almost 20 years ago.  He attacked the company for selling off brands without returning sufficient funds to shareholders.  He believes management’s targets are too low, and it is too easy for managers to make their bonus.  He also believes there is a need to hire more managers from outside the company.

He informed the company if he were a director he would reorganize the company to make it more streamlined, change the compensation plan, and do a better job of cutting costs.

P&G is dead set against adding Peltz, saying he would disrupt the board, and the company, in negative ways. CNBC.com reported Peltz’ claims the company is spending $100 million on the proxy fight to keep him off the board. P&G’s proxy statement puts that sum at $35 million.  Either number indicates P&G is spending a lot of money to stop the appointment of Peltz.

Nelson Peltz, Trian Partners

Nelson Peltz, Founder Trian Partners, LLC

The company defended itself, saying leadership has been growing EPS (earnings per share,) making productivity improvements, growing sales organically at 2%/year and returning huge value to shareholders.  They accuse Peltz of simply planning a split of the company into 3 parts so each can go public on its own – adding little value to shareholders while damaging the company’s ability to operate.

Unfortunately, P&G’s leadership has pretty much set itself up for this battle.  And shareholders may have good reason to add Peltz to the board in hopes of additional change.

P&G’s financial performance has been poor

Firstly, in the last 10 years the value of P&G has risen about 44%. But the S&P 500 has grown by 154.5%.  Shareholders would have done better owning the average than owning P&G.  Claims about how well P&G have done since the CEO arrived 2 years ago overlook the fact that just prior to his arrival, in November, 2014 P&G shares traded at $90-$93.85/share, which is just about where they are now.  So all that’s happened is a recovery to where things were previously, not a great success.  Shareholders have a right to be frustrated.

EPS has risen, but that has everything to do with share buybacks rather than earnings growth.  EPS has risen about 11%.  But since 2nd quarter of 2007 P&G has spent ~$61billion on share repurchases, reducing the number of shares from 3.32 billion to 2.74 billion, or 17.5%.  Rather than growing earnings, leadership has been making the capital structure smaller – and thus EPS has risen while earnings have not.  This is actually a program that goes all the way back to 1995, which indicates a long-term approach of focusing on EPS, which are manipulated, rather than earnings.

P&G has favored divestitures and share repurchases over innovation and acquisitions for growth

Meanwhile, P&G’s buyback program has been financed by a dramatic divestiture program, selling off very large businesses to raise cash.  Over the last decade major sales included:

2009 – selling the P&G pharma business
2012 – selling the water filtration business including Pur
2012 – selling Pringles (along with several other iconic brands)
2014 – selling the dog food business
2016 – selling the Duracell battery business
2016 – selling the beauty brand business

Management tried in its response to say that innovation was just fine at P&G.  But what it cited were line extensions like Tide PODs, GAIN Flings, Pampers Pants, and Oral B power toothbrush.  None of these are great new innovations launching significant sales.  None are new product platforms for high growth.  Rather they are typical sustaining innovations applied to brands that are long in the tooth.

This is typical of the long-term lack of valuable innovation at P&G. Do you recall in 2009 when the company lauded its development of the “P&G Public Toilet Database App?” Not exactly on the top 20 iTunes list.  Or do you remember in 2014 when P&G launched its “Basic” line of products, where it literally sold a less-good quality product hoping to attract a brand-conscious but quality uncaring targeted niche?  Peltz is making a good point, that leadership at P&G really has forgotten what good, long-term profit producing innovation is, while succumbing to the strategy of selling major business units (reducing revenue) then using the money to buy back shares rather than investing in future growth.

P&G has not shown it understands how trends are quickly changing its business

Meanwhile, the consumer goods industry is changing dramatically, and it is not clear that P&G’s leadership is really preparing for future changes.  P&G still relies heavily on television advertising to sell its products. But that approach had stopped generating profitable growth as far back as 2010. Back then Colgate was holding its market share, and growing revenues, on all its brands that compete with P&G while spending 25% less, and often much less, on advertising.

 

P&G is still stuck using marketing strategies that have been outdated for almost a decade. Comcast lost 90,000 subscribers in Q2, and the stock lost 7% today when Comcast management alerted investors it expects to lose 150,000 more in Q3.  And while viewership is declining, ad pricing is going up, making TV advertising a less effective and more expensive marketing tactic for consumer goods. As P&G brands have fallen further behind competitors in Instagram followers, and lack good social media programs like Wendy’s, Peltz has proposed a substantial increase in digitally savvy marketers.

P&G and Walmart logo

Simultaneously, distribution is changing dramatically.  Once P&G could rely on its product dominance to dictate space usage in grocery stores and discounters.  But the rise of e-commerce has dramatically affected these historical distribution channels.  Today the fastest growing grocer is Aldi, which eschews brands like P&G’s in favor of its own private label.  And after stunting the growth of discounters like WalMart, the leading e-commerce company, Amazon.com, has now purchased Whole Foods.  This is leading everyone to expect greater growth in on-line grocery shopping and additional at-home delivery, which undercuts the former strength P&G had in traditional brick-and-mortar stores with warehouse delivery models.

Management bragged of its $3 billion in e-commerce sales, but that is a drop in the bucket.  Is P&G ready to compete for sales in future markets where social media is more important than advertising?  Where mobile ads have more power than print, TV, radio and traditional internet banners?  Where social media groups drive more consumption behavior than company-sponsored social media pages with coupons and use recommendations?  Will P&G dominate product volume when it has to rely on Amazon.com and other sites to sell and deliver its products?  If people move to daily home deliveries, and less stock-up purchasing what will happen to P&G’s former brand advantage via high numbers of SKUs (stock keeping units) and large packaging options?

This will be an interesting proxy battle.  There is no doubt Peltz wants to shake up the board’s behavior, compensation plans, hiring programs, targets and many of the ways management runs the company.  Simultaneously, the P&G board believes it is moving in the right direction.  Large shareholders are conservative, and don’t like to create problems (P&G’s largest shareholders are Vanguard, Blackrock, State Street, BofA, Capital World, Trian, Northern Trust – which combined control 24% of P&G stock.)

But this isn’t about a complete change in the board.  It’s just a vote to add one additional member who is not happy with things the way they are.  Will these large shareholders see a need for someone to shake things up, or will they accept current leadership’s claims that things are on the right track?

It will be interesting to watch, because Peltz isn’t without some objective concerns about P&G’s future, given its performance the last decade and the amount of change facing the industry.

A Bitcoin Is Worth $4,000–Why You Probably Should Not Own One

A Bitcoin Is Worth $4,000–Why You Probably Should Not Own One

Even though most people don’t even know what they are, Bitcoins increased in value from about $570 to more than $4,300 — an astounding 750% — in just the last year.  Because of this huge return, more people, hoping to make a fast fortune, are becoming interested in possibly owning some Bitcoins.  That would be very risky.

Bitcoins are a crypto-currency.  That means they can be used like a currency, but don’t physically exist likeBitcoin dollar bills.  They are an online currency which can be used to buy things.  They are digital cash that exist as bits on people’s computers.  You can’t put them in a drawer, like dollar bills or gold Krugerrands.  Bitcoins are used to complete transactions – just like any currency.  Even though they are virtual, rather than physical, they are used like cash when transferred between people through the web.

Being virtual is not inherently a bad thing.  The dollars on our financial institution statement, viewed online, are considered real money, even though those are just digital dollars.  The fact that Bitcoins aren’t available in physical form is not really a downside, any more than the numbers on your financial statement are not available as physical currency either. Just like we use credit cards or debit cards to transfer value, Bitcoins can be spent in many locations, just like dollars.

What makes Bitcoins unique, versus other currencies, is that there is no financial system, like the U.S. Federal Reserve, managing their existence and value.  Instead Bitcoins are managed by a bunch of users who track them via blockchain technology.  And blockchain technology itself is not inherently a problem; there are folks figuring out all kinds of uses, like accounting, using blockchain.  It is the fact that no central bank controls Bitcoin production that makes them a unique currency.  Independent people watch who buys and sells, and owns, Bitcoins, and in some general fashion make a market in Bitcoins.  This makes Bitcoins very different from dollars, euros or rupees.  There is no “good faith and credit” of the government standing behind the currency.

Why are currencies different from everything else?

Currencies are sort of magical things.  If we didn’t have them we would have to do all transactions by barter.  Want some gasoline?  Without currency you would have to give the seller a chicken or something else the seller wants.  That is less than convenient.  So currencies were created to represent the value of things.  Instead of saying a gallon of gas is worth one chicken, we can say it is worth $2.50.  And the chicken can be worth $2.50.  So currency represents the value of everything.  The dollar, itself, is a small piece of paper that is worth nothing.  But it represents buying power.  Thus, it is stored value.  We hold dollars so we can use the value they represent to obtain the things we want.

Currencies are not the only form of stored value.  People buy gold and lock it in a safe because they believe the demand for gold will rise, increasing its value, and thus the gold is stored value.  People buy collectible art or rare coins because they believe that as time passes the demand for such artifacts will increase, and thus their value will increase.  The art becomes a stored value.  Some people buy real estate not just to live on, but because they think the demand for that real estate will grow, and thus the real estate is stored value.

But these forms of stored value are risky, because the stored value can disappear.  If new mines suddenly produce vast new quantities of gold, its value will decline.  If the art is a fake, its value will be lost.  If demand for an artist or for ancient coins cools, its value can fall.  The stored value is dependent on someone else, beyond the current owner, determining what that person will pay for the item.

Assets held as stored value can crash

Tulip photo with value lineIn the 1630s, people in Holland thought of tulip bulbs as stored value.  Tulips were desired, giving tulip bulbs value.  But over time, people acquired tulip bulbs not to plant but rather for the stored value they represented.  As more people bought bulbs, and put them in a drawer, the price was driven higher, until one tulip bulb was worth 10 times the typical annual salary of a Dutch worker — and worth more than entire houses.  People thought the value of tulip bulbs would  go up forever.

But there were no controls on tulip bulb production.  Eventually it became clear that more tulip bulbs were being created, and the value was much, much greater than one could ever get for the tulips once planted and flowered.  Even though it took many months for the value of tulip bulbs to become so high, their value crashed in a matter of two months.  When tulip bulb holders realized there was nobody guaranteeing the value of their tulip bulbs, everyone wanted to sell them as fast as possible, causing a complete loss of all value.  What people thought was stored value evaporated, leaving the tulip bulb holders with worthless bulbs.

While a complete collapse is unlikely, people should approach owning Bitcoins with great caution. There are other risks. Someone could hack the exchange you are using to trade or store Bitcoins. Also, cryptocurrencies are subject to wild swings of volatility, so large purchases or sales of Bitcoin can move prices 30% or more in a single day.

Be an investor, not a speculator, and avoid Bitcoins

There are speculators and traders who make markets in things like Bitcoins.  They don’t care about the underlying value of anything.  All they care about is the value right now, and the momentum of the pricing.  If something looks like it is going up they buy it, simply on the hope they can sell it for more than they paid and take a profit on the trade.  They don’t see the things they trade as having stored value because they intend to spin the transaction very quickly in order to make a fast buck.  Even if value falls they sell, taking a loss.  That’s why they are speculators.

Most of us work hard to put a few dollars, euros, pounds, rupees or other currencies into our bank accounts. Most of those dollars we spend on consumption, buying food, utilities, entertainment and everything else we enjoy.   If we have extra money and want the value to grow we invest that money in assets that have an underlying value, like real estate or machinery or companies that put assets to work making things people want.  We expect our investment to grow because the assets yield a return.  We invest our money for the long-term, hoping to create a nest egg for future consumption.

Unless you are a professional trader, or you simply want to gamble, stay away from Bitcoins.  They have no inherent value, because they are a currency which represents value rather than having value themselves.  The Bitcoin currency is not managed by any government agency, nor is it backed by any government.  Bitcoin values are purely dependent upon holders having faith they will continue to have value.  Right now the market looks a lot more like tulip mania than careful investing.

President Trump: The 5 Reasons You Are Not A Disruptive Leader And Instead Create Chaos

President Trump: The 5 Reasons You Are Not A Disruptive Leader And Instead Create Chaos

The news was filled this week with stories about President Trump’s “unorthodox” management style. From tweeting his thoughts on replacing Attorney General Jeff Sessions, to tweeting his multiple positions on healthcare law changes, to hiring a new communications director who lets loose with expletive-laden rants, people have been left questioning what sort of leadership style President Trump is trying to display.

Donald Trump promised to be a “disruptive leader”

Donald Trump ran for office as an outsider who pledged to disrupt Washington politics.  This was a message well received by many people.  They felt that “business as usual” in national politics was not serving them well, so they wanted change.  To them a disruptor could find a way to steer national politics back onto a course that was more aligned with the conservative middle Americans.  These voters felt that a businessman entrepreneur just might be the kind of leader who could disrupt the status quo in order to get something done for them.

Unfortunately, things have not worked out that way.  And largely this can be traced to the leadership style of President Trump.  Rather than a dedicated disruptor, ready to implement change, President Trump has proven to be a chaos generator that has stymied progress on pretty nearly all issues.  Disruptions can lead to positive change.  Chaos leads to stagnation and degradation as the system searches for homeostasis and a path forward.

From early age, we are taught not to be disruptive.  Disrupting someone during school, religious ceremonies, entertainment events leads to distractions and an inability to remain focused on the goal.  Thus, we are mostly taught to listen, learn and do what we’re told.  However, we also recognize there is a time to be disruptive, because the act of intervening in the process at times can lead to far more positive outcomes than maintaining the course.

But it takes good judgement, and reasoned action, to be a positive disruptive influence.  If you are in a crowded theater and you recognize a blaze it is time to disrupt the stage presentation.  But you have a choice.  If you jump up and yell “fire” you will create chaos.  Everyone suddenly realizes a problem, but with no idea how to deal with it a thousand different solutions emerge simultaneously.  Everyone starts looking out for their own interest, and they trample those around them in an effort to implement their own plans.  Many people get hurt, and frequently the goal of saving everyone by disrupting the presentation is lost in carnage created by the bad disruption leading to chaos.

What is successful disruptive leadership?

So, if you sense a pending fire you are far smarter to develop a plan, such as activating the evacuation notices and opening the exits, prior to making an alert.  And then, instead of yelling “fire” you say to folks “an issue has developed, please make your way down the evacuation routes to the open exits while we deal with the situation.  Please remain calm so everyone can exit safely.”  Your disruption can lead to successful outcome, rather than chaos.

I’ve spent over 20 years focusing on how disruptions can lead to positive change.  And it is clear that with disruptive innovations, and disruptive business models, their success relies on leaders that understand how to implement disruptions effectively.  Leadership matters.

Disruptive leaders think very hard about their desired outcomes, and they go to great lengths to describe what those future, better outcomes will look like.  They then create a plan of action before they do anything.  While the innovation might well be known, they are very, very careful to think through how that innovation will be adopted, then nurtured to gain acceptance and hopefully become mainstream.  These leaders are very careful about their language choices, and where they communicate, in order to encourage people to accept their vision and join with their plan.  They seek adoption rather than confrontation, and they discuss the desired outcomes rather than the disruption itself.  They gain trust and build a consensus for change, and then they systematically roll out their plan, which they adjust as necessary to meet unexpected market conditions.  They gradually move people along the implementation route by relentlessly focusing on the better outcome and reducing the fear inherent in accepting the disruption.

Five ways Donald Trump fails as a successful disruptive leader:

  1. The President has not portrayed a superior outcome which he can use to rally people to his viewpoint.  Despite talking about “making America great again” there is no picture of what that looks like.  What is this future “great” America he envisions and wants us to buy into?  What are the poor outcomes of today that he will greatly improve, leading to vastly superior future outcomes?  Without a clear description of the future, it is hard to gain supporters.  For example, will changes in health care improve care?  Lower the cost? What are the benefits, the better outcomes, of change?  What is the benefit of replacing the sitting attorney general?
  2. The President has not laid out his plan for bringing people on board to his future. Look at the recent effort to implement new health care legislation. At times the President has said there is a need to repeal current legislation and replace it, but he has offered no description of what the replacement should look like.  At other times he has said to repeal current legislation, but he has offered no insight into how that would lead to better outcomes than the current legislation provides.  At yet other times he has said to do nothing, and he expressed his hope that current legislation would fail even though he admitted this would lead to an outcome far worse than the status quo.  By not creating a plan, and bringing people on board to his plan, he has created chaos in the legislative process.
  3. President’s Trumps messages are built on negative language, not positive language about the future. His messages are long on how some person or current situation is weak, rather than explaining what a strong future would look like. He frequently attacks his predecessor, or his former electoral opponent, but does little to say what is good about his Presidency or recommendations or what he is specifically going to do that will create better outcomes.  He frequently talks about firing people in his administration, but talks little about the specifics of what good work people in his administration are doing.  These language choices are exclusive, not inclusive, and they create chaos among those who work in his administration, and members of Congress.  Instead of understanding the President’s goals and objectives people are wondering “what will he say next?”  And by appointing a communications director who uses outrageous, unacceptable and incendiary language he further exacerbates the problem of everyone losing any insight to his message because we are stunned and amazed at the choice of language.
  4. President Trump has the ability to communicate from the most Presidential locations. He can provide TV, radio and internet addresses from the oval office, or the White House platform. He can invite media in for press conferences or interviews to discuss his goals and ambitions, plans and pending decisions.  Or he can make himself, or his staff, available for press interviews.  And while he does some of this, we all spend every day wondering what Tweet he will send over the Twitter social network next.  Several million people use Twitter. It is for social exchange.  For the President to announce policy positions (such as banning transgenders from military service) or evaluations of key subordinates (such as referring to the attorney general as weak) or military policy (such as opining on the potential retribution toward North Korea) via Twitter belies the nature of the office and his role.  His selection of communication venues only serves to make his comments less valuable, rather than more important.
  5. President Trump neither remains consistent in his communications, nor does he exert loyalty. Changes on health care and denouncing his own staff does not create trust. How are people in the legislature, regulatory agencies or military going to become advocates for his goals when they don’t know if he can be trusted to support their actions, or support them as employees?  If you want people to take a different course of action, to let go of the status quo, they have to trust you.  Disruptive leaders time and again must state their positions with clarity and demonstrate support for those who do their best to promote the disruptive agenda.  They battle fear of the future with clarity around their support for future outcomes those who help describe how the future will be better.

There are times for disruptive leadership.  Status quo models become outdated, and outcomes decline as a result.  Change offers the opportunity for better outcomes, and helping people migrate to new innovations helps them toward a better future.  But implementing innovation and change requires skill at being a disruptive leader.  If the process is bungled, you can look like the guy who started a deadly rampage by yelling “fire” when a more reasoned approach would have prevailed.  If you don’t follow the best practices of disruptive leadership, you will create chaos.

What The NBA All-Star Game Venue Change Teaches Us About Decision-Making

Leaders like to be deciders. Most leaders think of themselves as decision makers. In 2006 President George Bush, defending Donald Rumsfeld as his Defense Secretary said “I am the Decider.  I decide what’s best.” It earned him the nickname “Decider-in-Chief.” Most CEOs echo this sentiment. Most leaders like to define themselves by their decisions.

But whether a decision is good or not is open to interpretation. Often immediately after a decision things may look great. It might appear as if that decision was obvious. And often decisions quickly make a lot of people happy.

As we enter the most intense part of the U.S. presidential election, both candidates are eager to tell potential voters what decisions they have made – and what decisions they will make if elected. And most people will look no further than the immediate expected impact of those decisions.

AP Photo/Chuck Burton, File

It takes time to determine the quality of any decision.

However, the quality of most decisions is not based on the immediate, or obvious, first implications. Rather, the quality of a decision is discovered over time, as the consequences are revealed – intended and unintended. Because quite often, what looked good at first can turn out to be very, very bad.

The people of North Carolina passed a law to control the use of public bathrooms. Most people of the state thought this was a good idea, including the governor. But some didn’t like the law, and many spoke up. Last week the NBA decided that it would cancel its All-Star game scheduled in Charlotte due to discrimination issues caused by this law. This change will cost Charlotte about $100 million.

 That action by the NBA is what’s called unintended consequences. Lawmakers didn’t really consider that the NBA might decide to take its business elsewhere due to this state legislation. It’s what some people call, “Oops. I didn’t think about that when I made my decision.”

Often unintended consequences are more important than first reactions to decisions.

Robert Reich, Secretary of Labor for President Clinton, was a staunch supporter of unions. In his book Locked in the Cabinet, he tells the story of visiting an auto plant in Oklahoma supporting the local union. He thought his support would incent the company’s leaders to negotiate more favorably. Instead, the company closed the plant. Laid-off everyone. Oops. The unintended consequences of what he thought was obvious support led to the worst possible worker outcome.

President Obama worked Congress hard to create the Affordable Care Act, or Obamacare, for everyone in America. One intention was to make sure employers covered all their workers, so the law required that if an employer had health care for any workers he had to offer that health care to all employees who worked over 30 hours per week. So almost all employers of part time workers suddenly said that none could work more than 30 hours. Those that worked 32 (four days per week) or 36 suddenly had their hours cut. Now those lower-income people not only had no health care, but less money in their pay envelopes. Oops. Unintended consequence.

President Reagan and his First Lady launched the “War on Drugs.” How could that be a bad thing? Illegal drugs are dangerous, as is the supply chain. But now, some 30 years later, the Federal Bureau of Prisons reports that almost half (46.3% or over 85,000) of inmates are there on drug charges. The U.S. now spends $51 billion annually on this drug war, which is about 20% more than is spent on the real war being waged with Afghanistan, Iraq and ISIS.  There are now over 1.5 million arrests each year, with 83% of those merely for possession. Oops. Unintended consequences. It seemed like such a good idea at the time.

This is why it is so important leaders take their time to make thoughtful decisions, often with the input of many other people. Because the quality of a decision is not measured by how one views it immediately. Rather, the value is decided over time as the opportunity arises to observe the unintended consequences, and their impact. The best decisions are those in which the future consequences are identified, discussed and made part of the planning – so they aren’t unintended and the “decider” isn’t running around saying “oops.”

Think hard about the long-term complications of any decision.

As you listen to the politicians this cycle, keep in mind what could be the unintended consequences of implementing what they say:

  • What would be the social impact, and transfer of wealth, from suddenly forgiving all student loans?
  • What would be the consequences on trade, and jobs, of not supporting historical government trade agreements?
  • What would be the consequences on national security of not supporting historically allied governments?
  • What would be the long-term consequence of not allowing visitors based on race, religion or sexual orientation?
  • What would be the consequence of not repaying the government’s bonds?
  • What would be the long-term impact on economic growth of higher regulations on banks – that already have seen dramatic increases in regulation slowing the recovery?
  • What would be the long-term consequences on food production, housing and lifestyles of failing to address global warming?

Business leaders should be very aware of the long-term consequences of their decisions. Every time a decision is necessary, is the best effort made to obtain all the information available on the topic? Are inputs and expectations obtained from detractors, as well as admirers? Is there a balance between not only what is popular, but what will happen months into the future? Did you consider the potential reaction by customers? Employees? Suppliers? Competitors?

There are very few “perfect decisions.” All decisions have consequences. Often, there is a trade-off between the good outcomes, and the bad outcomes. But the key is to know them all, and balance the interests and outcomes. Consider the consequences, good and bad, and plan for them. Only by doing that can you avoid later saying “oops.”

The U.K. Brexit: Economic Destruction Vs. Creative Destruction

The U.K. Brexit: Economic Destruction Vs. Creative Destruction

Photo by Spencer Platt/Getty Images

I’m a believer in Disruptive Innovation. For almost 100 years economists have written about “Creative Destruction,” in which new technologies come along making old technologies — and the companies built on them — obsolete. In the last 20 years, largely thanks to the insights of faculty at the Harvard Business School, we’ve seen a dramatic increase in understanding how new companies use new technologies to disrupt markets and wipe out the profitability of companies that were once clearly successful. In a large way, we’ve come to accept that Disruptive Innovation is good, and the concomitant Creative Destruction of the old players leads to more rapid growth for the economy, increasing jobs and the wherewithal of everyone. Creative Destruction, in the pursuit of progress, is good because it helps economies to grow.

But, not really everyone benefits from Creative Destruction. The trickle down benefits to lots of people can be a long time coming. When market shifts happen, and people lose jobs to new competitors — domestic or offshore — they only know that their life, at least short term, is a lot worse. As they struggle to pay a mortgage, and find a new job, they often learn their skills are outdated. There are new jobs, but these folks are often not qualified. As they take lesser jobs, their incomes dwindle, and they may well lose their homes. And their healthcare.

Economists call this workplace transition “temporary economic dislocation.” Fancy term. They claim that eventually folks do enter the workplace who are properly trained, and those folks make more money than the workers associated with the previous, now inferior, technology. And, eventually, everyone finds new work – at something.

 That’s great for economists. But terrible for the folks who lost their jobs.  As someone once said “a recession is when your neighbor loses his job. A depression is when you lose your job.”  And for a lot of people, the market shift from an industrial economy to an information economy has created severe economic depression in their lives.

A person learns to be a printer, or a printing plate maker, in the 1970s when they are 20-something.  Good job, makes a great wage. Secure work, since printing demand just keeps rising. But then along comes the internet with PDF and JPEG documents that people read on a screen, and folks simply quit needing, or wanting, printed documents. In 2016, now age 50-something, this printer or plate-maker no longer has a job. Demand is down, and its really easy to send the printing to some offshore market like Thailand, Brazil or India where printing is cheaper.

What’s he or she to do now? Go back to school you may say. But to learn how to do what? Say it’s online (or digital) document production. OK, but since everyone in the 20s has been practicing this for over a decade it takes years to actually be skilled enough to be competitive. And then, what’s the pay for a starting digital graphic artist? A lot less than what they made as a printer. And who’s going to hire the 58-62 year old digital graphic artist, when there are millions of well trained 20-somethings who seem to be quicker, and more attuned to what the publishers want (especially when the boss ordering the work is 35-42, and really uncomfortable giving orders and feedback to someone her parents’ age.) Oh, and when you look around there are millions of immigrants who are able to do the work, and willing to do it for a whole lot less than anyone native born to your country.

In England last week these disaffected people made it a point to show their country’s leadership that their livelihoods were being “creatively destroyed.” How were they to keep up their standard of living with the flood of immigrants? And with the wealth of the country constantly shifting from the middle class to the wealthy business leaders and bankers? And with work going offshore to less developed countries? While folks who have done well the last 25 years voted overwhelmingly to remain in the EU (such as those who live in what’s called “The City”), those in the suburbs and outlying regions voted overwhelmingly to leave the EU. Sort of like their income gains, and jobs, left them.

A whole lot of anger. To paraphrase the famous line from the movie Network, they were mad as Hell and they weren’t going to take it any longer. Simply put, if they couldn’t participate in the wonderful economic growth of EU participation, they would take it away from those who did.  The point wasn’t whether or not the currency might fall 10% or more, or whether stocks on the UK exchange would be routed. After all, these folks largely don’t go to Europe or America, so they don’t care that much what the Euro or dollar costs. And they don’t own stocks, because they aren’t rich enough to do so, so what does it hurt them if equities fall? If this all puts a lot of pain on the wealthy – well just maybe that is what they really wanted.

America is seeing this as well. It’s called the Donald Trump for president campaign. While unemployment is a remarkably low 5%, there are a lot of folks who are working for less money, or simply out of work entirely, because they don’t know how to get a job. They may laugh at Robert De Niro as a retired businessman now working for free in The Intern. But they really don’t think it’s funny.  They can’t afford to work for free. They need more income to pay higher property taxes, sales taxes, health care and the costs of just about everything else. And mostly they know they are rapidly being priced out of their lifestyle, and their homes, and figuring they’ll be working well into their 70s just to keep from falling into poverty.

These people hate President Obama. They don’t care if the stock market has soared during his presidency – they don’t own stocks (and if they do in a 401K or similar program they don’t care because it does them no good today). They don’t care that he’s created more jobs than anyone since Reagan or Roosevelt, because they see their jobs gone, and they blame him if their recent college graduate doesn’t have a well-paying job. They don’t care if America is closing in on universal health care, because all they see is that health care is becoming ever more expensive – and often beyond their ability to pay. For them, their personal America is not as good as they expected it to be – and they are very, very angry.  And the President is a very identifiable symbol they can blame.

Creative Destruction, and disruptive innovations, are great for the winners. But they can be wildly painful to the losers. And when the disruptive innovations are as big, and frequent, as what’s happened the last 30 years – globalized economy, nationwide and international super banks, outsourcing, offshoring and the entirety of the Internet of Things – it has left a lot of people really concerned about their future. As they see the top 1% live opulent lifestyles, they struggle to keep a 12 year old car running and pay the higher license plate fees. They really don’t care if the economy is growing, or the dollar is strong, or if unemployment is at near-record lows. They feel they are on the losing end of the stick. For them, well, America really isn’t all that great anymore.

So, hungry for revenge, they are happy to kill the goose for dinner that laid the golden eggs. They will take what they can, right now, and they don’t care if the costs are astronomical. They will let tomorrow sort out itself, in a bit of hyper-ignorance to evaluate the likely outcome of their own actions.

Despite their hard times, does this not sound at the least petty, and short-sighted? Doesn’t it seem rather selfish to damn everyone just because your situation isn’t so good? Is it really in the interest of your fellow man to create bad outcomes just because you’ve not done well?

Like The Best Tech Companies, Publicis Launches A Great Strategic Pivot

Like The Best Tech Companies, Publicis Launches A Great Strategic Pivot

People like to discuss “strategic pivots” in tech companies.  The term refers to changing a company’s strategy dramatically in reaction to market shifts. Like when Apple pivoted in 2000 from being the Mac company to its focus on mobile, which lead to the iPod, iPhone, and other mobile products.  But everyone needs to know how to pivot, and some of the most important pivots haven’t even been in tech.

Take for example Netflix.  Netflix won the war in video distribution, annihilating Blockbuster.  But then, when it seemed Netflix owned video distribution, CEO Reed Hastings pivoted from distribution to streaming.  He cut investment in distribution assets, and raised prices.  Then he spent the money learning how to become a tech company that could lead the world in streaming services.  It was a big bet that cannibalized the old business in order to position Netflix for future success.

Analysts hated the idea, and the stock price sank.  But CEO Hastings was proven right.  By investing heavily in the next wave of technology and market growth Netflix soared toward far greater success than had it kept spending money in lower cost distribution of cassettes and DVDs.

(From L to R) Philippe Dauman, US actress and singer Selena Gomez, MTV President Stephen Friedman and US director Jon Chu attend a Viacom seminar during the 59th International Festival of Creativity – Cannes Lions 2012, on June 21, 2012 in Cannes, southeastern France. The Cannes Lions International Advertising Festival, running from June 17 to 23, is a world’s meeting place for professionals in the communications industry.  (VALERY HACHE/AFP/GettyImages)

This week Arthur Sadoun, the CEO of the world’s third largest advertising agency (Publicis) announced he was betting on a strategic pivot.  And most in the industry questioned if he made a good decision.

Simply put, CEO Sadoun announced at the largest ad agency awards conference, the Cannes International Festival of Creativity, that Publicis would no longer participate in Cannes.  Nor would it participate in several other conferences including the very large South by Southwest (SXSW) and Consumer Electronics Show (CES.)  Instead, he would save those costs to invest in AR (artificial or augmented reality.)

In an industry long dominated by highly creative people who love mixing with other agency folks and clients, this was an enormous shock.  These conferences were where award winners marketed their creative capability, showing off how much they were admired by peers.  And they wined and dined clients seeking to build on awards to gain new business.  No one would expect any major agency to drop out, and most especially not an agency as large as Publicis.

In changing markets strategic pivots make sense.

And strategically this pivot makes a lot of sense.  The ad industry was once dominated by ads placed in newspaper, magazines and on TV.  But today print journalism is almost dead.  The demand for print ads is a fraction of 20 years ago.  And TV is no longer as prevalent as before.  Today, people spend more time looking at their smartphone than they do their TV.  The days of thinking high creativity would lead to high sales are in the past.  Fewer and fewer big advertisers care about who wins awards, and fewer are going to these conferences to decide who they would like to hire.

Today advertising is going “programmatic.”  Increasingly ads are placed by computers, on web and mobile sites.  Advertising is about finding the right eyeballs, at the right time, next to the right content in order to find a buyer.  Advertisers no longer spend money lavishly on mass media hoping for good results.  Instead ads are targeted, measured for response and evaluated for ROI based on media, location, user and a raft of other metrics.

And the industry has changed.  There still is an advertising agency business.  But it is under attack from tech companies like Google, Facebook, Twitter and Snap that promote to advertisers their ability to target the right clients for high returns on money spent.  The content is important, but today almost everyone in the industry will tell you success depends on your budget and how you spend it, not the creative.  And that is a lot more about understanding how we’re all interconnected, knowing how to measure device usage, profiling user behavior and programming the computers to put those ads in the right place, at the right time.

To pivot you must stop doing the old to start doing the new

Publicis has something like $10B in revenue.  Thus, dropping $20M on filing award applications at events like Cannes, and sending a contingent of employees to receive awards, meet people and have fun doesn’t sound like a lot.  But multiple that across the year and the total amount could well come to $100M-$200M.  That’s still only 2% of revenues – at most.  It would seem like not that much money given what has been a core part of historical marketing.

But, if Publicis is to compete in the future with the tech leaders, and emerging digital-oriented agencies, it has to develop technology that will make it a leader.  Publicis can’t invent money out of thin air, so it has to stop doing something to create the funds for investing in what’s coming next.  And stopping investing in something as “old school” as Cannes actually sounds really smart.  As boomer ad execs retire the newer generation is not going to conventions to find agencies, they are looking under the hood at the technology engines these companies provide.

In new strategic areas a little money can go a long way

And while $100M to $200M may not sound like a lot, it is enough money to make a difference in creating a tech team that can work on future-oriented technology like AI.  If spent wisely, that could truly move the needle.  If Publicis could demonstrate an ability to use proprietary AI technology to better place ads and manage the budget for higher returns it can survive, and perhaps thrive, in a digitally dominated ad industry future.  At the very least it can find its place next to Facebook and Google.

WPP, Omnicom and Interpublic should take serious notice.  Will they succeed in 2025 if they keep marketing the way they did in 1985?  Will this spending grow revenues if customers really don’t care about creative awards?  Will they remain relevant if  they lack their own technology to develop ads, campaigns and demonstrate positive rates of return on ad dollars spent?

CEO Sadoun’s approach to make the announcement without a lot of preliminary employee discussion shocked a lot of folks.  And it shocked the festival owners who now have to wonder what the future of their business will be.  But strategic pivots are shocking.  They demonstrate a dramatic shift in how resources are deployed to position a company for the future, rather than simply trying to defend and extend the past.

It’s a lot smarter to try what you don’t know than hope everything will stay the same.

Will this work?  There is no way to know if the Publicis leadership team can maneuver through the technology maze toward something great.  But, at least they are trying.  And that alone gives them a lot better shot at longevity than if they simply decided to do in 2018 what  they have always done.  Is your company ready to reassess its preparation for the future and address your strategy like you’re a tech company?  Are you spending money on market shifts, or simply doing the same thing you’ve always done?

The 9 Reasons Why Amazon Buying Whole Foods Is A Good Idea

The 9 Reasons Why Amazon Buying Whole Foods Is A Good Idea

Whole Food flagship store in Austin, Texas.

Amazon announced it was paying $13.7B to buy Whole Foods.  While not without risks, there are a lot of reasons this is a great idea:

1 – It makes Amazon a national grocery competitor overnight

Building any retail chain takes a long time.  Due to the intensity of competition, and low margins, building a grocery chain takes even longer.  Amazon would have spent decades trying to create its own chain.  Now it won’t lose all that time, and it won’t give competitors more time to figure out their strategies.

2- Now Amazon can get the necessary “deal dollars” to compete in groceries

Few people realize that no grocer makes money selling groceries. Revenues do not cover the costs of inventory, buildings and labor. On its own, selling groceries loses money.  Grocers survive on manufacturer “deal dollars.”

Companies like P&G, Nabisco, etc. pay grocers slotting fees to obtain shelf space, they pay premiums for eye level shelves and end caps, they pay new product fees to have grocers stock new items, they pay inventory fees to have grocers keep inventory on shelf and in back, they pay advertising fees to have signs in the stores and products in circulars, and they pay volume rebates for meeting, and exceeding, volume goals.  It is these manufacturer “deal dollars” that cover the losses on the store operations and create a profit for investors.

One reason Whole Foods prices are so high is they stock less of the mass market goods and thus receive fewer deal dollars.  Now Amazon can use Whole Foods to increase its volume in all products and dramatically increase its deal dollar inflow.  Something that Amazon sorely missed as a “delivery only” grocer.

3 – Amazon obtains a grocery distribution system

Grocery distribution is unique.  For decades grocers have worked with manufacturers, cooperatives, growers and other suppliers to create the shortest, most efficient distribution of food with the lowest inventory. In many instances replenishment quantities are shipped based on manufacturer access to real grocer sales data. Amazon is the best at what it does, but to compete in groceries it needed a grocery distribution system – and with Whole Foods it obtains one at scale without having to create it.

Additionally Amazon will obtain the corporate infrastructure of a grocer, without having to build one on its own.  All those buyers, merchandisers, real estate professionals, local ad buyers, etc. are there and ready to execute – something building would be very hard to do.

4 – Amazon obtains great locations

Whole Foods has 460 stores, and almost all are in great locations. Whole Foods focused on upscale, growing and often urban or suburban locations – all great for Amazon to grow its distribution footprint.  And hard sites to find.

These can be used to sell other products, such as other grocery items, or some selection of Amazon products if that makes sense.  Or these can be used to augment Amazon’s distribution system for local delivery – or as neighborhood drop-off locations for people who don’t want at-home delivery to pick up Amazon-purchased products. Or they can be sold/leased at very attractive prices.

5 – Amazon can change the Whole Foods brand in important, positive ways

“Whole Paycheck” has long been the knock on Whole Foods.  As mentioned before, the lack of mass market items meant their products lacked deal dollars and thus had to be priced higher. And their stores are large, and not the best use of space. The result has been a lot of trouble keeping customers, and one of the lowest sales per square foot in the grocery industry.

Amazon can easily use its low-price position to alter the Whole Foods brand concept to include things like Pepsi, Coke, Bounty, Gain – a slew of branded consumer goods previously eschewed by Whole Foods.  Adding these products could make the stores more useful to more customers, and greatly lower the average cost of a cart full of goods.  On its own, this brand transition has been impossible for Whole Foods.  As part of Amazon remaking the brand will be vastly easier.

6 – Amazon can personalize grocery shopping like it did general merchandise

If you shopped Amazon you know they really figure out your needs, and help you find what you want.  Amazon keeps track of your searches and purchases, and makes recommendations that often help the shopping experience and delight us as customers.

But today all that information on grocery shopping is un-mined.  Despite using a loyalty card, traditional grocers (and WalMart) have been unable to actually mine that information for better marketing. Now Whole Foods will be able to use Amazon’s incredible technology skills, including big data mining and artificial (or augmented) intelligence to actually help us make the grocery shopping experience better – less time intensive, and most likely less costly while still allowing us to fill our carts with what we need and what makes us happy.

7 – The deal is cheap

$13.7B is only 65% of the cash Amazon had on hand end of last quarter.  And Amazon has only $7.7B in long-term debt.  With a $460B market cap Amazon could easily take on more debt without adding significant financial risk.

But even more important, Amazon has the amazingly cheap currency that is Amazon stock.  Even at the offering price, Whole Foods trades at 34x earnings.  Amazon trades at 185x earnings.  Thus by swapping Amazon shares for Whole Foods shares Amazon lowers the price 80%!  Amazon isn’t spending real dollars, it is using its stock – which is an incredibly valuable move for its shareholders.

8 – This is a serious attack on WalMart

For the last several years WalMart’s general merchandise sales have been declining due to the Amazon Effect and growing on-line competitor sales.  For the last 3 years overall revenues have not grown at all.  To maintain revenue Walmart has shifted increasingly to groceries – which account for well over half of all WalMart revenues. By purchasing Whole Foods, Amazon takes direct aim at the only part of WalMart’s “core” business that it has not attacked.

Walmart’s net profit before taxes is ~4%. If Amazon can use Whole Foods to combine stores and on-line sales to take just 3% of WalMart’s grocery business away it could remove from Walmart ($485B revenues * 60% grocery * 3% market share loss) a net revenue decline of ~$9B.  Given that the cost of grocery goods sold is about 50% – that would mean a net loss in contribution of $4.5B – which would cut almost 25% out of Amazon’s $20B pre-tax income.  Raise the share taken to 5% and Amazon could cut WalMart’s pre-tax income by $7.25B, or ~35%.

The negative impact of declining store sales on the fixed costs of WalMart is atrocious. Even small revenue drops mean cutting staff, cutting inventory, cutting store size and eventually closing stores.  Look at how fast Sears and Kmart fell apart when sales started declining.  Like dominoes falling, declining sales sets off a series of bad events that dooms almost all retailers – as the quickened pace of retail bankruptcy filings has proven.

9 – This could be a huge win for Amazon shareholders

The above analysis, taking 3-5% out of Walmart’s grocery sales, say over 3 years, would be a huge gain attributed to the creation of a new Whole Foods combined with Amazon’s e-commerce.  Growing grocery revenues by $9-$14B would mean practically a doubling of Whole Foods.  Which sounds enormous – and most likely impossible for Whole Foods to do on its own, even if it did launch some kind of e-commerce initiative.

But this is not so unlikely given Amazon’s track record.  Amazon has been growing at over 25%/year, adding between $20-$25B of new revenues annually. In 3 years between 2013 and 2016 Amazon doubled its revenues.  So it is not that unlikely to expect Amazon puts forward an extremely ambitious push to turn around Whole Foods, increase store sales and use the combined entities to grow delivery sales of groceries and other general merchandise.

Is there risk in this acquisition?  Of course.  Combining any two companies is fraught with peril – combining IT systems, distribution systems, customer systems and cultures leaves enormous opportunities for missteps and disaster.  But the upsides are enormous.  Overall, this is a bet Amazon investors should be glad leadership is making – and it is a great benefit for Whole Foods investors.

As Immelt Leaves GE, Investors And Employees Have Little To Cheer

As Immelt Leaves GE, Investors And Employees Have Little To Cheer

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.

Why the ‘Amazon Effect’ Is So Huge In The USA, And Not In Other Countries

Why the ‘Amazon Effect’ Is So Huge In The USA, And Not In Other Countries

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.

The Amazon logo is displayed at the Nasdaq MarketSite, in New York’s Times Square, Tuesday, May 30, 2017. Online retail giant Amazon.com traded above $1,000 a share for the first time. (AP Photo/Richard Drew)

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.

Retail space of various countries adjusted for population

Chart courtesy of Felix Richter, Statista.com https://www.statista.com/chart/9454/retail-space-per-1000-people/

Retail space of various countries adjusted for population

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.