More of the same – problems – Dell Downgrade

Dell had a tough day Thursday when J.P.Morgan downgraded the stock to the equivalent of a sell (read article here).  The stock continues its relentless slide – despite the return of Mr. Dell as CEO (chart here).  Some quotes:

  • "Our downgrade … focuses squarely on the potential that Dell's PC exposure..could force the company to seek revenue offsets"  interpretation – revenues should go down
  • "looking for revenue from other sources, Dell could face new costst and competition that could destabilize margins and cause the company to dip into its cash reserves."  interpretation – entering new markets isn't free, and new competitors will make the road tough so expect Dell to go cash negative

  • "Dell gets around 60% of its total revenue from PC sales, which is an example of how exposed the company is to a market that is widely expected to shrink this year…PC unit shiptmets to fall this year by 13.5% from 2008" interpretation – this is primarily a one product company and that product is not going to grow

  • "the enterprise replacement cycle … could be deferred to next year … Dell will be hard-pressed to maintain its profit margins this year as the company faces more-entrenched consumer-market competitors in Acer and Hewlett-Packard" interpretation – Dell sells mostly to companies, who are not replacing PCs, and in the consumer market Dell will find tough sledding competing with Acer and HP

  • "Dell is on track with its plan to cut $3billion in costs by 2011" interpretation – Dell is cutting costs, not growing revenue

To steal from an old Kentucky Fried Chicken ad "Dell did one thing, and did it right."  Dell's Success Formula worked really well, and the company grew fantastically well as it improved execution while the corporate PC market was growingBut the market shifted.  Dell had not developed any White Space to enter new markets, so it was unprepared to keep growing.  When revenue growth slackened, the company did not Disrupt its Success Formula, but instead kept trying to do more, better, faster, cheaper.  And lacking revenue growth opportunities, the company is slashing costs in its effort to Defend its bottom line and old business model.  And all that has resulted in another downgrade – and a company worth a lot less than it was worth before.  Just as you would expect for a company that fell out of the Rapids and into the Swamp.

The source of dysfunctional Lock-in — GM

In 1993 Pulitzer Prize winning author David Halberstam wrote a book about the 1950s – called appropriately "The Fifties".  He takes time in this book to talk about GM – a company today that has seen its leadership embarrassed, and its value for investors disintegrate in the face of mounting competition.  It's humiliated executives have asked Congress for a bailout to save the employees and customers from total failure – because they seem unable to figure out a solution themselves.  Read what Mr. Halberstam, a New York Times reporter, had to say about GM's rise to prominence:

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"No one at GM could ever have dared forecast so much prosperity over such a long period of time.  It was a brilliant moment, unparalleled in American corporate history.  Success begat success… The postware economic boom may have benefited many Americans, but no one benefited more than General Motors.  The average car, which had cost $1,270 at the beginning of the decade, had risen to $1,822 by the end of it…twice as fast as the rest of the wholesale cost index.

There was in all of this success for General Motors a certain arrogance of power.  This was not only an institution apart; it was so big, so rich, and so powerful that it was regarded in the collective psyche of the nation as something more than a mere corporation:  It was like a nation unto itself, a seperate entity, with laws and a culture all its own.

The men who ran the corporation, almost without exception, came from small towns in America… Everything about them reflected their confidence tht they had achieved virtually all there was to achieve in life.  Others, critics, outside Detroit, might believe that these men were not such giants and might believe that they did not so much create that vast postwar economic wave as they had the good fortune to ride it… As for the intellectuals, if they wanted to drive small foreign cars, live in small houses, and make small salaries, why even bother to argue with them?

As success of the company grew, its informal rules gradually became codified.  The culture was first and foremost hierarchical:  An enterprising young executive tended to take all signals, share all attitudes and prejudices of the men above him, as his wife tended to play the sports and card games favored by the boss's wife, to emulate how she dressed and even to serve the same foods for dinner.

The essential goodness of the corporation was never questioned.  It as regarded as, of all the many places to work, the best, because it was the biggest, the most respected, made the most money and, very quietly, through bonuses and stock, rewarded its top people the most handsomely."

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If this was the world of GM, codified as Mr. Halberstam explains, it becomes easier to understand the behavior of GM in the 1960s, 1970s, 1980s and 1990s - as competitors kept chipping away at market share and power.  From 50% share of all automobiles sold in the 1950s, GM's share is now only half that.  Executives, managers and even union employees quickly came to believe (in the late 40's and 50's)the future would always be like the past.  But Toyota, Honda, Nissan, Subaru, Kia and others didn't accept GM's claim to a monarchy.  And now, everyone is paying for it.

Lock-in is built when companies are doing well.  And Lock-in keeps the organization from changing.  It is easy to belittle challenges, and blame poor performance on others.  As competitors evolve, at times making big improvements, the Locked-in organization will explain away poor performance – but resist accepting the need to change.  In the end, if we don't learn how to Disrupt the Lock-in and use White Space to become more competitive we all end up in the Whirlpool.  Even GM.

Adam Hartung Quoted in Investor’s Business Daily

You never know when interviewed exactly what the writer is looking for, what the article is, or how your comments will be used.  But I was delighted to be interviewed by the acclaimed weekly newspaper Investor's Business Daily a couple of weeks ago.  (The article can be found on Yahoo! business here.)

"Get Through It With Grit – by Sonja Carberry

Pust the envelope.  Adam Hartung, author of "Create Marketplace Disruption," points out that winning companies aren't afraid to shake things up, especially during a downcycle.  He said Cisco — instead of aiming to sell more products — has the "Disruptive" goal of making its offerings obsolete by creating new solutions.  "This kind of approach keeps you from riding the tail (of a trend) too long."

Tap rabble-rousers.  Hartung cited Apple's CEO as a prime example.  "Steve Jobs is a very dsruptive kind of guy," Hartung said.  So much so, Apple and Jobs parted ways in 1985.  When Jobs was coaxed back to Apple 15 years later, he championed such out-there ideas as the now-mainstream iPod."

What's great in this article is some information from the Managing Director of one of the world's top management consulting companies, Bain & Company.  Steve Ellis divulged from a recent Bain study that 24% more firms rose from the bottom to the top of their industries during the 2001 receission than the following sunnier economic period. 

What great support for the fact that when markets shift the opportunity is created for changing competitive position.  Those companies that build detailed future scenarios, obsess about competitors, Disrupt their internal Lock-ins and implement White Space can come out big winners during market shifts.  So if you're a leader, now's a good time to be more Steve Jobs like and not fear Disruption.  It's time to push your company to the top by taking advantage of competitor Lock-ins!!

Check your assumptions

(Read the following quote in Forbes, October 5, 1998, written by Peter Drucker) “As we advance deeper into the knowledge economy, the basic assumptions underlying much of what is taught and practiced in the name of management are hopelessly out of date… most of our assumptions about business, technology and organization are at least 50 years old.  They have outlived their time… Get the assumptions wrong and everything that follows from them is wrong.”

Last week, former Reserve Board Chairman Alan Greenspan admitted to Congress that his assumptions about financial services and the products being offered, including credit default swaps (CDS), were wrong (read article here).  As a result, what he thought would happen in the financial markets – from interest rates to equity prices to currency values – turned out to be wrong.  Unfortunately, this helped create the opportunity for runaway leverage and the banking meltdown which has affected world trade since early September.  When leaders operate with wrong assumptions, the price paid by everyone can be pretty hefty.

The reality is that pretty much all leaders work with assumptions about business that are very country specific.  The impact of global knowledge transfer – of worldwide information at a moment’s notice – of labor arbitrate happening in hours – and the immediacy of financing and financial reactions – is still not well understood by leaders trained in an earlier era.  Thus leaders under-recognized the speed with which manufacturing jobs could move around the world – as well as the speed with which IT services could move to lower cost markets.  Even though the current Federal Reserve Chairman (Dr. Bernanke) is a student of America’s Great Depression, what he doesn’t understand is that Depression happened in an isolated way to the USA.  Today, globalization means that problems with U.S. banks becomes a problem globally.  For all his studies of history – things in financial services have fundamentally shifted.  His assumptions are, well, often wrong.

In November there will be an economic summit.  Some are referring to it as the next “Bretton Woods” – a reference to the meeting in upstate New York which determined how foreign currency exchange rates would be set and how banks would interact between countries (read about the summit here).  Yet, there are others who say no changes are needed.  But let’s get real.  Of course we need to rethink how our country-based banking system works in a world where insurance companies and hedge funds often move faster and have more ability to affect markets than traditional banks.  In the 1800s banks in the USA issued their own currency – and then states issued their own currency.  Eventually this disappeared to federal currency.  So, do we now need a global currency?  With the change to the Euro in Eurpope the need for individual country currencies took a step toward unnecessary.  Should that trend continue?  You see, it’s easy to think about the world using old assumptions – like a U.S. dollar as independent of other countries – but does it make sense in a world where products and services are supplied globally and governments (such as India and China notably) now manipulate their currencies to maintain price advantages?

On Friday evening a “guru” on ABC’s Nightline was talking about the wild swings on the New York Stock Exchange and the NASDAQ.  He commented “the only way to get hurt on a roller coaster is to get off.  So hold onto your equities and keep buying.”  Give me a break.  A roller coaster is a closed system.  Even though it goes up and down, you know where it will end and the result.  WE DON’T KNOW THAT ABOUT EQUITIES TODAY.  Many, many companies we’ve known for decades could disappear (GM, Ford, Chrysler are prime examples).  Just like Lehman Brothers disappeared, and AIG practically so.  If you were an investor in common or preferred equities of Freddie Mac or Fannie Mae, your “roller coaster ride” did not have a happy ending – and you would obviously have been a whole lot smarter to have jumped off.  You may get bruised, but that would have been better than the disaster that loomed.

It is critically important to check assumptions.  This is not easy.  We don’t think about assumptions, they just are part of how we operate.  That’s why now, more than ever, it is incredibly important to do scenario planning which will challenge assumptions by opening our eyes to what really might happen.  Because you can never assume tomorrow will be like yesterday – not in business.  To survive you have to constantly be planning for a future that can be very, very different.  Doing more of what you always did will not produce the same results in a shifting world.  Planning for future shifts is one of the most important things managers can do.

Reducing solution options

Here’s some quotes issued today (October 9, 2008) by Merrill Lynch’s top economist, David Rosenberg (see full article here) :

"Desperate times require desperate actions and it is possible Ben Bernanke, despite his expertise in how to tap the entire toolbox of the central bank, hasn’t experimented enough… Perhaps the Fed should do something even more dramatic… To be sure, monetary policy isn’t the only answer.  A large-scale fiscal stimulus, a giant spending package on infrastructure, for example, would be useful to reverse the downtrend in employment and personal income…Our question is if the UK can manage to embark on this quasi-nationalization quest of its banking system, why can’t we?"

Here’s an economist in the largest U.S. brokerage, a very conservative organization, asking why we can’t nationalize banks, or pass a massive public works program.  And he wonders why not? 

The USA has been dominated by the conservative economic agenda since the landslide victory of Ronald Reagan.  At a time of stagflation (no growth yet high inflation and record high interest rates) President Reagan set forth an agenga which changed the economic direction.  Since then, the USA has been moving further and further along that agenda.  Spending on defense skyrocketed, entitlement programs were cut, industry regulations laxed (including the movement to self-regulate within industries), and taxes reduced.  For many people and politicians the objective became less about the results, and instead doing more.  Planks of that agenda have been extended for 25 years as the focus has become not on the results – but rather on operating within the parameters of that agenda.  Simply put, people believed if we did more, faster of the same things then the original would return.

But this isn’t 1980.  And circumstances are far different.  Nothing today looks like it did then.  Yet, most people are blinded by Lock-in to doing what previously worked, rather than experimenting and trying new things.  As serious as the market shift has been, and as great as the Challenges have become, people still have not Disrupted their awareness of the environmental shift.  They are trying to use the tools of the last war to fight this new war.  Lock-in is keeping them from considering other options.

It’s easy to be reminded of the economist John Keynes, a great influencer of the The New Deal policies of the 1930s.  As he proposed the greatest use of debt ever by a government, he was seriously challenged.  Leaders asked of him "won’t this debt inevitably lead, in the long-run, to runaway inflation and higher taxation that will cripple the economy?"  As he pondered the 20% national unemployment and accelerating bankruptcies he replied "in the long-run, we’re all dead."  What Dr. Keynes summed up was that beliefs, theories and assumptions weren’t terribly important.  What mattered were results.  The traditional economic approaches had led to the 1920s runaway market and resultant collapse – and what he felt the country needed was to put people back to work immediately.  He was ready to create some White Space to try something new in search of better results.

Similarly, in the 1970s Dr. Laffer proposed a different approach to economic thinking.  Creating something he called the "Laffer Curve" he said that if you cut taxes enough it would spur new investment and ecomomic recovery.  Although this had no experiential basis, he felt it was worth a try.  And President Reagan, facing the country’s problems proposed an idea that seemed heresy to most – cutting taxes by 50% or more!  He was ready to try White Space in the face of an economic Challenge rather than continue the practices which had not improved the economy during the prior 2 administations (Ford and Carter.)

It is very easy to Lock-in on something that works.  Once you see it work, you become confident it will work in the future.  You start thinking if you do enough of it, it has to work.  But markets shift.  The marginal value of doing more simply declines.  Like eating pie, the first piece is unbelievably good.  The second good, but by the fourth you’re not particularly interested any more.  While I can be enticed to do a job I don’t like for a piece of pie, after a few pieces I don’t see the value in more pie so I don’t have the same positive reaction.  And that is true of Success Formulas.  Competitors see the early results.  They mimic the behavior, and they work to surpass it.  Pretty soon, they offer not only pie, but cake and cookies and lots of competitive ideas.  The pie simply doesn’t produce the benefit it once did.  And we have to realize that it’s time to experiment and try something new.  To do things that may even seem heretical at the time – but which open the doors to potentially new results that get us back on the competitive track.

Listen to those who don’t love you

Ed Bronfman, Jr. is a scion of the family that used its ownership of Seagrams, and U.S. liquor prohibition, to build a fortune in Canada.  Eventually he made a very large investment in Warner Music and appointed himself CEO.  Unfortunately, his investment has not turned out as well as he would have liked due to market shifts in how people buy music.  Here’s his quote (source of quote here):

"We expected our business would remain blissfully unaffected even as the world of interactivity, constant connection and file sharing was exploding.  And of course we were wrong.  How were we wrong?  By standing still or moving at a glacial pace we inadvertently went to war wtih consumers by denying them what they wanted and could otherwise find – and as a result, of course, consumers won."

Lock-in caused Warner Music to be complacent – and ignore customers that switched to competitors.  When markets shift, standing still (doing the same thing – or Defending & Extending your old Success Formula) can cause you to become competitively less viable.

Here’s an even better quote from Bill Gates, founder of Microsoft (source of quote here):

"Your most unhappy customers are your greatest source of learning."

Listening to your biggest, and your best, customers is important, but you won’t learn much about the market.  They like your Success Formula and share your Lock-ins.  It’s the customers who complain that are telling you about changes in the marketplace.  They are telling you they will shift if they can find an alternative.  And those who outright become disloyal, who leave, are really able to tell you about market shifts and changes in competition that threaten your returns.  You might want to take your best customer golfing to keep her happy, but you should invest your resources in understanding the customers that complain, threaten to leave, cut their business or completely leave.  They can give you the market information you need to plan for a future with higher returns.

Pushing on a Rope

We all get so used to running our businesses that it is very easy to miss a significant market shift.  We may well be in the Rapids of growth and then within a very short time fall into the Swamp of stagnant revenue and lower margins.  Because we are so good at doing what we always did, our biases keep us thinking we will succeed while we ignore important signs of market shifts.  By the time we react, it can be too late.

Take music recording and sales.  For years this was a simple business.  EMI, RCA, Sony, etc. simply signed up a lot of artists who wanted contracts.  The music company spread its risk in a form of venture capital play by signing lots of bands and then needing only a few to succeed.  The artists had no way to make an album and get it distributed other than to sign a contract, often at very low initial returns, with a major studio.  It was a business that made it very easy for the large recording companies to make good money.

So we should not be surprised that when MP3 technology came along the major recording companies ignored it.  They blithely allowed Apple to set up iTunes and sell iPods while they kept right on pushing the same contracts to artists and making CDs.  What they ignored was that MP3 technology made it possible for consumers to bypass albums completely, dramatically impacting sales, and likewise artists could now bypass the recording studio by making their own songs and albums available directly to consumers across the web.  Even though this future was not hard to visualize, and plan for, the recording studios kept planning for past markets and ignored desperately needed changes given easily expected future market conditions.

Get the following statistics (all of the following information comes from Paul Grein at Chart Watch):

"The paid digital download medium scarcely existed five years ago and now it’s the biggest growth area in the music business. (It may be the only growth area in the music business.) Billboard reports that album sales in the first half of 2008 totaled 204.6 million, down slightly from 229.8 million in the first half of 2007. Digital track sales for the same period totaled 542.7 million, up substantially from 417.3 million….Just three albums topped 1 million copies in sales (CDs and digital downloads combined) in the first six months of 2008, the lowest total since Nielsen/SoundScan set up shop in 1991. Six albums sold 1 million copies in the first six months of 2007. Fully 16 albums hit the million mark in the first half of 2006. (The business hit its peak in 2001 when a whopping 37 albums reached the 1 million mark in the first 26 weeks of the year.)"

When markets shift, trying to maintain Lock-ins in the hope of making money is like pushing on a rope.  Lots of work with poor results.  When new technologies or market practices come available, we have to focus on new competitors to understand how they make money.  Likely, they will change the market in a way that diminishes the returns from old Success Formulas while making new Success Formulas more profitable.  Customers won’t tell you about new solutions, because they are buying your solution – right up until they switch and aren’t customers any more.  Focusing on customers only helps you understand and marginally improve your Locked-in old Success Formula.  You have to look at the new competitors to see what is happening in the market.  New competitors can show you that given market shifts, it’s better to pull the rope than push it. 

In today’s global and connected economy markets can shift a lot faster than they did in previous eras.  Resources and customers can shift quickly.  Old Success Formulas can become obsolete (unable to make above average returns) before we even have time to react.  If we don’t maintain a powerful focus on competitors, and generate scenarios about the future regardless of current market conditions, we will almost always be late to the changes.  And that can be deadly to sales and returns.  Just ask the people trying to generate profits by making and selling CDs today.

Misplaced optimism vs. Action

Do you have any doubt that the viability of traditional newspapers is at risk?  Every newspaper in America is printing fewer pages today than a year ago (and most fewer than 2 years ago).  Young people (meaning under 35 – if that’s really young) never got hooked on newspapers, and older readers are abandoning subscriptions, causing advertisers to abandon newspaper advertising – leaving the newspapers with big revenue shortfalls.  As ad spending on the internet keeps growing at 100%/year, and Google explodes with revenue and higher valuations as a result, is there any doubt that the typical morning newspaper will have to undergo fundamental restructuring?

Readers of this blog probably don’t have much doubt.  But read this quote from the CEO of a major Chicago newspaper – the Sun Times Media Group.  "The fallout of this forced downsizing of the nation’s newsrooms is not being replaced elsewhere in our society, nor is it likely to be.  Hence, with our most important asset, the newsroom, we will continue to have little competitionWhen the economy rebounds 12 to 18 months from now, as we believe it will, the newspapers will not only survive but somehow and in some form thrive again." (Read quote in Chicago Tribune article here.)

Give me a break.  Talk about putting your head in the sand.  Mr. Freidham is really saying "Hey, I’m Locked-in to what I’ve always done and I don’t want to change.  Just give me some time, and probably more money, and I’m sure somehow my old Success Formula will make money again.  Trust me."  Effectively, he’s saying investors should ignore all market information and simply hope, literally, that somehow they will again make money. 

That’s probably what the CEOs of Montgomery Wards, Polaroid, Fannie Mae, Brach’s Candy and Wicke’s Furniture were saying a few months before Chapter 11 wiped away their company existence. 

Meanwhile, the Huffington Post is opening an office in Chicago.  Now, traditionalists might not care about this.  But truthfully Ms. Huffington and a few of her 40-odd employees represent a new kind of competitor that is far less expensive, and makes a pretty good, competitive product.  Rather than newspaper journalists from the New York Times or Washington Post, who told us about Vietnam 40 years ago, we have Ms. Huffington and her cadre on television almost nightly.  Especially when it comes to politics, they are considered closer to the news sources than many leading newspapers, and their reporting is considerably more timely. If you want to know John McCain or Barack Obama’s next move on a vice presidential selection keep your browser on Huffington Post rather than waiting for what the Sun Times will print tomorrow.  The Huffington Post may not yet be the L.A. Times, but at a fraction of the cost they are rapidly making improvement, growing readership and advertisers, and making money in the process.

All the major newspapers could have opened web sites and become the Huffington Post.  Marketwatch.com, had no advantage over the Wall Street Journal.  But the newspaper leaders didn’t try to embrace the web and find a new Success Formula.  Instead of opening web bureaus and giving them lots of cash to figure out how to be the next CNNMoney.com they under-invested in the web environment.  They tried to make the web sites just some sort of mirror of the newspaper – without knowing how to get ad revenues for the effort.  And to this day, the major newspapers are still not internally Disrupting and opening White Space to redefine themselves on the web.  Successful web sites are not anything like newspapers – yet they distribute news rather effectively.

I like to read a newspaper.  But I don’t read every word.  I like the paper because I can scan it.  If I like the headline, I grab a few words.  If I like the article, I go online and find the article to read later digitally.  So why don’t newspapers just print the headlines, an article abstract and on-line addresses?  That’s just one idea out of probably a hundred to change how newspapers operate.  Why don’t they try them?  Because they don’t know how to make the on-line business profitable!  No major newspaper today sells on-line ads at the same time as print ads – and they don’t know how to sell on-line advertising effectively.  The publishers never Disrupted their operations, realized there is real risk in avoiding change, nor created White Space in which to learn.  Now the market shift to on-line is so far advanced they are without the resources and time to learn. 

Newspapers need to take action, and fastMisplaced optimism about the future is simply dreaming – yearning for the past to return.  There are things newspapers do well, and digging up stories is one of them.  But in a declining print readership market, they’ll lose that capability if they don’t quickly learn how to profitably monetize it.  With the Sun Times near bankruptcy due to years of mismanagement and fraud, and now Tribune Corporation sailing toward the brink due to its incredible debt load, it’s possible Chicago readers and advertisers could be without an effective local news source in just a few years! It would behoove these companies to realize the newspaper of old will never return, and pour their resources into discovering a new way to compete – Pronto!  Or we won’t have anybody left doing the hard work of journalism and it will be the consumers of news that suffer most.

Well put

After 30 years with Tribune company, the current publisher of The Chicago Tribune is leaving.  It’s his second time in the job.  Now the company is beleaguered by too much debt in the face of declining traditional readers and revenue – and without a plan to transition with market needs.  He feels  he’s changed all he can.  But as he departs, his statement was well put (read quote here):

"If there’s one thing I’ve learned in 30 years," he said, "it’s success is determined by great people far more than great plans because plans need to change, but great people change with the times."

Record Machinations

Do you remember the old Smith, Barney television ad where the professorial actor said “We make money the old fashion way.  We EARN it.”?

More executives appear to need reminding of this.  In today’s market report from Merrill Lynch (see info here, page 2) we learn that in the first quarter of 2007 the S&P 500 spent an incredible $117BILLION on share buybacks.  So much was spent buying back shares that it added from a full point to 1.5 points to EPS for the quarter!  In May and June IBM, WalMart and Home Depot announced share buyback plans of $50Billion (and keep in mind, just yesterday Home Depot announced real earnings would be down 18% this year! [see page 1 of same link]).   Conoco and Johnson & Johnson are announcing plans to buy back $25Billion of equity between them.

When businesses are growing they spend money on hiring employees, building plants and offices, traveling to see customers and making new products.  When they want to Defend & Extend their existing business they take the money out of such productive long-term uses and spend it instead on buying back their own stock.  An action which does not create a single job, nor new product, nor help the business create enhanced growth in revenue or profitability.  We have to be careful not to confuse financial machinations with real growth.