Do you remember when Merck (chart here) got clobbered? Merck was a high-flying pharmaceutical company, but in 2004 we heard that one of its "blockbuster" products, Vioxx, which was for arthritis relief, was causing heart attacks. The stock dropped more than 50%. But then, over the next couple of years, the stock slowly recovered. And a year ago the company took a nearly $500M accounting charge related to the Vioxx problems. But today, Merck announced it was profitable again and shareholders should feel better (see article here).
I think most investors can see through this. The huge write off last year was a classic financial machination designed to create profits this year – regardless of the real results. The company essentially "pulled forward" the accounting for a wide range of costs into a single quarter in order to keep those costs from appearing in future quarters. Thus, the current quarter is without those costs – making it a "slam dunk" to beat the previous results.
Merck's leaders would like investors to believe the company is profitable, thus a safe investment. But reality is that Merck missed the biologics business just as Pfizer did. It's blockbuster products are off or coming off patent, and despite enormous R&D expenditures there aren't any replacements at hand. Sales of highly promoted products (Zetia, Vytorin and Gardasil) are down 16% to 26%. Profits, highly manipulated by accounting rules, do not tell the story of a company that is badly stuck in the Swamp trying to do what it has always done – but producing declining results. Merck hit a growth stall, and like 93% of companies falling into this trap there is no sign the company will grow even at a consistent 2% again.
On the other hand, Amazon (see chart here) shows much smarter management sense. The New York Times reported early in 2009 that book sales last year fell 8% (article here). If Amazon had acted like Merck, it would be announcing a big write-off, and resturcturing, to deal with the horrible decline in book sales! But the decline in the old product (books) doesn't mean people don't have a thirst for information (just like people don't have a desire for better disease management in Merck's market). Google searches and articles read on the internet have skyrocketed. Increasingly, it appears people simply don't want to pay for a printed book. The want to read things on on their computer, or phone, or listen to them on the treadmill while working out or commuting. The demand is still there, but the format or medium is changing.
And that is where Amazon appears to be doing something very special. After launching the digital Kindle book reader in December, 2007, it appears the company may have sold upwards of 500,000 units in 2008 (read article here). According to the article, that would be 32% more units than iPod sold in its first year! Apparently, Kindle units sold out in both holiday seasons.
This is an example of a company creating a growth strategy in what appears to be a declining market. Amazon could remain stuck in the world of traditional books. And, Kindle is probably just a technology footnote on the road to more advanced and popular digital reading (or listening). But Kindle is in the market, and in pretty big numbers. If a small company had launched Kindle to those kinds of numbers, it would be a NASDAQ darling!! Amazon is in the market, learning, selling and making money. If the market keeps transitioning, Amazon is well positioned to succeed.
Smart management teams don't ride their business model too long. They launch new solutions before the demand is clear, and before the solution is clear. Before profits go to heck, and financial machinations become the norm, they make changes trying to get back into the Rapids. The set up White Space with new projects to learn, and regain growth. Merck leaders could take a lesson from Amazon – and quickly get into the solutions that will drive growth in the next 10 years.