Innovation – Why Bezos Succeeded, While Lampert Failed at Sears

Innovation – Why Bezos Succeeded, While Lampert Failed at Sears

Last week Sears announced sales and earnings.  And once again, the news was all bad.  The stock closed at a record, all time low.  One chart pretty much sums up the story, as investors are now realizing bankruptcy is the most likely outcome.

Chart Source: Yahoo Finance 5/13/16

Chart Source: Yahoo Finance 5/13/16

Quick Rundown:  In January, 2002 Kmart is headed for bankruptcy.  Ed Lampert, CEO of hedge fund ESL, starts buying the bonds.  He takes control of the company, makes himself Chairman, and rapidly moves through proceedings.  On May 1, 2003, KMart begins trading again.  The shares trade for just under $15 (for this column all prices are adjusted for any equity transactions, as reflected in the chart.)

Lampert quickly starts hacking away costs and closing stores.  Revenues tumble, but so do costs, and earnings rise.  By November, 2004 the stock has risen to $90.  Lampert owns 53% of Kmart, and 15% of Sears.  Lampert hires a new CEO for Kmart, and quickly announces his intention to buy all of slow growing, financially troubled Sears.

In March, 2005 Sears shareholders approve the deal.  The stock trades for $126.  Analysts praise the deal, saying Lampert has “the Midas touch” for cutting costs. Pumped by most analysts, and none moreso than Jim Cramer of “Mad Money” fame (Lampert’s former roommate,) in 2 years the stock soars to $178 by April, 2007.  So far Lampert has done nothing to create value but relentlessly cut costs via massive layoffs, big inventory reductions, delayed payments to suppliers and store closures.

Homebuilding falls off a cliff as real estate values tumble, and the Great Recession begins.  Retailers are creamed by investors, and appliance sales dependent Sears crashes to $33.76 in 18 months.  On hopes that a recovering economy will raise all boats, the stock recovers over the next 18 months to $113 by April, 2010.  But sales per store keep declining, even as the number of stores shrinks.  Revenues fall faster than costs, and the stock falls to $43.73 by January, 2013 when Lampert appoints himself CEO.  In just under 2.5 years with Lampert as CEO and Chairman the company’s sales keep falling, more stores are closed or sold, and the stock finds an all-time low of $11.13 – 25% lower than when Lampert took KMart public almost exactly 13 years ago – and 94% off its highs.

What happened?

Sears became a retailing juggernaut via innovation.  When general stores were small and often far between, and stocking inventory was precious, Sears invented mail order catalogues.  Over time almost every home in America was receiving 1, or several, catalogues every year.  They were a major source of purchases, especially by people living in non-urban communities.  Then Sears realized it could open massive stores to sell all those things in its catalogue, and the company pioneered very large, well stocked stores where customers could buy everything from clothes to tools to appliances to guns.  As malls came along, Sears was again a pioneer “anchoring” many malls and obtaining lower cost space due to the company’s ability to draw in customers for other retailers.

To help customers buy more Sears created customer installment loans. If a young couple couldn’t afford a stove for their new home they could buy it on terms, paying $10 or $15 a month, long before credit cards existed.  The more people bought on their revolving credit line, and the more they paid Sears, the more Sears increased their credit limit. Sears was the “go to” place for cash strapped consumers.  (Eventually, this became what we now call the Discover card.)

In 1930 Sears expanded the Allstate tire line to include selling auto insurance – and consumers could not only maintain their car at Sears they could insure it as well.  As its customers grew older and more wealthy, many needed help with financia advice so in 1981 Sears bought Dean Witter and made it possible for customers to figure out a retirement plan while waiting for their tires to be replaced and their car insurance to update.

To put it mildly, Sears was the most innovative retailer of all time.  Until the internet came along.  Focused on its big stores, and its breadth of products and services, Sears kept trying to sell more stuff through those stores, and to those same customers.  Internet retailing seemed insignificantly small, and unappealing.  Heck, leadership had discontinued the famous catalogues in 1993 to stop store cannibalization and push people into locations where the company could promote more products and services. Focusing on its core customers shopping in its core retail locations, Sears leadership simply ignored upstarts like Amazon.com and figured its old success formula would last forever.

But they were wrong. The traditional Sears market was niched up across big box retailers like Best Buy, clothiers like Kohls, tool stores like Home Depot, parts retailers like AutoZone, and soft goods stores like Bed, Bath & Beyond.  The original need for “one stop shopping” had been overtaken by specialty retailers with wider selection, and often better pricing.  And customers now had credit cards that worked in all stores.  Meanwhile, for those who wanted to shop for many things from home the internet had taken over where the catalogue once began.  Leaving Sears’ market “hollowed out.”  While KMart was simply overwhelmed by the vast expansion of WalMart.

What should Lampert have done?

There was no way a cost cutting strategy would save KMart or Sears.  All the trends were going against the company.  Sears was destined to keep losing customers, and sales, unless it moved onto trends.  Lampert needed to innovate.  He needed to rapidly adopt the trends.  Instead, he kept cutting costs. But revenues fell even faster, and the result was huge paper losses and an outpouring of cash.

To gain more insight, take a look at Jeff Bezos.  But rather than harp on Amazon.com’s growth, look instead at the leadership he has provided to The Washington Post since acquiring it just over 2 years ago. Mr. Bezos did not try to be a better newspaper operator.  He didn’t involve himself in editorial decisions.  Nor did he focus on how to drive more subscriptions, or sell more advertising to traditional customers.  None of those initiatives had helped any newspaper the last decade, and they wouldn’t help The Washington Post to become a more relevant, viable and profitable company.  Newspapers are a dying business, and Bezos could not change that fact.

Mr. Bezos focused on trends, and what was needed to make The Washington Post grow.  Media is under change, and that change is being created by technology.  Streaming content, live content, user generated content, 24×7 content posting (vs. deadlines,) user response tracking, readers interactivity, social media connectivity, mobile access and mobile content — these are the trends impacting media today.  So that was where he had leadership focus.  The Washington Post had to transition from a “newspaper” company to a “media and technology company.”

So Mr. Bezos pushed for hiring more engineers – a lot more engineers – to build apps and tools for readers to interact with the company.  And the use of modern media tools like headline testing.  As a result, in October, 2015 The Washington Post had more unique web visitors than the vaunted New York Times.  And its lead is growing.  And while other newspapers are cutting staff, or going out of business, the Post is adding writers, editors and engineers. In a declining newspaper market The Washington Post is growing because it is using trends to transform itself into a company readers (and advertisers) value.

CEO Lampert could have chosen to transform Sears Holdings.  But he did not.  He became a very, very active “hands on” manager.  He micro-managed costs, with no sense of important trends in retail.  He kept trying to take cash out, when he needed to invest in transformation.  He should have sold the real estate very early, sensing that retail was moving on-line.  He should have sold outdated brands under intense competitive pressure, such as Kenmore, to a segment supplier like Best Buy.  He then should have invested that money in technology.  Sears should have been a leader in shopping apps, supplier storefronts, and direct-to-customer distribution.  Focused entirely on defending Sears’ core, Lampert missed the market shift and destroyed all the value which initially existed in the great retail merger he created.

Impact?

Every company must understand critical trends, and how they will apply to their business.  Nobody can hope to succeed by just protecting the core business, as it can be made obsolete very, very quickly.  And nobody can hope to change a trend.  It is more important than ever that organizations spend far less time focused on what they did, and spend a lot more time thinking about what they need to do next.  Planning needs to shift from deep numerical analysis of the past, and a lot more in-depth discussion about technology trends and how they will impact their business in the next 1, 3 and 5 years.

Sears Holdings was a 13 year ride.  Investor hope that Lampert could cut costs enough to make Sears and KMart profitable again drove the stock very high.  But the reality that this strategy was impossible finally drove the value lower than when the journey started.  The debacle has ruined 2 companies, thousands of employees’ careers, many shopping mall operators, many suppliers, many communities, and since 2007 thousands of investor’s gains. Four years up, then 9 years down. It happened a lot faster than anyone would have imagined in 2003 or 2004.  But it did.

And it could happen to you.  Invert your strategic planning time.  Spend 80% on trends and scenario planning, and 20% on historical analysis.  It might save your business.

How Telltales Told You Not to Own Wal-Mart, and Continue To Do So

How Telltales Told You Not to Own Wal-Mart, and Continue To Do So

Wal-Mart market value took a huge drop on Wednesday.  In fact, the worst valuation decline in its history.  That decline continued on Thursday.  Since the beginning of 2015 Wal-Mart has lost 1/3 of its value.  That is an enormous ouch.

WMT stockBut, if you were surprised, you should not have been.  The telltale signs that this was going to happen have been there for years.  Like most stock market moves, this one just happened really fast.  The “herd behavior” of investors means that most people don’t move until some event happens, and then everyone moves at once carrying out the implications of a sea change in thinking about a company’s future.

All the way back in October, 2010 I wrote about “The Wal-Mart Disease.”  This is the disease of constantly focusing on improving your “core” business, while market shifts around you increasingly make that “core” less relevant, and less valuable.  In the case of Wal-Mart I pointed out that an absolute maniacal focus on retail stores and low-cost operations, in an effort to be the low price retailer, was being made obsolete by on-line retailers who had costs that are a fraction of Wal-Mart’s expensive real estate and armies of employees.

At that time WMT was about $54/share.  I recommended nobody own the stock.

In May, 2011 I reiterated this problem at Wal-Mart in a column that paralleled the retailer with software giant Microsoft, and pointed out that because of financial machinations not all earnings are equal.  I continued to say that this disease would cripple Wal-Mart.  Six months had passed, and the stock was about $55.

By February, 2012 I pointed out that the big reorganization at Wal-Mart was akin to re-arranging deck chairs on a sinking ship and said nobody should own the stock.  It was up, however, trading at $61.

At the end of April, 2012 the Wal-Mart Mexican bribery scandal made the press, and I warned investors that this was a telltale sign of a company scrambling to make its numbers – and pushing the ethical (if not legal) envelope in trying to defend and extend its worn out success formula.  The stock was $59.

Then in July, 2014 a lawsuit was filed after an overworked Wal-Mart truck driver ran into a car killing James McNair and seriously injuring comedian Tracy Morgan.  Again, I pointed out that this was a telltale sign of an organization stretching to try and make money out of a business model that was losing its ability to sustain profits.  Market shifts were making it ever harder to keep up with emerging on-line competitors, and accidents like this were visible cracks in the business model.  But the stock was now $77. Most investors focused on short-term numbers rather than the telltale signs of distress.

In January, 2015 I pointed out that retail sales were actually down 1% for December, 2014.  But Amazon.com had grown considerably.  The telltale indication of a rotting traditional retail brick-and-mortar approach was showing itself clearly.  Wal-Mart was hitting all time highs of around $87, but I reiterated my recommendation that investors escape the stock.

By July, 2015 we learned that the market cap of Amazon now exceeded that of Wal-Mart.  Traditional retail struggles were apparent on several fronts, while on-line growth remained strong.  Bigger was not better in the case of Wal-Mart vs. Amazon, because bigger blinded Wal-Mart to the absolute necessity for changing its business model.  The stock had fallen back to $72.

Now Wal-Mart is back to $60/share.  Where it was in January, 2012 and only 10% higher than when I first said to avoid the stock in 2010.  Five years up, then down the roller coaster.

From October of 2010 through January, 2015 I looked dead wrong on Wal-Mart.  And the folks who commented on my columns here at this journal and on my web site, or emailed me, were profuse in pointing out that my warnings seemed misguided.  Wal-Mart was huge, it was strong and it would dominate was the feedback.

But I kept reiterating the point that long-term investors must look beyond short-term reported sales and earnings.  Those numbers are subject to considerable manipulation by management. Further, short-term operating actions, like shorter hours, lower pay, reduced benefits, layoffs and gouging suppliers can all prop up short-term financials at the expense of recognizing the devaluation of the company’s long-term strategy.

Investors buy and hold.  They hold until they see telltale signs of a company not adjusting to market shifts.  Short-term traders will say you could have bought in 2010, or 2012, and held into 2014, and then jumped out and made a profit.  But, who really can do that with forethought?  Market timing is a fools game.  The herd will always stay too long, then run out too late.  Timers get trampled in the stampede more often than book gains.

In this week’s announcement Wal-Mart executives provided more telltale signs of their problems, and the fact that they don’t know how to fix them, and therefore won’t.

  • Wal-Mart is going to spend $20B to buy back stock in order to prop up the price.  This is the most obvious sign of a company that doesn’t know how to keep up its valuation by growing profits.
  • Wal-Mart will spend $11B on sprucing up and opening stores.  Really.  The demand for retail space has been declining at 4-6%/year for a decade, and retail business growth is all on-line, yet Wal-Mart is still massively investing in its old “core” business.
  • Wal-Mart will spend $1.1B on e-commerce.  That is the proverbial “drop in the competitors bucket.” Amazon.com alone spent $8.9B in 2014 growing its on-line business.
  • Wal-Mart admits profits will decline in the next year.  It is planning for a growth stall.  Yet, we know that statistically only 7% of companies that have a growth stall ever go on to maintain a consistent growth rate of a mere 2%.  In other words, Wal-Mart is projecting the classic “hockey stick” forecast.  And investors are to believe it?

The telltale signs of an obsolete business model have been present at Wal-Mart for years, and continue.

In 2003 Sears Holdings was  $25/share.  In 2004 Sears bought K-Mart, and the stock was $40. I said don’t go near it, as all the signs were bad and the merger was ill-conceived.  Despite revenue declines, consistent losses, a revolving door at the executive offices and no sign of any plan to transform the battered, outdated retail giant against growing on-line competition investors believed in CEO Ed Lampert and bid the stock up to $77 in early 2011. (I consistently pointed out the telltale signs of trouble and recommended selling the stock.)

By the end of 2012 it was clear Sears was irrelevant to holiday shoppers, and the stock was trading again at $40.  Now, SHLD is $25 – where it was 12 years ago when Mr. Lampert started his machinations.  Again, only a market timer could have made money in this company.  For long-term investors, the signs were all there that this was not a place to put your money if you want to have capital growth for retirement.

There will be plenty who will call Wal-Mart a “value” stock and recommend investors “buy on weakness.”  But Wal-Mart is no value.  It is becoming obsolete, irrelevant – increasingly looking like Sears.  The likelihood of Wal-Mart falling to $20 (where it was at the beginning of 1998 before it made an 18 month run to $50 more than doubling its value) is far higher than ever trading anywhere near its 2015 highs.

Bigger Is Not Always Better – Why Amazon Is Worth More than Walmart

Bigger Is Not Always Better – Why Amazon Is Worth More than Walmart

This week an important event happened on Wall Street.  The value of Amazon (~$248B) exceeded the value of Walmart (~$233B.)  Given that Walmart is world’s largest retailer, it is pretty amazing that a company launched as an on-line book seller by a former banker only 21 years ago could now exceed what has long been retailing’s juggernaut.

WalMart redefined retail.  Prior to Sam Walton’s dynasty retailing was an industry of department stores and independent retailers.  Retailing was a lot of small operators, primarily highly regional.  Most retailers specialized, and shoppers would visit several stores to obtain things they needed.

But WalMart changed that.  Sam Walton had a vision of consolidating products into larger stores, and opening these larger stores in every town across America.  He set out to create scale advantages in purchasing everything from goods for resale to materials for store construction.  And with those advantages he offered customers lower prices, to lure them away from the small retailers they formerly visited.

And customers were lured.  Today there are very few independent retailers.  WalMart has ~$488B in annual revenues.  That is more than 4 times the size of #2 in USA CostCo, or #1 in France (#3 in world) Carrefour, or #1 in Germany (#4 in world) Schwarz, or #1 in U.K. (#5 in world) Tesco.  Walmart directly employes ~.5% of the entire USA population (about 1 in every 200 people work for Walmart.)  And it is a given that nobody living in America is unaware of Walmart, and very, very few have never shopped there.

But, Walmart has stopped growing.  Since 2011, its revenues have grown unevenly, and on average less than 4%/year.  Worse, it’s profits have grown only 1%/year.  Walmart generates ~$220,000 revenue/employee, while Costco achieves ~$595,000.  Thus its need to keep wages and benefits low, and chronically hammer on suppliers for lower prices as it strives to improve margins.

140805_HO_OutAmazonAnd worse, the market is shifting away from WalMart’s huge, plentiful stores toward on-line shopping.  And this could have devastating consequences for WalMart, due to what economists call “marginal economics.”

As a retailer, Walmart spends 75 cents out of every $1 revenue on the stuff it sells (cost of goods sold.)  That leaves it a gross margin of 25 cents – or 25%.  But, all those stores, distribution centers and trucks create a huge fixed cost, representing 20% of revenue.  Thus, the net profit margin before taxes is a mere 5% (Walmart today makes about 5 cents on every $1 revenue.)

But, as sales go from brick-and-mortar to on-line, this threatens that revenue base.  At Sears, for example, revenues per store have been declining for over 4 years.  Suppose that starts to happen at Walmart; a slow decline in revenues.  If revenues drop by 10% then every $100 of revenue shrinks to $90.  And the gross margin (25%) declines to $22.50.  But those pesky store costs remain stubbornly fixed at $20.  Now profits to $2.50 – a 50% decline from what they were before.

A relatively small decline in revenue (10%) has a 5x impact on the bottom line (50% decline.) The “marginal revenue”, is that last 10%.  What the company achieves “on the margin.”  It has enormous impact on profits.  And now you know why retailers are open 7 days a week, and 18 to 24 hours per day.  They all desperately want those last few “marginal revenues” because they are what makes – or breaks – their profitability.

All those scale advantages Sam Walton created go into reverse if revenues decline.  Now the big centralized purchasing, the huge distribution centers, and all those big stores suddenly become a cost Walmart cannot avoid.  Without growing revenues, Walmart, like has happened at Sears, could go into a terrible profit tailspin.

And that is what Amazon is trying to do.  Amazon is changing the way Americans shop.  From stores to on-line.  And the key to understanding why this is deadly to Walmart and other big traditional retailers is understanding that all Amazon (and its brethren on line) need to do is chip away at a few percentage points of the market.  They don’t have to obtain half of retail.  By stealing just 5-10% they put many retailers, they ones who are weak, right out of business.  Like Radio Shack and Circuit City.  And they suck the profits out of others like Sears and Best Buy.  And they pose a serious threat to WalMart.

And Amazon is succeeding.  It has grown at almost 30%/year since 2010.  That growth has not been due to market growth, it has been created by stealing sales from traditional retailers.  And Amazon achieves $621,000 revenue per employee, while having a far less fixed cost footprint.

What the marketplace looks for is that point at which the shift to on-line is dramatic enough, when on-line retailers have enough share, that suddenly the fixed cost heavy traditional retail business model is no longer supportable.  When brick-and-mortar retailers lose just enough share that their profits start the big slide backward toward losses.  Simultaneously, the profits of on-line retailers will start to gain significant upward momentum.

And this week, the marketplace started saying that time could be quite near.  Amazon had a small profit, surprising many analysts.  It’s revenues are now almost as big as Costco, Tesco – and bigger than Target and Home Depot.  If it’s pace of growth continues, then the value which was once captured in Walmart stock will shift, along with the marketplace, to Amazon.

In May, 2010 Apple’s value eclipsed Microsoft.  Five years later, Apple is now worth double Microsoft – even though its earnings multiple (stock Price/Earnings) is only half (AAPL P/E = 14.4, MSFT = 31.)  And Apple’s revenues are double Microsoft’s.  And Apple’s revenues/employee are $2.4million, 3 times Microsoft’s $731k.

While Microsoft has about doubled in value since the valuation pinnacle transferred to Apple, investors would have done better holding Apple stock as it has more than tripled.  And, again, if the multiple equalizes between the companies (Apple’s goes up, or Microsoft’s goes down,) Apple investors will be 6 times better off than Microsoft’s.

Market shifts are a bit like earthquakes.  Lots of pressure builds up over a long time.  There are small tremors, but for the most part nobody notices much change.  The land may actually have risen or fallen a few feet, but it is not noticeable due to small changes over a long time.  But then, things pop.  And the world quickly changes.

This week investors started telling us that the time for big change could be happening very soon in retail.  And if it does, Walmart’s size will be more of a disadvantage than benefit.

How HR “best practices” Kill Innovation

How HR “best practices” Kill Innovation

Did you ever notice that Human Resource (HR) practices are designed to lock-in the past rather than grow?  A quick tour of what HR does and you quickly see they like to lock-in processes and procedures, insuring consistency but offering no hope of doing something new.  And when it comes to hiring, HR is all about finding people that are like existing employees – same school, same degrees, same industry, same background.  And HR tries its very hardest to insure conformity amongst employees to historical standard – especially regarding culture.

Several years ago I was leading an innovation workshop for leaders in a company that made nail guns, screw guns, nails and screws.  Once a market leader, sales were struggling and profits were nearly nonexistent due to the emergence of competitors from Asia.  Some of their biggest distributors were threatening to drop this company’s line altogether unless there were more concessions – which would insure losses.

They liked to call themselves a “fastener company,” which has long been the trend with companies that like to make it sound as if they do more than they actually do.

I asked the simple question “where is the growth in fasteners?”  The leaders jumped right in with sales numbers on all their major lines.  They were sure that growth was in auto-loading screwguns, and they were hard at work extending this product line.  To a person, these folks were sure they new where growth existed.

But I had prepared prior to the meeting.  There actually was much higher growth in adhesives.  Chemical attachment was more than twice the growth rate of anything in the old nail and screw business.  Even loop-and-hook fasteners [popularly referred to by the tradename Velcro(c)] was seeing much greater growth than the old-line mechanical products.

They looked at me blank-faced.  “What does that have to do with us?” the head of sales finally asked.  The CEO and everyone else nodded in agreement.

I pointed out to them they said they were in the fastener business.  Not the nail and screw business.  The nail and screw business had become a bloody fight, and it was not going to get any better.  Why not move into faster growing, less competitive products?

Competitors were making lots of battery powered and air powered tools beyond nail guns and screw guns, and their much deeper product lines gave them much higher favorability with retail merchandisers and professional tool distributors.  Plus, competitor R&D into batteries was already showing they could produce more powerful and longer-lasting tools than my client.  In a few major retailers competitors already had earned the position of “category leader” recommending the shelf space and layout for ALL competitors, giving them a distinct advantage.

This company had become myopic, and did not even realize it.  The people were so much alike that they could finish each others sentences.  They liked working together, and had built a tightly knit culture.  The HR head was very proud of his ability to keep the company so harmonious.

Only, it was about to go bankrupt.  Lacking diversity in background, they were unable to see beyond their locked-in business model.  And there sure wasn’t anyone who would “rock the boat” by admitting competitors were outflanking them, or bringing up “wild ideas”  for new markets or products.

According to the New York Times 80% of hiring is done based on “cultural fit.”  Which means we hire people we want to hang out with. Which almost always means people that are a lot like ourselves.  Regardless of what we really need in our company.  Thus companies end up looking, thinking and acting very homogenously.

It is common amongst management authors and keynote speakers to talk about creating “high-performance teams.” The vaunted Jim Collins in “Good to Great” uses the metaphor of a company as a bus.  Every company should have a “core” and every employee should be single-mindedly driving that “core.” He says that it is the role of good leaders to get everyone on the bus to “core.”  Anyone who isn’t 100% aligned – well, throw them off the bus (literally, fire them.)

We see this phenomenon in nepotism.  Where a founder, CEO or Chairperson who succeeds uses their leadership position to promote relatives into high positions.

Wal-Mart’s Board of Directors, for example, recently elected the former Chairman’s son-in-law to the position of Chairman.  He appears accomplished, but today Wal-Mart’s problem is Amazon and other on-line retail. Wal-Mart desperately needs outside thinking so it can move beyond its traditional brick-and-mortar business model, not someone who’s indoctrinated in the past.

The Reputation Institute just completed its survey of the most reputable retailers in the USA.  Top of the list was Amazon, for the third straight year.  Wal-Mart wasn’t even in the top 10, despite being the largest U.S. retailer by a considerable margin.  Wal-Mart needs someone at the top much more like Jeff Bezos than someone who comes from the family.

malcolm-forbes-publisher-diversity-the-art-of-thinking-independentlyDespite what HR often says, it is incredibly important to have high levels of diversity.  It’s the only way to avoid becoming myopic, and finding yourself with “best practices” that don’t matter as competitors overwhelm your market.

Ever wonder why so many CEOs turn to layoffs when competitors cause sales and/or profits to stall?  They are trying to preserve the business model, and everyone reporting to them is doing the same thing.  Instead of looking for creative ways to grow the business – often requiring a very different business model – everyone is stuck in roles, processes and culture tied to the old model.  As everyone talks to each other there is no “outsider” able to point out obvious problems and the need for change.

In 2011, while he was still CEO, I wrote a column titled “Why Steve Jobs Couldn’t Find a Job Today.” The premise was pretty simple. Steve Jobs was not obsessed with “cultural fit,” nor was he a person who shied away from conflict.  He obsessed about results.  But no HR person would consider a young Steve Jobs as a manager in their company.  He would be considered too much trouble.

Yet, Steve Jobs was able to take a nearly dead Macintosh company and turn it into a leader in mobile products.  Clearly, a person very talented in market sensing and identifying new solutions that fit trends.  And a person willing to move toward the trend, rather than obsess about defending and extending the past.

Quotation-W-Somerset-Maugham-trouble-men-charm-ideas-Meetville-Quotes-97641Does your organization’s HR insure you would seek out, recruit and hire Steve Jobs, or Jeff Bezos?  Or are you looking for good “cultural fit” and someone who knows “how to operate within that role.”  Do you look for those who spot and respond to trends, or those with a history related to how your industry or business has always operated?  Do you seek people who ask uncomfortable questions, and propose uncomfortable solutions – or seek people who won’t make waves?

Too many organizations suffer failure simply because they lack diversity.  They lack diversity in geographic sales, markets, products and services – and when competition shifts sales stall and they fall into a slow death spiral.

And this all starts with insufficient diversity amongst the people.  Too much “cultural fit” and not enough focus on what’s really needed to keep the organization aligned with customers in a fast-changing world. If you don’t have the right people around you, in the discussion, then you’re highly unlikely to develop the right solution for any problem.  In fact, you’re highly unlikely to even ask the right question.

Don’t Fight Trends – So Don’t Invest in Best Buy

Don’t Fight Trends – So Don’t Invest in Best Buy

Best Buy, the venerable electronics retailer, is hitting 52 week highs.  Coming off a low of $24 in April, 2014 the current price of about $40 is a 67% increase in just 10 months.  Analysts are now cheering investors to own the stock, with Marketwatch pronouncing that the last bearish analyst has thrown in the towel.

If you are a trader, perhaps you want to consider this stock.  But if you aren’t an investment professional, and you buy and hold stocks for years, then Best Buy is not a stock you should own.

eCommerce

The bullish case for owning Best Buy is based on recovering sales per store, and recovering earnings, after a reduction in the number of stores, and employees, lowered costs.  Further, with Radio Shack now in bankruptcy sales are showing an uptick as customers swing over. And that is expected to continue as Sears closes more stores on its marches toward bankruptcy.  Additionally, it is hoped that lower gasoline prices will allow consumers to spend more on electronics and appliances at Best Buy.

But, this completely ignores the trend toward on-line retail sales, and the long-term deleterious impact this trend will have on Best Buy.  According to the U.S. Census Bureau, on-line sales as a percent of all retail have grown from less than 2.4% in 2005 to over 7.6% by end of 2014 – more than tripling! But more critical to this discussion, all retail sales includes automobiles, lumber, groceries – lots of things where there is little or no online volume.

As most folks know, the number one category for online sales is computers and consumer electronics, which consistently accounts for about 20% of ALL online retail.  In fact, about 25% of all consumer electronics are sold online.  So the growth in online retail is disproportionately in the Best Buy wheelhouse.  The segment where Best Buy competes against streamlined online retailers such as NewEgg.com, ThinkGeek.com and the ever-dominant Amazon.com.

So while in the short term some traditional retail customers will now shift demand to Best Buy, this is not unlike the revenue “bounce” Best Buy received when Circuit City failed.  Short term up, but the long term trend continued hammering away at Best Buy’s core market.

This is a big deal because the marginal economic impact of this shift is horrific to Best Buy.  In traditional retail most costs are “fixed,” meaning they can’t be changed much month to month.  The cost of real estate, store maintenance, utilities and staff cannot be easily adjusted – unless there is a decision to close a gob of stores.  Thus losing even a few sales, what economists call “marginal” sales, wreaks havoc on earnings.

Back in 2010 and 2011 Best Buy made a net income (’12 and ’13 were losses) of about 2.6% – or about $2.60 on every $100 revenue.  Cost of Goods sold is about 75% of revenue.  So on $100 of revenue, $25 is available to cover fixed costs.  If revenue falls by just $10, Best Buy loses $2.50 of margin to cover fixed costs.  Remember, however, that the net income is only $2.60.  So losing 10% of revenue ($10 out of the $100) means Best Buy loses $2.50 of contribution to fixed costs, and that is deducted from net income of $2.60, leaving Best Buy with a meager 10cents of profitability.  A 10% loss of revenue wipes out 96% of profits!

Now you know why retailers who lose even a small part of their sales are suddenly closing stores right and left.

Looking forward, online retail sales are forecast to grow by another 57%, reaching 11% of total retail by 2018.  But, as we know, this is disproportionately going to be driven by consumer electronics.  Which means that while sales for Best Buy stores are up short term, long term they will plummet.  That means there will be more store closings, and layoffs as sales shrink.  And, increasingly Best Buy will have to compete head-to-head online against entrenched, leading competitors who have been stealing market share for 10+ years.

If you want to trade on the short-term uptick in revenue, and return to slight profitability, then hold your breath and see if you can outsmart the market by picking the right time, and price, for buying and selling Best Buy.  But, if you like to invest in strong companies you expect to grow for another 5 years without having to be a market timer, then avoid Best Buy.

Quite simply, it is never a good idea to bet against a long term trend.  Short term aberrations will happen, and it may look like the trend has changed.  But the trend to online commerce is picking up steam, not reducing.  If you want to invest in retail, you want to invest in those companies that demonstrate they can capture the customer’s revenue in the growing, online marketplace.