by Adam Hartung | Oct 25, 2015 | Current Affairs, Defend & Extend, Food and Drink, In the Swamp, In the Whirlpool, Leadership, Web/Tech
This week McDonald’s and Microsoft both reported earnings that were higher than analysts expected. After these surprise announcements, the equities of both companies had big jumps. But, unfortunately, both companies are in a Growth Stall and unlikely to sustain higher valuations.
McDonald’s profits rose 23%. But revenues were down 5.3%. Leadership touted a higher same store sales number, but that is completely misleading.
McDonald’s leadership has undertaken a back to basics program. This has been used to eliminate menu items and close “underperforming stores.” With fewer stores, loyal customers were forced to eat in nearby stores – something not hard to do given the proliferation of McDonald’s sites. But some customers will go to competitors. By cutting stores and products from the menu McDonald’s may lower cost, but it also lowers the available revenue capacity. This means that stores open a year or longer could increase revenue, even though total revenues are going down.
Profits can go up for a raft of reasons having nothing to do with long-term growth and sustainability. Changing accounting for depreciation, inventory, real estate holdings, revenue recognition, new product launches, product cancellations, marketing investments — the list is endless. Further, charges in a previous quarter (or previous year) could have brought forward costs into an earlier report, making the comparative quarter look worse while making the current quarter look better.
Confusing? That’s why accounting changes are often called “financial machinations.” Lots of moving numbers around, but not necessarily indicating the direction of the business.
McDonald’s asked its “core” customers what they wanted, and based on their responses began offering all-day breakfast. Interpretation – because they can’t attract new customers, McDonald’s wants to obtain more revenue from existing customers by selling them more of an existing product; specifically breakfast items later in the day.
Sounds smart, but in reality McDonald’s is admitting it is not finding new ways to grow its customer base, or sales. The old products weren’t bringing in new customers, and new products weren’t either. As customer counts are declining, leadership is trying to pull more money out of its declining “core.” This can work short-term, but not long-term. Long-term growth requires expanding the sales base with new products and new customers.
Perhaps there is future value in spinning off McDonald’s real estate holdings in a REIT. At best this would be a one-time value improvement for investors, at the cost of another long-term revenue stream. (Sort of like Chicago selling all its future parking meter revenues for a one-time payment to bail out its bankrupt school system.) But if we look at the Sears Holdings REIT spin-off, which ostensibly was going to create enormous value for investors, we can see there were serious limits on the effectiveness of that tactic as well.
MIcrosoft also beat analysts quarterly earnings estimate. But it’s profits were up a mere 2%. And revenues declined 12% versus a year ago – proving its Growth Stall continues as well. Although leadership trumpeted an increase in cloud-based revenue, that was only an 8% improvement and obviously not enough to offset significant weakness in other markets:
It is a struggle to see the good news here. Office 365 revenues were up, but they are cannibalizing traditional Office revenues – and not fast enough to replace customers being lost to competitive products like Google OfficeSuite, etc.
Azure sales were up, but not fast enough to replace declining Windows sales. Further, Azure competes with Amazon AWS, which had remarkable results in the latest quarter. After adding 530 new features, AWS sales increased 15% vs. the previous quarter, and 78% versus the previous year. Margins also increased from 21.4% to 25% over the last year. Azure is in a growth market, but it faces very stiff competition from market leader Amazon.
We build our companies, jobs and lives around successful products and services. We want these providers to succeed because it makes our lives much easier. We don’t like to hear about large market leaders losing their strength, because it signals potentially difficult change. We want these companies to improve, and we will clutch at any sign of improvement.
As investors we behave similarly. We were told large companies have vast customer bases, strong asset bases, well known brands, high switching costs, deep pockets – all things Michael Porter told us in the 1980s created “moats” protecting the business, keeping it protected from market shifts that could hurt sales and profits. As investors we want to believe that even though the giant company may slip, it won’t fall. Time and size is on its side we choose to believe, so we should simply “hang on” and “ride it out.” In the future, the company will do better and value will rise.
As a result we see that Growth Stall companies show a common valuation pattern. After achieving high valuation, their equity value stagnates. Then, hopes for a turn-around and recovery to new growth is stimulated by a few pieces of good news and the value jumps again. Only after a few years the short-term tactics are used up and the underlying business weakness is fully exposed. Then value crumbles, frequently faster than remaining investors anticipated.
McDonald’s valuation rose from $62/share in 2008 to reach record $100/share highs in 2011. But valuation then stagnated. It is only this last jump that has caused it to reach new highs. But realize, this is on a smaller number of stores, fewer products and declining revenues. These are not factors justifying sustainable value improvement.
Microsoft traded around $25/share from March, 2003 through November, 2011 – 8.5 years. When the CEO was changed value jumped to $48/share by October, 2014. After dipping, now, a year later Microsoft stock is again reaching that previous valuation ($50/share). Microsoft is now valued where it was in December, 2002 (which is half its all-time high.)
The jump in value of McDonald’s and Microsoft happened on short-term news regarding beating analysts earnings expectations for one quarter. The underlying businesses, however, are still suffering declining revenue. They remain in Growth Stalls, and the odds are overwhelming that their values will decline, rather than continue increasing.
by Adam Hartung | Apr 15, 2014 | Current Affairs, In the Rapids, Leadership, Transparency
Zebra Technologies is a company most people don’t recognize. Yet, I bet every product you buy has the product on which they specialize.
Since 1982 Zebra has been the leader in bar code printers and readers. Zebra was a pioneer in the application of bar codes for tracking pallets through warehouses, items used in a manufacturing line, shipment tracking and other uses for manufacturing and supply chain management. As the market leader Zebra Technologies developed its own software (ZPL) for printing barcodes, and made robust printing and reading machines that were the benchmark for rugged, heavy duty applications at companies from Caterpillar, to UPS and FedEx, to WalMart.
Although the company dabbled in RFID technology for product tracking, and is considered a leader in that market, the new technology really never “took off” due to higher costs compared with the boring, but effective and remarkably cheap, bar code. So Zebra plodded away making ever better, smaller, cheaper, faster bar code printers. It may not have been exciting, like the nondescript headquarters in far-suburban Chicago, but it met the market needs. Zebra was an excellent operational company that was delivering on its focus.
Even if it was, well …… boring.
But, like all markets, the bar code market began shifting. Generic software companies, like Microsoft, produced drivers that would work from a cheap PC to allow
cheap generic printers, like those from HP, to print bar codes. These were cheap enough to be considered disposable. Not a good thing for the better, but more expensive, market leader. Competitive, non-proprietary software and hardware leads to lower prices and margin compression. It’s a differentiation stealer.
Worse, lots of customers stopped caring much about bar codes altogether. Zebra’s customers realized bar codes were everywhere. Nothing new was really happening. When it came to delivering on the promise of really efficient, accurate and low cost supply chain management the bar code had a place. But no longer an exciting one. When your product is boring discussions with customers easily slip toward price rather than new products. And when you’re talking about price, and how to keep existing business, relevancy is at risk. You become a target for a new competitor to come along and steal your thunder (and profits) by relegating your product to generic-doom while taking the high rode of delivering more value by changing the game.
So hand it to Zebra’s leadership team that they observed the risk of staying focused on their status quo, and took action to change the game themselves. Today Zebra announced it is buying the enterprise device business of Motorola. And this is a big bet. At a price of $3.5B, Zebra is spending an amount nearly equal to its existing net worth. And it is borrowing $3.25B – almost the whole cost – greatly increasing the company’s debt ratios. That is a gutsy move.
Yet, in this one move Zebra will nearly triple its revenues.
This decision is not without risk. The acquired Motorola business has seen declining revenues – like a $500M decline in the last year (roughly 25%.) With many products built on Microsoft software, customers have been shifting to other solutions. Exactly how the old technologies will integrate with new ones in the Motorola lines is not clear. And even less clear is how a combined company will bring together old-line printer/scanners using proprietary software with the diverse, and honestly pricey, products that Motorola enterprise has been selling, to offer more competitive solutions.
Yet, investors should be encouraged. Doing nothing would spell disaster for Zebra. It is a company that needs to re-invent itself for today’s pressing business needs — which have little in common with the top needs 30 years ago (or even 10 years ago.) In October, Zebra launched Zatar, a Web-based software that allows companies to deploy and manage devices and sensors connected to the Internet. In December Zebra purchased a company (Hart) for its cloud-based software to manage inventory. Now Zebra is looking to use these integration tools to bring together all kinds of devices the new company will manufacture to help companies achieve an entirely new level of efficiency and capability in today’s real-time manufacturing and logistics world.
We should admire CEO Anders Gustaffson’s leadership team for recommending such bold action. And the company’s Chairman and Board for approving it. Of course “there’s many a slip twixt the cup and the lip,” but at least Zebra’s investors, employees, suppliers and customers can now see that Zebra is really holding a viable cup, and that it is putting together a serious effort to provide better delivery to buyers lips.
This is a play to grow the company by following the trend to “the internet of things” with new solutions that are potential game changers. And there’s no way you can win unless you’re in the game. With these acquisitions, there is no doubt that what was mostly a manufacturing company – Zebra – is now “in the game” for doing new things with new technologies.
This does beg some questions: What is your company doing to be a game changer? Are you resting on the laurels of strong historical sales – and maybe a strong historical market position? Do you recognize that your market is shifting, and it is undercutting historical strengths? Are you relying on operational excellence, while new technologies are threatening your obsolescence?
Or — are you thinking like the leaders at Zebra Technologies and taking bold action to be the industry game-changing leader, even if it means stretching your financials, your management team and the technology?
Most of us would rather be in the former, than the latter, I think.
by Adam Hartung | Aug 23, 2013 | In the Swamp, Leadership, Software, Web/Tech
Steve Ballmer announced he would be retiring as CEO of Microsoft within the next 12 months. This extended timing, rather than immediately, shows clear the Board is ready for him to go but there is nobody ready to replace him.
The big question is, who would want Ballmer's job? It will be very tough to make Microsoft an industry leader again. What would his replacement propose to do? The fuse for a turnaround is short, and the options faint.
Microsoft has been on a downhill trajectory for at least 4 years. Although the company has introduced innovations in gaming (xBox and Kinect) as well as on-line (games and Bing), those divisions perpetually lose money. Stiff competitors Sony, Nintendo and Google have made these forays intellectually interesting, but of no value for investors or customers. The end-game for Microsoft has remained Windows – and as PC sales decline that's very bad news.
Microsoft viability has been firmly tied to Windows and Office sales. Historically these have been unassailable products, creating over 100% of the profits at Microsoft (covering losses in other divisions.) But, these products have lost growth, and relevancy. Windows 8 and Office 365 are product nobody really cares about, while they keep looking for updates from Apple, Google, Amazon and Samsung.
The market started going mobile 10 years ago. As Apple and Google promoted increased mobility, Microsoft tried to defend & extend its PC stronghold. It was a classic business inflection point in the making. Everyone knew at some point mobile devices would be more important than PCs. But most industry insiders (including Microsoft) kept thinking it would be later rather than sooner.
They were wrong. The shift came a lot faster than expected. Like in sailboat racing, suddenly the wind was taken out of Microsoft's sails as competitors shot to the lead in customer interest. While people were excited for new smartphones and tablets, Microsoft tried to re-engineer its historical product as an extension into the new market.
Windows 8 tablets and Surface tablets were ill-fated from the beginning. They did not appeal to the huge installed base of Windows customers, because changes like touch screens and tiles simply were too expensive and too behaviorally different. And they offered no advantage for people to switch that had already started buying iOS and Android products. Not to mention an app availability about 10% of the market leaders. Simply put, investing in Windows 8 and its own tablet was like adding bricks to a downhill runaway truck (end-of-life for PCs) – it sped up the time to an inevitable crash.
And spending money on poorly thought out investments like the Barnes & Noble Nook merely demonstrated Microsoft had money to burn, rather than a strategy for competing. Skype cost some $8B, but how has that helped Microsoft become more competive? It's not just an overspending on internal projects that failed to achieve any market success, but a series of wasted investments in bad acquisitions that showed Microsoft had no idea how it was going to regain industry leadership in a changing marketplace going more mobile and into the cloud every month.
Now the situation is pretty dire, and now is the time for Microsoft to give up on its defend and extend strategy for Windows/Office. Customers are openly uninterested in new laptops running Windows 8. And Win 8.1 will not change this lackadaisical attitude. Nobody is interested in Windows 8 phones, or tablets. This has left companies in the Microsoft ecosystem like HP, Dell and Nokia gasping for air as sales tumble, profits evaporate and customers flock to new solutions from Apple and Samsung. Instead of seeking out an update to Office for a new PC, people are using much lighter (and cheaper) cloud services from Amazon and office solutions like Google docs. And most of those old add-on product sales, like printers and servers, are disappearing into the cloud and mobile displays.
So now, after being forced to write off Surface and report a horrible quarter, the Board has pushed Ballmer out the door. Pretty remarkable. But, incredibly late. Just like the leaders at RIM stayed too long, leaving the company with no future options as Blackberry sales plummeted, Ballmer is taking leave as sales, profits and cash flow are taking a turn for the worst. And only months after a reorganization that simply made the whole situation a lot more confusing for not only investors, but internal managers and employees.
Microsoft has a big cash hoard, but how long will that last? As its distribution system falters, and sales drop, the costs will rapidly catch up with cash flow. Big layoffs are a certainty; think half the workforce in 2 years. Equally certain are sales of divisions (who can buy xBox market share and turn it competitively profitable?) or shut-downs (how long will Bing stay alive when it is utterly unnecessary and expensive to maintain?)
But, there is a better option. Without the cash from
Windows/Office, you can't keep much of the rest of Microsoft walking. So
now is the time to cut investments in Windows/Office and put money into the
best things Microsoft has going – primarily Kinect and cloud services. A radical restructuring of its spending and investments.
Kinect is an incredible product. It has found multiple applications Microsoft fails to capitalize upon. Kinect has the possibility of becoming the centerpiece for managing how we connect to data, how we store data, how we find data. It can bring together our smartphone, tablet and historical laptop worlds – and possibly even connect this to traditional TV and radio. It can be the centerpiece for two-way communications (think telephone or skype via all your devices.) Coupled with the right hardware, it can leapfrog iTV (which we still are waiting to see) and Cisco simultaneously.
In cloud services it will take a lot to compete with leaders Amazon, IBM, Apple and Google. They have made big investments, and are far in front. But, this is the bread-and-butter market for Microsoft. Millions of small businesses that want easy to use BYOD (bring your own device) environment, and easy access to data, documents and functionality for IT, like guaranteed data back-up and uptime, and user functionality like all those apps. These customers have relied on Microsoft for these kind of services for years, and would enjoy a services provider with an off-the-shelf product they can implement easily and cheaply that supports all their needs. Expensive to develop, but a growing market where Microsoft has a chance to leapfrog competitors.
As for Bing, give it to Yahoo – if Marissa Mayer will take it. Stop the bloodletting and get out of a market where Microsoft has never succeeded. Bing is core to Yahoo's business. If you can trade for some Yahoo stock, go for it. Let Yahoo figure out how to sell content and ads, while Microsoft refocuses on the new platform for 2017; from the user to the infrastructure services.
Strong leaders have their benefits. But, when they don't understand market shifts, and spend far too long trying to defend & extend past markets, they can put their organizations in terrible jeopardy of total failure. Ballmer leaves no with clear replacement, nor with any vision in place for leapfrogging competitors and revitalizing Microsoft.
So it is imperative the new leader provide this kind of new thinking. There are trends developing that create future scenarios where Microsoft can once again be a market leader. And it will be the role of the new CEO to identify that vision and point Microsoft's investments in the right direction to regain viability by changing the game on the current winners.
