Smisek’s United Ouster – Were You Really Surprised?

Smisek’s United Ouster – Were You Really Surprised?

Jeff Smisek, CEO of United Continental Holdings, was fired this week. It appears he was making deals with public officials (specifically the Chairman of the Port Authority of New York and New Jersey) to keep personally favored flights of politicians in the air, even when unprofitable, in a quid-pro-quo exchange for government subsidies to move a taxiway and better airport transit.

Wow, horse-trading of the kind that put the governor of Illinois in the penitentiary.

United-Jeff-Smisek-FiredBut you have to ask yourself, couldn’t you see it coming?  Or are we just so used to lousy leadership that we think there’s no end to it?

United has been beset with a number of problems.  Since Mr. Smisek organized the merger of Continental (his former employer) with United, creating the world’s largest airline at the time, things have not gone well.  Since announcing the merger in 2010, more has gone wrong than right at United:

The merged airline didn’t start in a great position.  It was in 2009 that a budding musician watched United baggage handlers destroy his guitar, leading to a series of videos on bad customer service that took to the top of YouTube and iTunes and his book on the culture of customer abuse at United underscored a major PR nightmare.

How could things seem to constantly become worse?  It was clear that at the top, United’s leadership cared only about cost control (ironically code named Project Quality.) Operational efficiency was seen as the only strategy, and it did not matter how much this strategy disaffected employees, suppliers or customers.  In 2013 United ranked dead last in the quality ranking of all airlines by Wichita State University, and the airline replied by saying it really didn’t care.

The power of thinking that if you focus on pennies and nickels the quarters and dollars will take care of themselves is strong.  It encourages you be very focused on details, even myopic, and operate your business very narrowly.  And it can set you up to make really dumb mistakes, like possibly trading airline flights for construction subsidies.

Focus, focus, focus often leads to being blind, blind, blind to the world around you.

There were ample signs of all the things going wrong at United, and the need for a change. The open question is why it took a criminal investigation into bribing government officials for the airline’s Board to fire the CEO?  Bad performance apparently didn’t matter?  Do you have to be an accused lawbreaker to be shown the door?

The story broke in February, so the Board has had a few months to find a replacement CEO.  Mr. Oscar Munoz will now take the reigns.  But one has to wonder if he is up for the challenges.  As a former railroad President, his world of relationships was much smaller than the millions of customers and 84,000 employees at United.

United’s top brass has a serious need “to get over itself.”  United’s internal focus, driven by costs, has disenfranchised its brand embassadors, its customer base, and many industry analysts.

United needs to become a lot clearer about what customers really need and want. Years of overly simplistic “all customers care about is price” has commoditized United’s approach to air travel.  Customers have been smart enough to see through lower seat prices, only to be stuck with seat assignment and baggage fees raising total trip cost.  And charging for everything on the plane, including cheesy TV shows, has customers wondering just how far from Spirit Airlines’ approach United would drift before someone reminded leadership what their customers want and why they used to choose United.

Unfortunately, it is a bit unsettling that CEO Munoz said his first action will be to take 90 days “traveling the system and listening and talking to our people and working with our management team.”  Sounds like a lot more internal focus.  Spending more time talking to customers at United’s hubs, and seeing how they are treated from check-in to baggage, might do him a lot more good.

United became big via acquisition.  That is much different than building an airline, like say Southwest did.  Growth via purchase is not the same as growth via loyal customers and an attractive brand proposition.  United has clearly lost its way.  It has a lot of problems to solve, but first among them should be understanding what customers want.  Then designing the model to profitably deliver it.

Surface 3 and Apple Watch – Red Oceans v Blue Oceans

Surface 3 and Apple Watch – Red Oceans v Blue Oceans

Microsoft launched its new Surface 3 this week, and it has been gathering rave reviews.  Many analysts think its combination of a full Windows OS (not the slimmed down RT version on previous Surface tablets,) thinness and ability to operate as both a tablet and a PC make it a great product for business.  And at $499 it is cheaper than any tablet from market pioneer Apple.

Surface 3

Meanwhile Apple keeps promoting the new Apple Watch, which was debuted last month and is scheduled to release April 24.  It is a new product in a market segment (wearables) which has had very little development, and very few competitive products.  While there is a lot of hoopla, there are also a lot of skeptics who wonder why anyone would buy an Apple Watch.  And these skeptics worry Apple’s Watch risks diverting the company’s focus away from profitable tablet sales as competitors hone their offerings.

Apple Watch

Looking at these launches gives a lot of insight into how these two companies think, and the way they compete.  One clearly lives in red oceans, the other focuses on blue oceans.

Blue Ocean Strategy (Chan Kim and Renee Mauborgne) was released in 2005 by Harvard Business School Press.  It became a huge best-seller, and remains popular today.  The thesis is that most companies focus on competing against rivals for share in existing markets.  Competition intensifies, features blossom, prices decline and the marketplace loses margin as competitors rush to sell cheaper products in order to maintain share.  In this competitively intense ocean segments are niched and products are commoditized turning the water red (either the red ink of losses, or the blood of flailing competitors, choose your preferred metaphor.)

On the other hand, companies can choose to avoid this margin-eroding competitive intensity by choosing to put less energy into red oceans, and instead pioneer blue oceans – markets largely untapped by competition.  By focusing beyond existing market demands companies can identify unmet needs (needs beyond lower price or incremental product improvements) and then innovate new solutions which create far more profitable uncontested markets – blue oceans.

Obviously, the authors are not big fans of operational excellence and a focus on execution, but instead see more value for shareholders and employees from innovation and new market development.

If we look at the new Surface 3 we see what looks to be a very good product.  Certainly a product which is competitive.  The Surface 3 has great specifications, a lot of adaptability and meets many user needs – and it is available at what appears to be a favorable price when compared with iPads.

But …. it is being launched into a very, very red ocean.

The market for inexpensive personal computing devices is filled with a lot of products. Don’t forget that before we had tablets we had netbooks.  Low cost, scaled back yet very useful Microsoft-based PCs which can be purchased at prices that are less than half the cost of a Surface 3. And although Surface 3 can be used as a tablet, the number of apps is a fraction of competitive iOS and Android products – and the developer community has not yet embraced creating new apps for Windows tablets. So Surface 3 is more than a netbook, but also a lot more expensive.

Additionally, the market has Chromebooks which are low-cost devices using Google Chrome which give most of the capability users need, plus extensive internet/cloud application access at prices less than a third that of Surface 3.  In fact, amidst the Microsoft and Apple announcements Google announced it was releasing a new ChromeBit stick which could be plugged into any monitor, then work with any Bluetooth enabled keyboard and mouse, to turn your TV into a computer.  And this is expected to sell for as little as $100 – or maybe less!

ChromeBit

This is classic red ocean behavior.  The market is being fragmented into things that work as PCs, things that work as tablets (meaning run apps instead of applications,) things that deliver the functionality of one or the other but without traditional hardware, and things that are a hybrid of both.  And prices are plummeting.  Intense competition, multiple suppliers and eroding margins.

Ouch.  The “winners” in this market will undoubtedly generate sales.  But, will they make decent profits?  At low initial prices, and software that is either deeply discounted or free (Google’s cloud-based MSOffice competitive products are free, and buyers of Surface 3 receive 1 year free of MS365 Office in the cloud, as well as free upgrade to Windows 10,) it is far from obvious how profitable these products will be.

Amidst this intense competition for sales of tablets and other low-end devices, Apple seems to be completely focused on selling a product that not many people seem to want.  At least not yet.  In one of the quirkier product launch messages that’s been used, Apple is saying it developed the Apple Watch because its other innovative product line – the iPhone – “is ruining your life.

Apple is saying that its leaders have looked into the future, and they think today’s technology is going to move onto our bodies.  Become far more personal.  More interactive, more knowledgeable about its owner, and more capable of being helpful without being an interruption.  They see a future where we don’t need a keyboard, mouse or other artificial interface to connect to technology that improves our productivity.

Right.  That is easy to discount.  Apple’s leaders are betting on a vision.  Not a market.  They could be right.  Or they could be wrong.  They want us to trust them.  Meanwhile, if tablet sales falter…..  if Surface 3 and ChromeBit do steal the “low end” – or some other segment – of the tablet market…..if smartphone sales slip….. if other “forward looking” products like ApplePay and iBeacon don’t catch on……

This week we see two companies fundamentally different methods of competing.  Microsoft thinks in relation to its historical core markets, and engaging in bloody battles to win share.  Microsoft looks at existing markets – in this case tablets – and thinks about what it has to do to win sales/share at all cost.  Microsoft is a red ocean competitor.

Apple, on the other hand, pioneers new markets.  Nobody needed an iPod… folks were  happy enough with Sony Walkman and Discman.  Everybody loved their Razr phones and Blackberries… until Apple gave them an iPhone and an armload of apps.  Netbook sales were skyrocketing until iPads came along providing greater mobility and a different way of getting the job done.

Apple’s success has not been built upon defending historical markets.  Rather, it has pioneered new markets that made existing markets obsolete.  Its success has never looked obvious. Contrarily, many of its products looked quite underwhelming when launched.  Questionable.  And it has cannibalized its own products as it brought out new ones (remember when iPods were so new there was the iPod mini, iPod nano and iPod Touch? After 5 years of declining iPod sale Apple has stopped reporting them.)  Apple avoids red oceans, and prefers to develop blue ones.

Which company will be more successful in 2020?  Time will tell.  But, since 2000 Apple has gone from nearly bankrupt to the most valuable publicly traded company in the USA.  Since 1/1/2001 Microsoft has gone up 32% in valueApple has risen 8,000%.  While most of us prefer the competition in red oceans, so far Apple has demonstrated what Blue Ocean Strategy authors claimed, that it is more profitable to find blue oceans.  And they’ve shown us they can do it.

Alligators Gal

 

Why Now is the Time To Buy Tesla Stock

Why Now is the Time To Buy Tesla Stock

Crude oil has dropped 50% in just 6 months.  At under $50/barrel, gasoline is now selling for under $2/gallon in many places.  This is a price rollback to 2008 prices – something almost no one expected in early 2014.

It is easy to jump to conclusions about what this will mean for sales of some products.  And many analysts have been saying this is a terrible scenario for Tesla, which sells all electric cars.  The theory is pretty simple, and goes something like this: People buy electric cars to save on petrol costs, so when petrol prices fall their interest in electric cars decline.  With gasoline cheap again, nobody will want an electric car, so Tesla will do poorly.

But this is just an example of where common wisdom is completely wrong.  And now that Tesla has lost about 1/3 of its value, due to this popular belief, it is offering investors a tremendous buying opportunity.

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There are three big reasons we can expect Tesla to continue to do well, even if gasoline prices are low in the USA.

First, Teslas are great cars.  Not simply great electric cars.  So quickly we forget that Consumer Reports gave the Model S 99 out of a possible 100 points – the highest rating for an automobile ever.  In 2013 Motor Trend had its first ever unanimous selection of the Best Car of the Year when all the judges selected the Model S.  The Model S, and the Roadster before it, have won over customers not just because they use less petroleum – but rather because the speed, handling, acceleration, fit and detail, design and ride are considered extremely good – even when comparing with the likes of Mercedes and BMW – and when you don’t even consider it is an electric car.

It is a gross mis-assumption to say people buy Teslas because they are electric powered.  People are buying Teslas because they are great cars which are fun to drive, perform well, look stylish, have low maintenance costs and very low operating costs.  And they are more ecological in a world where people increasingly care about “going green.”  In 2015 consumers will be able to choose not only the Roadster, and the fairly pricey Model S, but soon enough the smaller, and less expensive, Model 3 which is targeted squarely at BMW Series 3 customers.  Teslas are designed to compete with all cars for consumer dollars, not just electric cars and not just on the basis of using less fuel.

Second, the market for autos is global and gasoline isn’t cheap everywhere.  Take for example Hong Kong, where gasoline still retails for $8.50/gallon (as of 31Dec. 2014.) Or in Paris or Munich where gasoline costs $5/gallon – even though the Euro’s value has shrunk to only $1.20.  Outside the USA most developed countries have a lot more demand for oil than they have production (if they have any at all.)

Almost all of these countries offer incentives for buying electric cars.  For example, in Hong Kong and Singapore the import tax on an auto can be 100-200% of the car’s price (literally double or triple the price due to import taxes.)  But in these same countries the tax is greatly reduced, or eliminated entirely, for buying an electric car for policy reasons to promote lower oil consumption and cleaner city air.  So a $100,000 Mercedes E class in Hong Kong will cost $200,000+, while a $100,000 Model S costs $100,000.

Further, outside the USA most countries heavily tax gasoline and diesel in order to discourage consumption and yield infrastructure funds.  So even as oil prices go down, gasoline prices do not decline in lock-step with oil price declines.  Consumers in these countries have a much greater demand than U.S. consumers for high mileage (and electric) cars almost regardless of crude oil prices.  So thinking that low USA gasoline prices reduces demand for electric cars is actually quite myopic.

Third, do you really think oil prices will stay low forever?  Oil is a commodity with incredible political impact.  Pricing is based on much more than “supply and demand.”  At any given time Aramco, or its lead partners such as Saudi Arabia and the UAE, can decide to simply pump more, or less fuel.  Today they are happy to pump a lot of oil because it hurts countries with which they have a bone to pick – such as Russia (now almost out of bank reserves due to low oil prices) and Iran.  And it helps USA consumers, reducing domestic interest in things like the Keystone Pipeline which could lessen long-term reliance on Aramco oil.  And investing in risky development projects like the arctic ocean.  Tomorrow these countries could decide to pump less, as they did in the mid-1970s, driving up prices and almost killing the U.S. economy.

Oil prices have a long history of instability.  Like most commodities.  That’s why a state economy like Texas, where they produce a lot of oil, could boom the last 4 years, while manufacturing states (like Wisconsin and Illinois) suffered.  With oil back under $50/barrel drilling rigs will go into mothballs, oil leases will go undeveloped, fracking projects will be stalled and the economy of oil producing states will suffer. Like happened in the mid-1980s when Saudi Arabia once again began flooding the market with oil and exploration and production companies across Texas went out of business.

Most people are smart enough to realize you look at all aspects of owning a new car.  There are a lot of reasons to buy Tesla automobiles.  Not only are they good cars, but they are changing the sales model by eliminating those undesirable auto dealers most consumers hate.  And they are offering charging stations in many locations to make refills painless.  And you don’t have to change the oil, or do quite a bit of other maintenance.  And you do less damage to the environment.  It’s not simply a matter of the price of fuel.

It is always risky to oversimplify consumer behavior.  Decisions are rarely based entirely on price. And, as Apple has shown with sales if iOS devices and Macs, people often buy more expensive products when they offer a better experience and brand.  Long term investors know that when a stock is beaten down by a short-term reaction to a short-term phenomenon (such as this fast decline in oil prices) it often creates an opportunity to buy into a company with a great future potential for growth.

Sorry Meg, Your Hockey Stick Forecast for HP Won’t Happen – Sell

If you're still an investor in Hewlett Packard you must be new to this blog.  But for those who remain optimistic, it is worth reveiwing why Ms. Whitman's forecast for HP yesterday won't happen.  There are sound reasons why the company has lost 35% of its value since she took over as CEO, over 75% since just 2010 – and over $90B of value from its peak. 

HP was dying before Whitman arrived

I recall my father pointing to a large elm tree when I was a boy and saying "that tree will be dead in under 2 years, we might as well cut it down now."  "But it's huge, and has leaves" I said. "It doesn't look dead."  "It's not dead yet, but the environmental wind damage has cost it too many branches,  the changing creek direction created standing water rotting its roots, and neighboring trees have grown taking away its sunshine.  That tree simply won't survive.  I know it's more than 3 stories tall, with a giant trunk, and you can't tell it now – but it is already dead." 

To teach me the lesson, he decided not to cut the tree.  And the following spring it barely leafed out.  By fall, it was clearly losing bark, and well into demise.  We cut it for firewood.

Such is the situation at HP.  Before she became CEO (but while she was a Director – so she doesn't escape culpability for the situation) previous leaders made bad decisions that pushed HP in the wrong direction:

  • Carly Fiorina, alone, probably killed HP with the single decision to buy Compaq and gut the HP R&D budget to implement a cost-based, generic strategy for competing in Windows-based PCs.  She sucked most of the money out of the wildly profitable printer business to subsidize the transition, and destroy any long-term HP value.
  • Mark Hurd furthered this disaster by further investing in cost-cutting to promote "scale efficiencies" and price reductions in PCs.  Instead of converting software products and data centers into profitable support products for clients shifting to software-as-a-service (SAAS) or cloud services he closed them – to "focus" on the stagnating, profit-eroding PC business.
  • His ill-conceived notion of buying EDS to compete in traditional IT services long after the market had demonstrated a major shift offshore, and declining margins, created an $8B write-off last year; almost 60% of the purchase price.  Giving HP another big, uncompetitive business unit in a lousy market.
  • His purchase of Palm for $1.2B was a ridiculous price for a business that was once an early leader, but had nothing left to offer customers (sort of like RIM today.)  HP used Palm to  bring out a Touchpad tablet, but it was so late and lacking apps that the product was recalled from retailers after only 49 days. Another write-off.
  • Leo Apotheker bought a small Enterprise Resource Planning (ERP) software company – only more than a decade after monster competitors Oracle, SAP and IBM had encircled the market.  Further, customers are now looking past ERP for alternatives to the inflexible "enterprise apps" which hinder their ability to adjust quickly in today's rapidly changing marektplace.  The ERP business is sure to shrink, not grow.

Whitman's "Turnaround Plan" simply won't work

Meg is projecting a classic "hockey stick" performance.  She plans for revenues and profits to decline for another year or two, then magically start growing again in 3  years.  There's a reason "hockey stick" projections don't happen.  They imply the company is going to get a lot better, and competitors won't.  And that's not how the world works.

Let's see, what will likely happen over the next 3 years from technology advances by industry leaders Apple, Android and others?  They aren't standing still, and there's no reason to believe HP will suddenly develop some fantastic mojo to become a new product innovator, leapfrogging them for new markets. 

  1. Meg's first action is cost cutting – to "fix" HP.  Cutting 29,000 additional jobs won't fix anything.  It just eliminates a bunch of potentially good idea generators who would like to grow the company.  When Meg says this is sure to reduce the number of products, revenues and profits in 2013 we can believe that projection fully.
  2. Adding features like scanning and copying to printers will make no difference to sales.  The proliferation of smart devices increasingly means people don't print.  Just like we don't carry newspapers or magazines, we don't want to carry memos or presentations.  The world is going digital (duh) and printing demand is not going to grow as we read things on smartphones and tablets instead of paper.
  3. HP is not going to chase the smartphone business.  Although it is growing rapidly.  Given how late HP is to market, this is probably not a bad idea.  But it begs the question of how HP plans to grow.
  4. HP is going not going to exit PCs.  Too bad.  Maybe Lenovo or Dell would pay up for this dying business.  Holding onto it will do HP no good, costing even more money when HP tries to remain competitive as sales fall and margins evaporate due to overcapacity leading to price wars.
  5. HP will launch a Windows8 tablet in January targeted at "enterprises."  Given the success of the iPad, Samsung Galaxy and Amazon Kindle products exactly how HP will differentiate for enterprise success is far from clear.  And entering the market so late, with an unproven operating system platform is betting the market on Microsoft making it a success.  That is far, far from a low-risk bet.  We could well see this new tablet about as successful as the ill-fated Touchpad.
  6. Ms. Whitman is betting HP's future (remember, 3 years from now) on "cloud" computing.  Oh boy.  That is sort of like when WalMart told us their future growth would be "China."  She did not describe what HP was going to do differently, or far superior, to unseat companies already providing a raft of successful, growing, profitable cloud services.  "Cloud" is not an untapped market, with companies like Oracle, IBM, VMWare, Salesforce.com, NetApp and EMC (not to mention Apple and Amazon) already well entrenched, investing heavily, launching new products and gathering customers.

HPs problems are far deeper than who is CEO

Ms. Whitman said that the biggest problem at HP has been executive turnover.  That is not quite right.  The problem is HP has had a string of really TERRIBLE CEOs that have moved the company in the wrong direction, invested horribly in outdated strategies, ignored market shifts and assumed that size alone would keep HP successful.  In a bygone era all of them – from Carly Fiorina to Mark Hurd to Leo Apotheker – would have been flogged in the Palo Alto public center then placed in stocks so employees (former and current) could hurl fruit and vegetables, or shout obscenities, at them!

Unfortately, Ms. Whitman is sure to join this ignominious list.  Her hockey stick projection will not occur; cannot given her strategy. 

HP's only hope is to sell the PC business, radically de-invest in printers and move rapidly into entirely new markets.  Like Steve Jobs did a dozen years ago when he cut Mac spending to invest in mobile technologies and transform Apple.  Meg's faith in operational improvement, commitment to existing "enterprise" markets and Microsoft technology assures HP, and its investors, a decidedly unpleasant future.