Sayonara Sony – How Industrial, MBA Management Killed a Great Company

Who can forget what a great company Sony was, and the enormous impact it had on our lives?  With its heritage, it is hard to believe that Sony hasn't made a profit in 4 consecutive years, just recently announced it will double its expected loss for this year to $6.4 billion, has only 15% of its capital left as equity (debt/equity ration of 5.67x) and is only worth 1/4 of its value 10 years ago!

After World War II Sony was the company that took the transistor technology invented by Texas Instruments (TI) and made the popular, soon to become ubiquitous, transistor radio.  Under co-founder Akio Morita Sony kept looking for advances in technology, and its leadership spent countless hours innovatively thinking about how to apply these advances to improve lives.  With a passion for creating new markets, Sony was an early creator, and dominator, of what we now call "consumer electronics:"

  • Sony improved solid state transistor radios until they surpassed the quality of tubes, making good quality sound available very reliably, and inexpensively
  • Sony developed the solid state television, replacing tubes to make TVs more reliable, better working and use less energy
  • Sony developed the Triniton television tube, which dramatically improved the quality of color (yes Virginia, once TV was all in black & white) and enticed an entire generation to switch.  Sony also expanded the size of Trinitron to make larger sets that better fit larger homes.
  • Sony was an early developer of videotape technology, pioneering the market with Betamax before losing a battle with JVC to be the standard (yes Virginia, we once watched movies on tape)
  • Sony pioneered the development of camcorders, for the first time turning parents – and everyone – into home movie creators
  • Sony pioneered the development of independent mobile entertainment by creating the Walkman, which allowed – for the first time – people to take their own recorded music with them, via cassette tapes
  • Sony pioneered the development of compact discs for music, and developed the Walkman CD for portable use
  • Sony gave us the Playstation, which went far beyond Nintendo in creating the products that excited users and made "home gaming" a market.

Very few companies could ever boast a string of such successful products.  Stories about Sony management meetings revealed a company where executives spent 85% of their time on technology, products and new applications/markets, 10% on human resource issues and 5% on finance.  To Mr. Morita financial results were just that – results – of doing a good job developing new products and markets.  If Sony did the first part right, the results would be good.  And they were.

By the middle 1980s, America was panicked over the absolute domination of companies like Sony in product manufacturing.  Not only consumer electronics, but automobiles, motorcycles, kitchen electronics and a growing number of markets.  Politicians referred to Japanese competitors, like the wildly successful Sony, as "Japan Inc." – and discussed how the powerful Japanese Ministry of Trade and Industry (MITI) effectively shuttled resources around to "beat" American manufacturers.  Even as rising petroleum costs seemed to cripple U.S. companies, Japanese manufacturers were able to turn innovations (often American) into very successful low-cost products growing sales and profits.

So what went wrong for Sony?

Firstly was the national obsession with industrial economics.  W. Edward Deming in 1950s Japan institutionalized manufacturing quality and optimization.  Using a combination of process improvements and arithmetic, Deming convinced Japanese leaders to focus, focus, focus on making things better, faster and cheaper.  Taking advantage of Japanese post war dependence on foreign capital, and foreign markets, this U.S. citizen directed Japanese industry into an obsession with industrialization as practiced in the 1940s — and was credited for creating the rapid massive military equipment build-up that allowed the U.S. to defeat Japan.

Unfortunately, this narrow obsession left Japanese business leaders, buy and large, with little skill set for developing and implementing R&D, or innovation, in any other area.  As time passed, Sony fell victim to developing products for manufacturing, rather than pioneering new markets

The Vaio, as good as it was, had little technology for which Sony could take credit.  Sony ended up in a cost/price/manufacturing war with Dell, HP, Lenovo and others to make cheap PCs – rather than exciting products.  Sony's evolved a distinctly Industrial strategy, focused on manufacturing and volume, rather than trying to develop uniquely new products that were head-and-shoulders better than competitors.

In mobile phones Sony hooked up with, and eventually acquired, Ericsson.  Again, no new technology or effort to make a wildly superior mobile device (like Apple did.)  Instead Sony sought to build volume in order to manufacture more phones and compete on price/features/functions against Nokia, Motorola and Samsung.  Lacking any product or technology advantage, Samsung clobbered Sony's Industrial strategy with lower cost via non-Japanese manufacturing.

When Sony updated its competition in home movies by introducing Blue Ray, the strategy was again an Industrial one – about how to sell Blue Ray recorders and players.  Sony didn't sell the Blue Ray software technology in hopes people would use it.  Instead it kept it proprietary so only Sony could make and sell Blue Ray products (hardware).  Just as it did in MP3, creating a proprietary version usable only on Sony devices.  In an information economy, this approach didn't fly with consumers, and Blue Ray was a money loser largely irrelevant to the market – as is the now-gone Sony MP3 product line.

We see this across practically all the Sony businesses.  In televisions, for example, Sony has lost the technological advantage it had with Trinitron cathode ray tubes.  In flat screens Sony has applied a predictable, but money losing Industrial strategy trying to compete on volume and cost.  Up against competitors sourcing from lower cost labor, and capital, countries Sony has now lost over $10B over the last 8 years in televisions.  Yet, Sony won't give up and intends to stay with its Industrial strategy even as it loses more money.

Why did Sony's management go along with this?  As mentioned, Akio Morita was an innovator and new market creator.  But, Mr. Morita lived through WWII, and developed his business approach before Deming.  Under Mr. Morita, Sony used the industrial knowledge Deming and his American peers offered to make Sony's products highly competitive against older technologies.  The products led, with industrial-era tactics used to lower cost. 

But after Mr. Morita other leaders were trained, like American-minted MBAs, to implement Industrial strategies.  Their minds put products, and new markets, second.  First was a commitment to volume and production – regardless of the products or the technology.  The fundamental belief was that if you had enough volume, and you cut costs low enough, you would eventually succeed.

By 2005 Sony reached the pinnacle of this strategic approach by installing a non-Japanese to run the company.  Sir Howard Stringer made his fame running Sony's American business, where he exemplified Industrial strategy by cutting 9,000 of 30,000 U.S. jobs (almost a full third.) To Mr. Stringer, strategy was not about innovation, technology, products or new markets.  

Mr. Stringer's Industrial strategy was to be obsessive about costs. Where Mr. Morita's meetings were 85% about innovation and market application, Mr. Stringer brought a "modern" MBA approach to the Sony business, where numbers – especially financial projections – came first.  The leadership, and management, at Sony became a model of MBA training post-1960.  Focus on a narrow product set to increase volume, eschew costly development of new technologies in favor of seeking high-volume manufacturing of someone else's technology, reduce product introductions in order to extend product life, tooling amortization and run lengths, and constantly look for new ways to cut costs.  Be zealous about cost cutting, and reward it in meetings and with bonuses.

Thus, during his brief tenure running Sony Mr. Stringer will not be known for new products.  Rather, he will be remembered for initiating 2 waves of layoffs in what was historically a lifetime employment company (and country.)  And now, in a nod to Chairman Stringer the new CEO at Sony has indicated he will  react to ongoing losses by – you guessed it – another round of layoffs.  This time it is estimated to be another 10,000 workers, or 6% of the employment.  The new CEO, Mr. Hirai, trained at the hand of Mr. Stringer, demonstrates as he announces ever greater losses that Sony hopes to – somehow – save its way to prosperity with an Industrial strategy.

Japanese equity laws are very different that the USA.  Companies often have much higher debt levels.  And companies can even operate with negative equity values – which would be technical bankruptcy almost everywhere else.  So it is not likely Sony will fill bankruptcy any time soon. 

But should you invest in Sony?  After 4 years of losses, and entrenched Industrial strategy with MBA-style leadership focused on "numbers" rather than markets, there is no reason to think the trajectory of sales or profits will change any time soon. 

As an employee, facing ongoing layoffs why would you wish to work at Sony?  A "me too" product strategy with little technical innovation that puts all attention on cost reduction would not be a fun place.  And offers little promotional growth. 

And for suppliers, it is assured that each and every meeting will be about how to lower price – over, and over, and over.

Every company today can learn from the Sony experience.  Sony was once a company to watch. It was an innovative leader, that pioneered new markets.  Not unlike Apple today.  But with its Industrial strategy and MBA numbers- focused leadership it is now time to say, sayonara.  Sell Sony, there are more interesting companies to watch and more profitable places to invest.

Drop 2011 Dogs for 2012’s Stars – Avoid Kodak, Sears, Nokia, RIMM, HP, Sony – Buy Apple, Amazon, Google, Netflix

The S&P 500 ended 2011 almost exactly where it started.  If ever there was a year when being invested in the right companies, and selling the dogs, mattered for higher portfolio returns it was 2011.  The good news is that many of the 2011 dogs were easy to spot, and easy to sell before ruining your portfolio. 

There were many bad performers.  However, there was a common theme.  Most simply did not adjust to market shifts.  Environmental changes, from technology to regulations, made them less competitive thus producing declining returns as newer competitors benefitted.  Additionally, these companies chose – often over the course of several years – to eschew innovation and new product launches.  They chose to keep investing in efforts to defend and extend historical, but troubled, businesses rather than innovate toward a more successful future.

Looking at the trends that put these companies into trouble we can recognize the need to continue avoiding these companies, even though many analysts are starting to say they may be "value stocks." Instead we can invest in the trends by buying companies likely to grow and increase portfolio returns in 2012.

Avoid Kodak – Buy Apple or Google

Few companies are as iconic as Eastman Kodak, inventor of amateur photography and creator of the star product in the hit 1973 Paul Simon song "Kodachrome." However, it was clear in the late 1980s that digital cameras were going to change photography.  Kodak itself was one of the primary inventors of the core technology, but licensed it to others in order to generate cash it invested trying to defend and extend photographic film and paper sales.  In my 2008 book "Create Marketplace Disruption" I highlighted Kodak as a company so locked-in to film sales that it was unwilling to even consider moving into new markets.

In 2011 EK lost almost all its value, falling from $3.85 share to about 60 cents.  The whole company is now worth only $175M as it rapidly moves toward NYSE delisting and bankruptcy, and complete failure.  The trend that doomed EK has been 2 decades in the making, yet like an ocean freighter collision management simply let momentum kill the company.  The long slide has gone on for years, and will not reverse.  If you want to invest in photography your best plays are smart phone suppliers Apple, and Google for not only the Android software but the Chrome apps that are being used to photoshop images right inside browser windows.

Avoid Sears – Buy Amazon

When hedge fund manager Ed Lampert took over KMart by buying their bonds in bankruptcy, then used that platform to buy Sears back in 2006 the Wall Street folks hailed him as a genius. "Mad Money" Jim Cramer said "Fast Eddie" Lampert was his former college roommate, and that was all he needed to recommend buying the stock.  On the strength of such spurrious recommendations, Sears Holdings initially did quite well.

However, I was quoted in The Chicago Tribune the day of the Sears acquisition announcement saying the merged company was doomed – because the trends were clear.  Wal-Mart was in pitched battle with Target to "own" the discount market which had crushed KMart.  Sears was pinched by them on the low end, and by better operators of vertically focused companies such as Kohl's for clothing, Best Buy for appliances and Home Depot for repair and landscape tools.  Sears was swimming against the trends, and Ed Lampert had no plans to re-invent the company.  What lay ahead was cost-cutting and store closings which would kill both brands in a market already overly saturated with traditional brick-and-mortar retailers as long-term more sales moved on-line.

Now Sears Holdings has gone full circle.  In the last 12 months the stock has dropped from $95 to $31.50 – a decline of more than two thirds (a loss of over $7B in investor value.)  Sears and KMart have no future, nor do the Craftsman or Kenmore brands.  After Christmas management announced a new round of store closings as same stores sales continues its never-ending slide, and finally most industry analysts are saying Sears has nowhere to go but down. 

The retail future belongs to Amazon.com – which is where you should invest if you want to grow portfolio value in 2012.  Look to Kindle Fire and other tablets to accelerate the retail movement on-line, while out-of-date Sears becomes even less relevant and of lower value.

Stay out of Nokia and Research in Motion – Buy Apple

On February 15 I wrote that Nokia had made a horrible CEO selection, and was a stock to avoid.  Nokia invesors lost about $18B of value in 2001 as the stock lost  50% of its market cap in 2011 (62% peak to trough.) May 20 I pounded the table to sell RIMM, which lost nearly 80% of its investor value in 2011 – nearly $60B! 

Both companies simply missed the market shift in smart phones.  Nokia did its best Motorola imitation, which missed the shift from analog to digital cell phones – and then completely missed the shift to smart phones – driving the company to near bankruptcy and acquisition by Google for its patent library.  With no game at all, the Nokia Board hired a former Microsoft executive to arrange a shotgun wedding for launching a new platform – 3 years too late.  Now Apple and Android have over 400,000 apps each, growing weekly, while Microsoft is struggling with 50k apps, no compelling reason to switch and struggles to build a developer network.  Nokia's road to oblivion appears clear.

RIM was first to the smartphone market, and had it locked up for years.  Unfortunately, top management and many investors felt that the huge installed base of corporate accounts, using Blackberry secure servers, would protect the company from competition.  Now the New York Times has reported RIM leadership as one of the worst in 2011, because an installed base is no longer the competitive entry barrier Michael Porter waxed about in the early 1980s.  Corporations are following their users to better productivty by moving fast as possible to the iOS and Android worlds. 

RIM's doomed effort to launch an ill-devised, weakly performing tablet against the Apple iPod juggernaut only served to embarrass the company, at great expense.  At this point, there's little reason to think RIM will do any better than Palm did when the technology shifted, and anyone holding RIMM will likely end up with nothing (as did holders of PALM.)  If you want to be in mobile your best pick is market leading and profitably growing Apple, with a second position in Google as it builds up ancillary products like Chrome to leverage its growing Android base.

 Avoid HP and Sony – Buy Apple

Speaking of Palm, to paraphrase Senator Dirkson "that billion here, a billion there" that added up to some real money lost for HP.  Mark Hurd consolidated HP into a company focused on building volume largely in other people's technology – otherwise known as PCs.  As printing declines, and people shift to tablets and cloud apps, HP has less and less ability to build its profit base. The trends were all going in the wrong direction as market shifts make HP less and less relevant to consumer and corporate customers. 

Selecting Mr. Apotheker was a disastrous choice, and I called for investors to dump the stock when he was hired in January.  An ERP executive, he was firmly planted in the technology of the 1990s.  With a diminished R&D, and an atrophied new product development organization HP is nothing like the organization of its founders, and the newest CEO has offered no clear path for finding the trends and re-igniting growth at HP.  If you want to grow in what we used to call the PC business you need to be in tablets now – and that gets you back, once again, to Apple first, and Google second.

Which opens the door for discussing what in the 1960s through 1980s was the most innovative of all consumer electronics companies, Sony.  But when Mr. Morita was replaced by an MBA CEO that began focusing the company on the bottom line, instead of new gadgets, the pipeline rapidly dried.  Acquisitions, such as a music label, replaced R&D and new product development.  Allegiance to protecting the CD and DVD business, and the players Sony made – along with traditional TVs and PCs – meant Sony missed the wave to MP3, to mobile digital entertainment devices, to DVRs and the emerging market for interactive TV.  What was once a leader is now a follower. 

As a result Sony has lost $4.5B in investor value the last 3 year, and in 2011 lost half its value falling from $37 to $18/share.  As Apple emerges as the top consumer electronics technology leader and profit creator, closely chased by Google, it is unlikely Sony will ever recover that lost value. 

Buying Apple, Amazon, Google and Netflix

This column has already made the case for Apple.  It is almost incomprehensible how far a lead Apple has over its competition, causing investors to fear for its revenue growth prospects.  As a result, the companies P/E multiple is a remarkably low single-digit number, even though its growth is well into the double digits!  But its existing position in growth markets, technology leadership and well oiled new product development capability nearly assures continued profitbale growth for at least 5 years.  Even though the stock, which I recommended as my number 1 buy in January, 2011, has risen some 30% maintaining a big position is remains an investors best portfolio enhancer.

Amazon was a wild ride in 2011, and today is worth almost the same as it was one year ago.  Given that the company is now larger, has a more dominant position in publishing and is the world leader on the trend to on-line retail it is a very good stock to own.  The choice to think long-term and build its user links through sales of Kindle Fire at cost has limited short-term profits, but every action Amazon has taken to grow has paid off handsomely because they accelerate the natural trends and position Amazon as the leader.  Remaining with the trends, and the growth, offers the potential for big payoff this year and for years to come.

Google remains #2 in most markets, but remains aligned with the trends.  It was disappointing that the company cancelled so many great products in 2011 – such as Gear and Wave. And it faces stiff competition in its historical ad markets from the shift toward social media and Facebook's emergence.  However, Google is the best positioned company to displace Microsoft on all those tablets out there with its Chrome apps, and it still is a competitor with the potential for long-term value creation.  It's just hard to be as excited about Google as Apple and Amazon. 

Netflix started 2011 great, but then stumbled.  Starting the year at $190, Netflix rose to $305 before falling to $75.  Investors have seen an 80% decline from the peak, and a 60% decline from beginning of the year.  But this was notably not because company revenues or profits fell, because they didn't.  Rather concerns about price changes and long-term competition caused the stock to drop.  And that's why I remain bullish for owning Netflix in 2012.

Growth can hide a multitude of sins, as I pointed out when making the case to buy in October.  And Netflix has done a spectacular job of preparing itself to transition from physical DVDs to video downloads.  The "game" is not over, and there is a lot of content warring left.  But Netflix was first, and has the largest user base.  Techcrunch recently reported on a Citi survey that found Netflix still has nearly twice the viewership of #2 Hulu (27% vs. 15%.) 

Those who worry about Amazon, Google or Apple taking the Netflix position forget that those companies are making huge bets to compete in other markets and have shown less interest in making the big investments to compete on the content that is critical in the download market.  AOL and Yahoo are also bound up trying to define new strategies, and look unlikely to ever be the content companies they once were.

For those who are banking on competitive war with Comcast and other cable companies to kill off Netflix look no further than how they define themselves (cable operators,) and their horrific customer relationship scores to realize that they are more interested in trying to preserve their old business than rapidly enter a new one.  Perhaps one will try to buy Netflix, but they don't have the management teams or organization to compete effectively.

The fact is that Netflix still has the best strategy for its market, which is still growing exponentially, has the best pricing and is rapidly growing its content to remain in the top position.  That makes it a likely pick for "turnaround of the year" by end of 2012 (at least in the tech/media industry) – even as investments rise over the next 12 months.