by Adam Hartung | Feb 3, 2009 | Uncategorized
Do you remember when Merck (chart here) got clobbered? Merck was a high-flying pharmaceutical company, but in 2004 we heard that one of its "blockbuster" products, Vioxx, which was for arthritis relief, was causing heart attacks. The stock dropped more than 50%. But then, over the next couple of years, the stock slowly recovered. And a year ago the company took a nearly $500M accounting charge related to the Vioxx problems. But today, Merck announced it was profitable again and shareholders should feel better (see article here).
I think most investors can see through this. The huge write off last year was a classic financial machination designed to create profits this year – regardless of the real results. The company essentially "pulled forward" the accounting for a wide range of costs into a single quarter in order to keep those costs from appearing in future quarters. Thus, the current quarter is without those costs – making it a "slam dunk" to beat the previous results.
Merck's leaders would like investors to believe the company is profitable, thus a safe investment. But reality is that Merck missed the biologics business just as Pfizer did. It's blockbuster products are off or coming off patent, and despite enormous R&D expenditures there aren't any replacements at hand. Sales of highly promoted products (Zetia, Vytorin and Gardasil) are down 16% to 26%. Profits, highly manipulated by accounting rules, do not tell the story of a company that is badly stuck in the Swamp trying to do what it has always done – but producing declining results. Merck hit a growth stall, and like 93% of companies falling into this trap there is no sign the company will grow even at a consistent 2% again.
On the other hand, Amazon (see chart here) shows much smarter management sense. The New York Times reported early in 2009 that book sales last year fell 8% (article here). If Amazon had acted like Merck, it would be announcing a big write-off, and resturcturing, to deal with the horrible decline in book sales! But the decline in the old product (books) doesn't mean people don't have a thirst for information (just like people don't have a desire for better disease management in Merck's market). Google searches and articles read on the internet have skyrocketed. Increasingly, it appears people simply don't want to pay for a printed book. The want to read things on on their computer, or phone, or listen to them on the treadmill while working out or commuting. The demand is still there, but the format or medium is changing.
And that is where Amazon appears to be doing something very special. After launching the digital Kindle book reader in December, 2007, it appears the company may have sold upwards of 500,000 units in 2008 (read article here). According to the article, that would be 32% more units than iPod sold in its first year! Apparently, Kindle units sold out in both holiday seasons.
This is an example of a company creating a growth strategy in what appears to be a declining market. Amazon could remain stuck in the world of traditional books. And, Kindle is probably just a technology footnote on the road to more advanced and popular digital reading (or listening). But Kindle is in the market, and in pretty big numbers. If a small company had launched Kindle to those kinds of numbers, it would be a NASDAQ darling!! Amazon is in the market, learning, selling and making money. If the market keeps transitioning, Amazon is well positioned to succeed.
Smart management teams don't ride their business model too long. They launch new solutions before the demand is clear, and before the solution is clear. Before profits go to heck, and financial machinations become the norm, they make changes trying to get back into the Rapids. The set up White Space with new projects to learn, and regain growth. Merck leaders could take a lesson from Amazon – and quickly get into the solutions that will drive growth in the next 10 years.
by Adam Hartung | Feb 2, 2009 | Current Affairs, Defend & Extend, Leadership, Lock-in
The U.S. banks are asking for more bailout money – and Congress is resisting (read article here.) Most people don't understand why banks are failing, and lots of them are ready to say "let them fail." But why they are failing is important – because the solution has to be linked to the diagnosis, don't you think?
Back in the old days of hyper-inflation (think 1970s) corporations developed a perverse problem. They had buildings on their balance sheet for $1million, but inflation had made the land, buildings and other assets worth $10million (or $20million). The corporations weren't allowed to mark up their assets to market value. So the banks couldn't lend them more money. As a result, fellows like T. Boone Pickens created a new business opportunity. They simply went to banks and borrowed money based on the real value of the underlying assets, and bought the corporations. Having no desire to run these companies, they often sold off the assets to pay off debt and kept the profits and the companies (and their employees) went away. They were called corporate raiders. And their existence could be traced to accounting.
When banks lend money they are required to have reserves which back up the loans. Banks can lend multiples of their reserves. They have leverage, because every dollar of reserves can create several dolalrs of new loans. As the reserves go up, they can loan more money. If they raise reserves by $1, they can loan out, say, $6.
But today, the bank loans already on the books (not new loans) - especially real estate loans – are going down in value (it's more complicated than this because of various bond offerings and insurance products on the mortgages, but the idea is pretty close). There is an accounting rule which says if a loan goes down in value, the bank has to estimate the new value of the loan and mark the loan down to market value (mark-to-market accounting). So, as real estate tumbles, the loan value tumbles. Every dollar of loan value comes straight out of reserves. This is called reverse leverage. Because if a loan goes down in value by $1, and $1 comes out of reserves, suddenly the bank has to reduce its total loan portfolio by $6 – get that? Instead of one loan being affected, suddenly a lot of loans are affected. Because one loan has to be marked down, in order to cover its reserve requirements, the bank may have to call up the local retailer and ask her to cut her inventory loan by 30% – because the bank no longer has sufficient reserves to cover all her debt. Ouch!!! One bad apple sort of starts spoiling the barrel – to use an old expression.
Suddenly, the reverse of the T. Boone Pickens opportunity happens. A few write-offs eliminate the reserves, making new lending impossible and actually (because real estate has cratered so badly) causing banks to call in perfectly good loans to cover their reserve requirements. (By the way, miss your reserve requirement and, by law, you go into default and the regulators take over your bank.) "But," you might say, "this means perfectly good debts are being called, and perfectly good loan opportunities are being ignored, just because of an accounting convention." And you would be right.
How far would you like the economy to stagnate because of an accounting convention? Sure, there was good reason for this rule. It was intended to keep banks from making questionable loans. But not many banks – not many economists – and not many accountants – expected real estate to drop 20% in value across the U.S.A.
The Japanese came across this problem in the middle-1990s. Their economy exploded in the 1980s. Real estate in Tokyo became the most expensive in the world. Ginza retail property was worth $1M per square foot! And middle-class Japanese discovered homes they had purchased for $80,000 were worth $1M! Young Japanese families buying new homes spent the $1M, and went deeply into debt. Then, the Japanese economy cooled. And real estate values tumbled.
But Japanese regulators would not let the banks write off these loans. They said "either this loan is repaid, in full, or you must write down your reserves." Banks quit lending. The Japanese economy nosedived into recession. And it has still not recovered. Stock prices, real estate prices, prices of everything have remained stuck. And the economy has not grown. After more than 12 years, the Japanese are still in a recession. You may not care, after all you don't live in Japan. But if you live in Japan you've struggled for a raise, you've struggled to pay bills, and if young you've struggled to find a job for 12 years. There are thousands of stories of highly qualified young Japanese college graduates who have never been able to find a job, thus never married – effectively never started their adult lives. Stuck. Families stuck by an extended recession as old debts are slowly, painfully slowly, repaid.
So what should America now do? Should we stick with the old accounting rules? Should we mark down loans, creating bank reserve problems? We know this means banks will ask for bailout funds – to get reserves back up. But we don't want to cover those reserve requirements – for fear the money will be spent on private jets and big bonuses. Maybe, just maybe, we should change the accounting rule.
By the way, I'm not the first with this idea by a long shot. Steve Forbes, a noted conservative, is one of the leaders for this change. He spoke to it on Meet the Press yesterday. This isn't really a hard question, is it? Why would anyone extend a recession, or create a depression, when an accounting rule is very close to the center of the problem? Something as easy to change as an accounting rule.
The issue is Lock-in. Our old enemy of the stuck corporation. Lock-in to past practices that causes the company to keep doing what it always did – even though everyone agrees there has to be change. Lock-in keeps the company on a path to sure destruction. The old accounting rules were based upon what used to be true. Thirty years ago, it was rampant inflation that gripped the U.S. economy. Double digit inflation screwed up everything business leaders and regulators had ever been taught. At one point, in 1978, President Carter went through 3 heads of the Federal Reserve (that's Bernanke's job) in under 1 year! Old accounting conventions were turning business upside down, and destroying healthy corporations. And mark-to-market (rather than acquisition cost), which allowed companies (and banks) to bring assets to "current value" was critical to a healthy economy and the management of healthy businesses.
But who's more Locked-in than economists and accountants? Not exactly known as a "progressive" group of people. Yet, the future for America is totally clear if we keep doing what's been done in the past. The government and industry forecasters have a trend that's very predictable. Without change, liquidity remains hampered, the economy remains on a downward tilt, layoffs continue and problems worsen. Something fundamentally needs to change.
So, using The Phoenix Principle, we know what's needed. Firstly, we can learn from our competitors. The Japanese situation has been studied to death, and the results are well documented. Universally, economists have demonstrated that Lock-in to old practices has hampered the Japanese economy dramatically. As the other developed countries struggle with falling real estate, the first to take action will come out the big winner. The first to find a way to move forward gets an advantage.
We now need to Disrupt! Someone has to help us stop and realize that more of the same has a clear future – and that future is not pleasant. Something has to change. Then we need to create White Space. Instead of changing the rules for all banks, we need to carve out some healthy but jeapardized banks in which to test the practice. We need to allow them to change their accounting, and watch the results. If it works, we can learn and replicate. Don't test on Citibank and Bank of America, which are huge and possibly unable to survive. Test where we can learn what works, and FAST.
Nobody wants another depression. And most people don't want to keep putting tax dollars into banks shoring up reserves. So maybe, just maybe, we should try something new. Like changing the accounting rule. Let's give it a shot, test it with some banks that are strong but struggling, and see if we can't figure out how to apply changes in a way that can get the economy going again!
by Adam Hartung | Jan 29, 2009 | Uncategorized
In the late 1990s Dell's value exploded (see chart here). From a share-adjusted price of $2.00, value exploded 30X in the internet boom from 1997 to 2000. People loved Dell because it had a Success Formula completely aligned with market conditions at the time. Dell had eschewed R&D, offering products which were combinations of off-the-shelf components. Offering a huge variety of a limited product line – PCs and laptops – Dell focused on how to take orders fast and deliver the product fast. While other companies put energy into product development, Dell put its resources into supply chain optimization at a time when internet use was exploding and the technology was becoming pretty much generic.
Since peaking, Dell's value has declined 8 3% -from about $100/share to $10. On the slippery slope of decline, value fell more than 60% since September. Dell was so focused on executing its Success Formula it missed some important market shifts. First, competitors were able to copy Dell's early advantages and provide customers lower prices. Second, customers moved away from wanting the highest growing PC products (servers) on the Dell technology standard products from Microsoft – moving increasingly to Linux solutions. And third, customers simply quit buying PCs and laptops at old growth rates. They are much more willing to keep products longer, rather than switch every year or so, and focus has moved to Blackberries and other mobile products – away from the products Microsoft offered. As a result of these market shifts, Dell's relentless focus on execution provided continuously declining marginal returns. Doing more of what it always did led to declining value at Dell.
Now the rumor is Dell will be launching a mobile phone (read article here). But a quick look shows there has been no change in the Dell Success Formula. The company is still trying to sell a product with no technology added by Dell – using instead off-the-shelf technology from Google and (surprise) Microsoft. Like it did in PCs, Dell looks to copy leading competitive products – this time targeting the Apple iPhone. It appears Dell thinks it can use its now long-in-the-tooth supply chain "strength" (which looks a lot less competitive advantaged than before) to take "me too" products to market in hopes customers will jump at their "standardized" distribution approach.
Only now isn't the 1990s, and mobile phones aren't anything like PCs and laptops. There are many low cost distribution avenues for mobile phones that get products into customers hands really, really cheap and really, really fast. And customers aren't looking for "standard" products, instead showing a very high affinity for new gadgets and bells (just ask Motorola that hung onto its market leading RAZR too long instead of bringing out new products). And thirdly, supply chain issues were important in PCs and laptops largely because most were bought by corporations – not individuals. But mobile phones are not a corporate IT purchase. Individuals by mobile phones.
In a different environment, isn't it surprising Dell would think its old Success Formula could produce good results? When things change, doing more of what you used to do well isn't likely to bring back old returns. Businesses have to change their Success Formulas to meet new and emerging market needs. Dell has to dramatically change its Success Formula if it hopes to regain competitiveness – not just put another me-too product into its old Locked-in processes. Even if Mr. Dell has returned as the CEO.
by Adam Hartung | Jan 28, 2009 | Current Affairs, Defend & Extend, In the Swamp, In the Whirlpool, Leadership, Lock-in
In a recent presentation I told the audience that they had quit printing newspapers in Detroit during the week. The audience said they weren't surprised, and didn't much care. The other day I asked a room full of college students when the last time was they looked at a newspaper (not read, just looked) – and not a single person could remember the last time. In Houston I asked two groups for the headline of the day that morning – not a single person had looked at the newspaper, and none in the group subscribed to a newspaper. Even my wife, who used to demand a Wednesday newspaper so she could receive the grocery ads, asked me why we bother to subscribe any more because she now gets the ads in the mail. This wholly unscientific representation was pretty clear. People simply don't care much about newspapers any more.
So, if you had $100 bucks to invest, and you had the following options, would you invest it in
- A professional baseball team (like the Boston Red Sox or Chicago Cubs)?
- A manhattan skyscraper?
- A newspaper?
That is exactly the question which is facing the New York Times Company (see chart here), and their decision is to invest in a newspaper. In fact, they are selling their interest in the Boston Red Sox and 19 floors in their Manhattan headquarters so they can prop up the newspaper business which saw ad revenue declines of greater than 16% – and classified ad declines of a whopping 29% (read article here). (Classified ads are for cars, lawn mowers, and jobs – you know, the things you now go to find on Craigslist.com, ebay.com, vehix.com and Monster.com and aren't likely to ever spend money on with a newspaper.)
The value of New York Times Company has dropped 90% in the last 5 years – from $50 to $5. The decline in advertising is not a new phenomenon, nor is it related to the financial crisis. People simply quit reading newspapers several years ago, and that trend has continued. Simultaneously, competition for ads grew tremendously – such as the classified ads described above. Corporate advertisers discovered they could reach a lot more readers a lot cheaper if they put ads on the internet using services from Google and Yahoo! There was no surprise in the demise of the newspaper business.
At NYT, the smart thing to do would be to sell, or maybe close, the newspaper and maximize the value of investments in About.com and other web projects (which today are only 12% of revenue) as well as Boston Sports (owner of the Red Sox) and hang on to that Manhattan property until real estate turns around in 5 years (more or less). Why sell the most valuable things you own, and put the money into a product that has seen double-digit demand and revenue declines for several years?
Of course, Tribune Company isn't showing any greater business intelligence. Management borrowed far, far more than the newspaper is worth 2 years ago through an employee stock ownership plan (can you understand "good-bye pension"?). So last week they sold the Chicago Cubs. For $900million. Tribune bought the Cubs, including Wrigley Field, 28 years ago for $20million. That's a 14.5% annualized rate of return for 28 consecutive years. Not even Peter Lynch, the famed mutual fund manager, can claim that kind of record!
Through adroit management and good marketing, they modernized the Wrigley Field assets and the Cubs team – and without ever winning the World Series drove the value straight up. As fast as people quit reading the Chicago Tribune newspaper they went to Cubs games. Who cares if the team doesn't win, there's always next year. And unlike newspapers, there aren't going to be any more professional baseball teams in Chicago (there are already two for those who don't know - Chicago's White Sox won the World Series in 2005). And they aren't building any additional arenas in downtown Chicago to compete with Wrigley Field. Here's a business with monopoly-like characteristics and unlimited value creation potential. But management sold it in order to pay off the debt they took on to take the newspaper private.
Defending the original business gets Locked-in at companies. Long after its value has declined, uneconomic decisions are made to try keeping it alive. Smart competitors don't sell good assets to invest in bad businesses. They follow the capitalistic system and direct investments where their value can grow. The New York Times may be a good newspaper – but who cares if people would rather get their news from TV and the internet – and they don't read newspapers "for fun?" When people don't read, and advertisers can get better return from media vehicles that don't have the printing and distribution costs of newspapers, what difference does it make if the outdated product is "good?" If you think the New York Times Company is cheap at $5.00 a share, you'll think it's really cheap in bankruptcy court. Just ask the employee shareholders at Tribune Company.
by Adam Hartung | Jan 27, 2009 | Current Affairs, Defend & Extend, In the Swamp, Leadership, Lifecycle, Web/Tech
Last week was quite a contrast in tech results. Google announced it had hired 99 new employees in the fourth quarter, but was planning to lay off 100. Not good news, but a veritable growth binge compared to Microsoft - that announced it was laying off 5,000 from its Windows business. To put it bluntly, people aren't buying PCs and that's the focus of all Microsoft sales. As the PC business stagnates – not hard to predict given the shift to newer products like netbooks, Blackberry's and iPhones - revenues at Microsoft have stagnated as well.
So now the pundits are predicting that Microsoft's weakness indicates an acquisition of Yahoo! is in the offing (read article here). The story goes that with things weak, Microsoft will buy Yahoo! to defend its survivability. Not dissimilar to the logic behind Pfizer's acquisition of Wyeth.
But does this really make sense? Microsoft is fully Locked-in to a completely outdated Success Formula. Mr. Ballmer has shown no ability to do anything beyond execute the old monopolistic model of controlling the desktop. Only a massive Disruption by founder Bill Gates kept Microsoft from falling victim to Netscape in the 1990s. But there hasn't been any White Space at Microsoft, and year after year Microsoft is falling further behind in the technology marketplace. Now the growth is gone in their technology. It's just a "cash cow" that is producing less cash every year. Microsoft is a boring company with boring management that has no idea how to compete against Google. They would strip out whatever market intelligence Yahoo! has left in an effort to turn the company into Microsoft. There would be nothing left of value, and a lot of cash burned up in the process.
Why shouldn't Yahoo! buy Microsoft? Google is the leader in search and on-line ad sales. The closest competitor is Yahoo!, which is so far behind it needs massive cash and engineering resources to develop a competitive attack. Yahoo! has a new CEO with the smarts and brass to Disrupt things and create a new Success Formula. Yahoo! could take advantage of the cash flow from Microsoft to develop new products, possibly products we've not thought of yet, that could create some viable competition for Google. We don't need another Microsoft, but we do need another Google! Why shouldn't Yahoo! take over the engineers and technical knowledge at Microsoft, as well as distribution, and use that to develop new solutions for web applications from possibly search to who knows what! Maybe something that moves beyond the iPhone and Blackberry!
What's the odds of this happening? Not good. That would defy conventional wisdom that the company with all the cash should win. But we all know that as investors we don't value cash in the bank, we value growth. So the company with growth opportunities, and the management to invest in new solutions, should be the one that "milks" the "cash cow." The growing company should be cutting the investment in old solutions that are near end-of-life (like Windows 7), and putting the money into growth programs that can generate much higher rates of return. By all logic of finance, and investing, Yahoo! should buy Microsoft. It's Ms. Bartz we need running a high tech company, shaking things up as the underdog ready to use White Space to develop new solutions that can generate growth. Like she did when beating Calma and DEC. Not the CEO best known for his on-stage monkey imitation and no idea how to generate growth because he's so committed to Defending & Extending the old cash business — completely missing every new technology innovation in the last decade.
Yahoo! has a chance of being a viable competitor. Yahoo! has a chance of competing against Google and pushing both companies to new solutions making the PC an obsolete icon of the past. But if Microsoft buys Yahoo!, it will do nobody any good.
by Adam Hartung | Jan 26, 2009 | Defend & Extend, General, In the Swamp, Leadership, Lock-in
Do you remember when Home Depot was a Wall Street – and customer – darling? Home Depot was only 20 years old when its incredible growth story vaulted it onto the Dow Jones Industrial Average 9 years ago, replacing Sears. Unfortunately, that youthful ascent turned out to be the company crescendo. Since peaking in value within a year, Home Depot has lost more than 2/3 of its value (see chart here). Things have not been good for the company that "changed the rules" on home do-it-yourself sales.
Along the way, Home Depot changed its CEO a couple of times. And it opened some White Space type of projects. But today, the company announced it was shutting down those projects (Expo Design Centers, YardBIRDs, HD Bath) cutting 5,000 jobs - and an additional 2,000 jobs in a "streamlining" efforts (read article here). In the process, it affirmed revenue will decline 8% this year while earnings per share will drop 24%.
Amidst this background, the stock rose 4.5%.
Home Depot is a company with a very strong Success Formula. That Success Formula met the market needs so well in the 1980s and 1990s that the company excelled beyond all expectations. But like most companies, Home Depot was a "one trick pony." It knew how to do one thing, one way. Then in the early 2000s, competitors started catching up. And Home Depot didn't have anything new to offer. The market started shifting to competitors with lower price – or competitors with even better customer service – leaving Home Depot "stuck in the middle" decent at both price and service not not best at either. And with nothing really knew to attract customers.
So Home Depot launched Expo Design Centers. It was leadership's effort to go further upmarket – to sell even higher priced home items. This was a failed effort from the start:
- Leadership did not tie its projects to any committed scenario of the future where Expo would create a leadership position. There was no scenario planning which showed a critical need for Home Depot to change.
- Expo did not learn from competitors, nor did it set any new standards that exceeded competitors. KDA and others had long been doing what Expo did – and even better! Rather than obsessing about competitors in order to realize where Home Depot was weak, and finding new ways to grow the market, Home Depot decided to launch its own idea without powerful competitive information.
- Thirdly, Home Depot did not Disrupt at all. Although Expo existed, it was never considered important to the company future. Leadership never said it needed to do anything different, nor that it felt these new projects were critical to company success. Instead, leadership let all the employees believe these projects were merely trial balloons with limited commitment.
- And, for sure, Expo and other projects did not meet the real criteria of White Space because they lacked the permission to violate Home Depot Lock-ins and the resources to really be successful.
Now, years later, with the company in even more trouble, Home Depot is closing these stores. It appears management is taking a page from Sears – the company they displaced on the DJIA – which closed its hardware and other store concepts to maintain its focus on traditional Sears. And we all know how that's worked out. Leadership is wiping out growth opportunities to save cost, in order to Defend its now poorly performing Success Formula, rather than using them to try developing a solution for declining revenues and profits. So easy to simply quit. Instead of re-orienting the projects along The Phoenix Principle to try and fix Home Depot, leadership is killing the growth potential to save cost with hopes that some miracle will return the world to the days when Home Depot grew and made above-average returns.
What do Home Depot leaders want employees, investors and vendors to anticipate will turn around this company? Even though Home Depot was a phenomenal success, once it hit a growth stall it fell amazingly fast. Not its historical growth rate, nor its size, nor its reputation was able to stop the ongoing decline that befell Home Depot once it hit a growth stall. (By the way, 93% of those companies that hit a growth stall follow the same spiraling downward path as Home Depot). As Sears has shown, a retailer cannot cost-cut its way to success. Refocusing on its "core business" will not return Home Depot to its halcyon days. And these cuts further assure ongoing company decline.
by Adam Hartung | Jan 25, 2009 | Defend & Extend, In the Swamp, Leadership, Science
Two weeks ago I blogged about R&D layoffs at Pfizer (chart here), and warned that all signs were indicating Pfizer was nearing really big trouble because it had missed the boat on new technologies as it road out its patent protection looking for new ways to extend its outdated Success Formula.
Now we hear rumors that Pfizer is planning a mega- acquisition by purchasing Wyeth (chart here) for some $65B (read article here). That's about 3 times revenue for a company growing at less than 10%/year. This acquisition will most likely keep Pfizer alive – but it's benefits for shareholders will probably be nonexistent – and probably a negative. And the impact on employees is almost sure to be a net loss.
Pfizer missed the move to "biologics" – which is the term for the new forms of disease control products that use genetics, bio-engineering and nano-technology as their basis rather than a heavy reliance on chemistry and pharmacology. As a result, its new product pipeline has not met company growth needs. So now that Pfizer is buying a company with significantly biologic solutions, Pfizer leadership is sure to argue that it is filling its pipleline gap with the new solutions and all will be good going forward.
But the reality is that there are much cheaper ways for Pfizer to get into biologics than spending $65billion – a big chunk of it cash – on a huge acquistion. With banks stopped and investors realing, there are dozens of projects in universities and small companies that are begging for funding. These range from invention stage, to well into clinical trials. If Pfizer wanted to become a successful company it would
- Tell investors and customers its scenario for the future, with insights to how the company sees growth and the investments it needs to make
- Telling investors and employees the competitors that are most important to watch, and how they plan to deal with those competitors
- Disrupting its old Success Formula. Leadership would make sure all employees and management are stopped, and recognize the company needs to make a serious change if it is to catch up with market shifts and regain viability
- It would invest in multiple solution areas and multiple projects, and the allow them to operate independently as White Space where Pfizer could learn how to modify its Success Formula in order to regain growth and success in the future.
This clearly is not what is happening at Pfizer. Instead, the company is planning to take a big cash hoard, which if it doesn't want to invest in White Space it could return to investors, and spend it on a huge acquisition. We all know that almost all big acquisitions do not achieve desired goals, and that the buying investors get the short end of the stick as the selling investors achieve a premium. Why? Because the buying leaders, like those at Pfizer, are without a solution and looking for the acquisition to cover over past sins and make them look smart and powerful. So, driven largely by ego, they overpay to get a company as if that makes them the "winner."
But what happens? We can expect that Pfizer will find out it has to do something drastic to make the overpayment potentially work, and staff cuts will quickly ensue. Probably across-the-board employee cuts in the name of "synergy", but which weakens the acquired company. Then, as it absorbs Wyeth, Pfizer will push to force its old Success Formula onto Wyeth – after all, Pfizer is the "winner". But Pfizer needed Wyeth, not vice-versa. As it cuts cost, it cuts into the value they ostensibly paid for. Many of the best at Wyeth will go elsewhere to continue competing as they know produces better results. The value of the acquisition will go down as Pfizer "integrates" the acquisition, rather than raise it.
But in a year, Pfizer will declare victory, no matter what. Pfizer's revenue has been flat for at least 4 years (stuck in the Swamp) at about $48B. Wyeth's revenue has been growing at about 10%/year and is about $22B. So in a year, Pfizer can say "Revenues are now $65B, an increase of 30%". Of course, the reality would be that revenues were down 7%. Of course they will brag about their integration project, and brag about various cost cuts implemented to streamline "execution." Pfizer leadership will say they made the right move, even if all they did was use up a cash hoard in order to delay changing the company. That, by the way, is what I call "financial machination". If you can't dazzle the investor with brilliance, make a big enough acquisition so you can baffle them with bulls***.
If you're a Wyeth investor, take the money and run. You don't want to stick around for a takeover destined to lower total value and reduce the excitement of new R&D programs and medical solutions. Go find alternative companies that need cash, and help them move forward with their new solutions. If you're a Pfizer investor, don't be fooled. If the analysts cheer the takeover, and the stock pops, it's unlikely you'll get a better time to sell. The leadership has demonstrated the last 5 years, as growth has been nonexistent and the equity value has steadily declined, that they don't know how to regain growth. This acquisition is not changing the leadership, managers nor Success Formula of Pfizer that has long been producing lower returns. This acquisition is the latest in Defend & Extend moves to protect the outdated Success Formula. If this gives you an opportunity to get out – take it! Within 2 years the "new" Pfizer will be a lot more like the old Pfizer than Wyeth.
by Adam Hartung | Jan 22, 2009 | Current Affairs, Defend & Extend, In the Swamp, Leadership, Lock-in, Web/Tech
Microsoft announced today it intends to lay off 5,000 workers (read article here). This action, included in its announcement that Microsoft is going to miss its earnings estimate, spooked the market and is blamed for a one-day market dip (read here). The company's equity value, meanwhile, dropped to an 11-year low – out of its 33 year life (see chart here). Of course, the blame was placed on the weak economy.
But we all know that Microsoft has been struggling. The Vista launch was a disaster. A joke. Techies resoundingly ignored the product – as did their employers. Because Vista was so weak, Microsoft is looking to launch yet another operating system – just 2 years after Vista was launched. Incredible, given that Vista was more than 2 years late being launched! Additionally, in an effort to increase interest in Windows 7, the new product, Microsoft has dramatically increased the availability of beta versions for review (read here).
Microsoft was once the only game in town. But over the last few years, Linux has made inroads. Maybe not too much on the desktop or laptop, but definitely in the server world. The hard core users of network machines have been finding the cappbilities of Linux superior to Windows, and the cost attractive. Additionally, netbooks, PDAs and mobile phones are gaining share on laptops every day. Customers are finding new solutions that utilize network applications from companies such as Google are increasingly attractive. By laying off 5,000, Microsoft is not addressing its future needs – to remain highly competitive in operating systems and applications against new competitors. It is retrenching. This doesn't make Microsoft stronger. Rather, it makes Microsoft an even weaker target for those who have the company in their sites.
Why should anyone be excited about a company that is willing to cut 7.5% of its workforce while it is losing market share? Sure, the company is still dominant in many segments. But once the same could be said for Digital Equipment (DEC), Wang, Lanier, Compaq, Silicon Graphics, Sun Microsystems, Cray and AT&T. All fell victims to market shifts making them irrelevant. Not overnight – but over time irrelevant, nonetheless.
It's hard to imagine, today, a world without Microsoft domination. After all, this was a company sued by the government for monopolistic practices. Yet, we know that even market domination does not protect a company from market shifts. Microsoft's layoffs demonstrate a company planning from the past – it's former dominance – rather than planning for the future. Many industry leaders are already seeing a technology future far less dependent upon Microsoft. Shifting software solutions as well as changing uses of platforms (largely the declining importance of desktop and laptop Wintel machines) is making Microsoft less important.
Trying to Defend & Extend its past glory is not serving Microsoft well. Once, any changes in its operating system was front page news. Now, a new release struggles to get attention. Microsoft is at great risk – and its layoffs will weaken the company at a time when it cannot afford to be weakened. When Microsoft most needs to be obsessing about competitor's emerging strengths, and using Disruptions to open White Space where it can put employees to work on new solutions, Microsoft is cutting back and making itself more vulnerable to competitors now surrounding on all fronts. This should be a big concern for not only those being laid off, but those remaining as employees and those investors who have already seen a huge decline in company value.
by Adam Hartung | Jan 21, 2009 | Innovation, Leadership, Lock-in, Web/Tech
By now most people know the story of eBay. Originally, the founders were looking at the internet as a place to trade PEZ dispensers. But over the next 2 decades, eBay became the world's biggest garage sale. If you have something to sell, you can list it on eBay to a world of potential buyers. While there was a price to listing, it was small and eBay offered a nation of buyers compared to Craig's list which typically only got local buyers amidst a rash of junk listings created by their willingness to allow free listings of on-line items.
Given the current economy, you would expect eBay to be doing gangbusters. When would be a better time to unload the stuff you don't need than now? But unfortunately, eBay revenue is down 6% versus last year, and gross merchandise volume is down 12% versus year ago. Even though eBay has expanded by adding Shopping.com, Stubhub and other sites, total revenue for the Merchandise unit is down 16% versus last year. (read eBay results here)
eBay demonstrates the risk of being Locked-in to a single business model (and single Success Formula). For about 2 decades internet growth has pulled along growing revenues at eBay. Without doing anything differently, eBay grew because more and more people "discovered" the web. As unhappy customers escalated in alarming rates, and lawsuits against unsrupulous eBay suppliers mounted, eBay blithely kept close to its "core," doing more of the same and only adding businesses that helped the "core" internet business grow – such as the acquisition of Paypal to handle small internet purchase transactions. Many people thought eBay would grow forever – as the internet grew.
But now we can see that hiccups happen in all technology markets. Customers are not only using the web, they are getting more savvy. Fewer are willing to buy from unknown suppliers that may not follow through with promised products – and no back-up from eBay. Fewer folks are willing to pay for listings as skeptical buyers are less trusting of those listings – and thus they turn to the free Craig's list. Just being in the right technology market is not enough to keep a business growing.
Lock-in has served eBay well for 20 years. But "times are changing." Now customers are more sophisticated, and looking for more confidence and assurances. They don't trust the eBay model implicitly, like they once did, knowledgable about increasing fraud and lousy customer service from sales people that don't care. The simple eBay Success Formula isn't producing the results it once did.
These latest results should worry everyone who depends on eBay as a supplier, employee or investor. If things don't turn around in the next quarter, eBay will officially enter a growth stall. Even though eBay has been a huge success, like many internet companies eBay could rapidly see an equally remarkable fall. Customers and suppliers can leave eBay just as fast as they left Pets.com.
Most companies expect their Success Formulas to help them grow indefinitely. But we know that highly dynamic markets means this is extremely unlikely. Markets shift – and right now the internet market is shifting fast along with the traditional retail market. eBay is a company that has not prepared for market shifts at all, remaining exclusively tied to its original Success Formula. As a result, the company has no plan to do anything differently even though the market is changing fast. And that is the risk of companies that don't invest in scenario planning, obsessive competitor analysis and White Space during the good times. They can all too easily wake up one day to a dramatic shift in fortune with no idea what to do about it.
You don't have to be GM or Sears to be Locked-in and at risk of market shifts. Even leading companies run the risk. If you devote yourself to Defending & Extending your historical business, ignore internal Disruptions and don't implement White Space to find new opportunities for growth, you risk the business. Because no one can predict when, or how fast, markets will change putting the old business at risk.
by Adam Hartung | Jan 20, 2009 | Defend & Extend, Innovation, Lock-in
As we enter 2009, more people than ever are talking about behaving ecomically. From TV news to newspapers to web sites there are a rash of articles about how to save money. Many of these talk about how to save pennies on things electic consumption (changing incandescent to flourescent bulbs) or food (buy raw ingredients rather than partially prepared frozen.) It seems almost everyone is keen to find ways to save money.
When we look at American homes, the biggest cost is clearly housing. Mortgate, insurance, property taxes (or rent) and heating/air conditioning are the biggest cost of practically every household. The second, by a wide margin, is transportation. The cost of automobiles, insurance and fuel far outweigh any other cost – including food – except for a minority of urbanites that avoid owning a car altother. As we saw last year during the oil runup, for most people finding ways to save money on transportation is very high on the list of concerns.
Yet, the easiest ways to save money are largely ignored. We all know from advertisements on TV and public service announcements that mass transit is cheaper and more "green" than personal transportation. Yet, Americans still prefer the flexibility of their own transportation. Even though the fully loaded cost of a car averages between $500 and $800 per month (and can go much higher for pricier autos).
So, why don't more people drive motorcycles? It is easy to find a used motorcycle for $2,000 to $4,000 - especially smaller engined machines that are ideal for commuting. Most motorcycle insurance costs $100 per year, compared to more than $100 per month for most cars. Most motorcycles average 40 miles per gallon, with some exceeding 100 mpg. And their 0 to 60 performance greatly exceeds low cost and low powered autos that seek higher mileage. Even large motorcycles with big engines that easily tour along at 70-80 miles per hour achieve more than 35 mpg and can exceed 50 mpg on highways. There is simply no way to ignore the fact that the cost of owning and operating two-wheeled transportation is less per year than a single month of even a cheap 4-wheeled auto.
If you go outside the USA, motorbikes are prevalent. They are much easier to maneuver in heavy traffic – virtually ignoring traffic jams. And parking costs range from $0 (because there are many places to hide one in an alley, on a side street or even on sidewalks with two-wheeled parking spots) to a mere fraction of an auto – which costs from $40/day to $200/month in most cities. Where gasoline has long cost $4.00/gallon (north of $1.00 per liter in most countries) the benefits of motorcycles has led the rapid growth of riders. In India motorbikes are so prevalent some cities have considered banning them in order to make more room for autos and "raise the community standars" – bans unlikely to pass and even less likely to be enforced.
So why don't Americans buy more motorcycles? Ask your friends and neighbors – and maybe yourself. Odds are, you never considered it. Somewhere in your mind, motorcycles are stuck in a strange land between gangs (the Hells Angels) and those who can't afford a car. When someone asks about riding one, the immediate image is "dangerous" – yet statistics show that motorcycle riders are less than 5% as likely to be in an accident as an auto driver. Motorcyclists are dramatically safer than auto drivers, and that is reflected in the remarkably lower insurance rates. And when motorcycles are involved in accidents, the costs of repair are rarely even 10% of the cost to repair a car.
Americans don't ride motorcycles largely because they never have. America was always a "car" society. The home of Ford, GM and Chrysler, people bought and drove cars. Of course this was augmented by ample oil reserves leading to very low gasoline prices for many years – something not available in most countries. Whereas in Europe and Asia motorcycles led the transportation movement. It was much more common for the first vehicle to be two-wheeled rather than four.
People are talking a lot about how to be economical. But the reality is that most people are locked-in to old practices. They will switch light bulbs so they have more money for gasoline. They will turn down the heat in winter so they can pay for car parking when going into the city or to work. People will try to make small adjustments around the edges of life so they can Defend & Extend the lifestyle to which they are accustomed.
There are lots of opportunities for us to change our lives. We can make big changes that lower the cost of living. But to implement these requires we Disrupt our lives. Until we challenge the status quo, and change our Lock-in to things we've always done, we don't really consider doing things that can make a big difference.
In the meantime, take a look at buying a motorcycle (read more about motorcycle use in America here.) You might be surprised just how economical they are – and how fun! Your fear of leaving your car at home might dissipate if you ever took a ride on a motorized bike. And you'll be surprised just how much money it can put back into your wallet every month. And it will drop your carbon footprint more than anything else you can do – except switch to mass transit.
