by Adam Hartung | Oct 20, 2008 | In the Swamp, In the Whirlpool, Leadership, Lock-in
With the economy soft, and sales harder to come by, more companies are thinking about what changes they can make to be more competitive. But what we’re seeing now is the emergence of competitors that Disrupted when times were good, and the decline of those who chose to Defend & Extend old Success Formulas in order to maximize profits back then.
Let’s take a look at Sun Microsystems (see chart here.) Trading today at $5.25/share, Sun was a darling of the internet boom – peaking at about $250/share in 2000. But $5.25/share (adjusted for splits) is about what Sun was worth in the mid-1990s. At that time Sun was a big winner as internet usage exploded and the telecom companies – as well as industry participants from tech to manufacturers – could not get enough Unix servers. Everyone was predicting that the need for servers was never going to decline, and Sun was "#1 with a rocket", to use an old radio term for a big hit song.
In 1995 Sun held a management retreat for all its managers and higher in Monterey, CA. Scott McNealy, the chairman and CEO, asked the audience "if you could buy Apple, would you do it?" The audience reacted with a positive roar! These managers all saw the benefit of having a low-price workstation line to augment their expensive servers. Further, Unix was notoriously difficult to use and the hope of bringing a better GUI interface was very appealing. They saw that if they could help the sales of Macs it would be a great way to slow the Wintel (Microsoft Windows plus Intel microprocessor) PC platform – which was the biggest competitor to Unix. And Apple had lots of applications in media and the office that eluded the very techie Sun products. These managers, directors and V.P.s had all thought about an Apple + Sun merger, and they saw the opportunities.
Mr. McNealy looked at the raucous, hopeful crowd and said, "you think you could fix that mess? With all we have to do to keep up with market growth, you don’t see buying Apple as a major diversion?" The air was sucked out of the room. Obviously, Apple was troubled. But there was real hope for growth in new and unpredictable ways from combining the two companies, their positive brands, their great technologies and their creative roots. But Mr. McNealy went on to tell the audience that the executive team had thought about the acquisition, and just couldn’t see doing it. It would be too disruptive.
That management retreat had as its keynote speaker Gary Hamel, author of Competing for the Future. Mr. Hamel gave a great presentation about how his research showed great companies figured out their core – their core strength – and then reinforced that strength. The rest of the retreat was spent with the management personnel in various break-out sessions defining the "core" at Sun Microsystems and then identifying how Sun could reinforce that core.
Of course, it only took 5 years for the internet bubble to burst. The telecoms were some of the first victims, with their value plummeting. Demand for servers fell off a proverbial cliff. Meanwhile, Unix servers from IBM and others had increased in performance and capability – giving the once high-flying Sun a competitive kick in the pants. Worse, the power of Wintel servers had continued to increase, making the price difference between a Unix server and a Wintel server much less acceptable. IT Department customers were beginning to shift to PC servers in order to lower cost. And Sun, with its focus on servers, had no desktop product to sell – no competitor to the PC – nor any software products to sell. The internet market was rapidly shifting toward Cisco and those who sold robust network gear. Sun was watching its market disappear right out from under it – and happening in weeks.
Now it’s unclear what the future holds for Sun Microsystems (read article here). Sales have not recovered. Losses have been mounting. Sun’s dealing with hundreds of millions of dollars in restructuring costs (again), and some of its businesses are now worth so little that the company is probably going to be forced to write off millions (maybe billions) in goodwill on the books. If it has to write off too much good will, Sun could end up declaring bankruptcy.
The time for Disruption at Sun was when business was good – in 1995 and 1996. Had they bought Apple, who knows what combination might have happened. At the time, Cisco (see chart here) was growing quite handily. But Cisco built into its ethos the notion that the company would obsolete its own products. This desire, to never ride too far out the product curve and instead cannibalize their own sales before competitors did, has allowed Cisco to keep growing revenues and profits. Instead of "focusing on its core" Cisco keeps looking for the competitors (companies and products) that could make Cisco obsolete – and using those competitors to help Cisco drive growth.
Even with Disruptions, many competitors will not survive this recession. Not because the managers are lazy or sloppy. But because they will become victims of better competitors who built Success Formulas more aligned with future market needs. Those who Disrupted in 2005 and 2006, who positioned themselves for globalization and rapid market shifts, will do relatively better in 2009 than those who chose to Defend & Extend what they used to do. The best time to Disrupt and create White Space is when things are good – because that prepares you to win big when markets shift and times get tough.
by Adam Hartung | Oct 17, 2008 | General, Innovation, Leadership, Openness
Ever heard of "confirmation bias"? It’s a term that refers to how our behavior changes due to Lock-in. As we develop Lock-in we don’t see all the information around us. Instead, we start filtering information according to our Lock-ins – focusing on the things related to what we know and mostly ignoring things not related. As a result we often start missing things that could be really important. Consider someone who makes hammers (or pheumatic hammers) and nails. They can easily ignore glues, or super-powerful adhesive tape, when those solutoins might well be a greater long-term profit threat than offshore hammer and nail manufacturers!
Another example. A recent headline in The Chicago Tribune read "Abbott Absorbed with new Stent Therapy" (read article here). (See Abbott chart here) The article talks about how newly engineered dissolvable stents have been working extremely well in trials. If you aren’t in the health care industry, or being treated for a possible heart attack, or an investor in Abbott, you might well completely ignore the article. But, that would be a mistake.
Bio-engineering is going to be as important to our future as air travel and computers became. It was easy for people in 1928 riding horses, or driving a Model A, to think air travel was something exotic and only interesting for people obsessed with flight. But, we all know that by the end of WWII airplanes had changed the world, and the way we travel. Likewise, it would have been easy for people with slide rules and adding machines in 1968 to ignore computer discussions when they were mostly about mainframes in air conditioned basements. Yet, by the 1980s computers were everywhere and businesses that were early adopters figured out how to gain significant advantages. And that’s the truth about bio-engineering today. It will make a huge difference in all aspects of our lives.
Fistly, simple things. Like we’re more likely to live longer. But beyond that, injuries will be less onerous. As we learn how to engineer products that are somewhere between inanimate and living, we are able to come closer to the bionic man/woman. We’ll be able to repair major injuries in a fraction of the time. We’ll be able to regrow damaged organs – from skin to livers. We’ll regrow nerves – making paralyzation a temporary phenomenon and dramatically lowering the impact of strokes. Injured soldiers will return to the battlefield within days – instead of going home badly hurt. Senior citizens will regrow damaged or arthritic joints, instead of replacing them with major surgery making it possible for them to work much longer. Athletes will be able to increase performance in ways we’ve never before imagined – and the line between "natural" and "performance enhanced" will become impossible to define.
But think bigger. There is no computer in our bodies, yet we do amazingly complex analytics in record speed. Even a 2 year old can recognize the difference between a bird and a plane in a fraction of a second. Ask a computer to do that simple task! So we can expect a wave of bio-computers to be developed. Devices that use chemical reactions to process information rather than electrons acting in logic gates. How will we apply this technology to our lives and work? Cars that drive themselves? Super-secure baby walkers? Pens that never misspell words? Foods that never overcook? Foods that never spoil? Clothes that change to dissipate or hold-in heat depending on ambient temperature? Floors that purge themselves of dirt – pushing it to the surface for automatic removal?
When we are able to make chemicals – even cells – smart, what happens to the world around us? Do we ever need to go to a dentist if we can have smart toothpaste that eats away tarter and placque, applying flouride, without going into the enamel? Can we eat anything we want if we take products that absorb poison – or possibly fats – and discharge it through the system? Do cosmetics become obsolete if we all have skin creams that repair damage and keep skin forever young? What happens at companies like Procter & Gamble?
As you go to work and do your job, it’s easy to get focused on the industry in which you compete – and the traditional way that industry worked. You stop looking sideways at technologies in other fields not related to what you do today. And that can be a huge mistake. Because it’s often someone that takes a technology you ignored and apply it to your customers’ needs who makes you less valuable. Microsoft singlehandedly, and without much thought, destroyed the encyclopedia business by giving away what was considered a third-rate product (Encarta – for more on this story read Blown to Bits by Evans & Wurster). Encyclopedia Britannica never saw it coming as they kept trying to print a better product.
Spend some time reading ALL the headlines – and keep your eyes open for opportunities that you previously never considered.
by Adam Hartung | Oct 16, 2008 | General, In the Rapids, In the Swamp, Leadership, Lock-in, Openness
Traders help markets function. Because they take short-term positions, sometimes hours, a day or a few days, they are constantly buying and selling. This means that for the rest of us, investors who want to have returns over months and years, there is always a ready market of buyers and sellers out there allowing us to open, increase, decrease or close a position. Traders are important to having a constantly available market for most equity stocks. But, what we know most about traders is that over the long term more than 95% don’t make money. Despite all the transaction volume, their rates of return don’t come close to the Dow Jones Industrial Average – in fact most of them have negative rates of return. Only a few make money.
For investors it’s not important what the daily prices are of a stock, but rather what markets the company is in, and whether the markets and the company are profitably growing. On days like today, which saw the DJIA down triple digits and up triple digits in the same day (read article here), it’s really important we keep in mind that the value of any company in the short term, on any given day, can fluctuate wildly. But honestly, that’s not important. What’s important is whether the company can exp[ect to grow over months and years. Because if it can, it’s value will go up.
Let’s take a look at a couple of companies in the news today. First there’s Google (see chart here). Despite the recession, despite the financial sector meltdown and despite the wild volatility of the financial markets, the number of internet ads continued to go up. Paid clicks actually went up 18% versus a year ago. (read article about Google results here). Gee, imagine that. Do you suppose that given the election interest, the market interest during this financial crisis and the desire to learn at low cost more people than ever might be turning to the internet? Does anyone really think internet use is going to decline – even in this global recession? Google is positioned with a near-monopoly in internet ad placement (Yahoo! is fast becoming obsolete – and is trying to arrange to use Google technology to save itself see Yahoo! chart here]). By competing in a high growth market – and constantly keeping White Space alive developing new products in this and other high-growth markets – Google can look out 3, 5, 10 years and be reasonably assured of growing revenues and profits. And that’s irrespective of the Dow Jones Industrial Average (where Google might well replace GM someday) or whether Microsoft buys the bumbling Yahoo! brand (read about possible acquisition here).
On the other hand, there’s Harley Davidson (see chart here). Motorcycles use considerably less gasoline than autos, so you would think that people would be buying them this past summer as gasoline hit record high $4.00/gallon plus prices. Yet, Harley saw it’s sales tumble 15.5% (much worse than the heavyweight cycle overall market drop of 3%) (read article about Harley Davidson’s results here.) The problem is that Harley is an icon – for folks over 50! The whole "Rebel Without a Cause" and "Easy Rider" image was part of the 1940s post war rebellion, and then the 1960s anti-war rebellion. Both not relevant for the vast majority of motorcycle buyers who are under 35 years old! Additionally, long a company to Defend & Extend its brand, Harley Davidson has raised the average price of its motorcycles to well over $25,000 – a sum greater than most small cars! Comparably sized, and technologicially superior, motorcycles made by Japanese manufacturers sell for $10,000 and less! Worse, the really fast growing part of the market is small motorcycles and scooters that can achieve 45 to 90 miles per gallon – compared to the 30 mile per gallon Harley Davidsons – and Harley has no product at all in that high growth segment! Harley Davidson is a dying technology and a dying brand in an overall growing market. No wonder the company is selling at multi-year lows (down 50% this year and 67% over 2 years) . Even though the stock market may be down, Harley Davidson is unlikely to be a good investment even when the market eventually goes back up (if Harley survives that long without bankruptcy!)
Watching the Dow Jones Industrial Average, or the daily stock price of any company, isn’t very helpful. Daily, prices are controlled by the activity of traders – who come and go incredibly fast and mostly lose money. What’s important is whether the company is keeping itself in the Rapids of Growth. Google is doing a great job at this. Harley Davidson is Locked-in to its old image and thoroughly entrenched in trying to Defend & Extend its Lock-in – completely ignoring for the past decade the more rapid growth in sport bikes, smaller bikes and scooters. As investors, customers, employees and suppliers what we care about is the ability of management to Disrupt their Lockins and use White Space to stay in the Rapids of growth.
by Adam Hartung | Oct 15, 2008 | Defend & Extend, In the Swamp, Leadership, Lock-in
Are people risk averse? Or do they like risk? Would you believe those questions don’t matter, when trying to understand risk?
Today we’re being told that the bankers who ran some of the world’s largest investment banks were taking ridiculous risks – and the decisions to take on those risks is now undoing financial services globally. Were these bankers all gunslingers – willing to take crazy risks? Would you believe me if I said they didn’t think they were taking much, if any risk?
Risk is a relative term. What’s "risky" is really a matter of perception. Let’s say I drive to work on a local highway every day. The traffic cruises at 65 miles per hour, but since I’m always late I drive 75. On a particularly late day I drive 80. Because I usually drive 75, the relative risk seems small. But the reality is that at 80 the chances of a minor mishap becoming a disaster are far greater. Once you are comfortable driving 75, the perception of greater risk is only the marginal difference between 75 and 80 – so it seems small. Over time, if I choose to keep driving a bit faster, within short order I’ll be driving 100 miles per hour. This may seem crazy – yet there are many drivers on Germany’s high-speed autobahn highways that drive this fast – and faster!! To those of us who poke along every day at 65 miles per hour these speed demons of the autobahn seem to be taking a crazy risk – but to them, working up to those high speeds gradually over time, the relative risk now seems quite small.
And this is what happens in our business. When a bank takes a deposit, it then can loan money. But should it lend dollar for dollar – deposit compared to loans? While nonbankers might say "don’t lend more than you borrowed" that seems ridiculously conservative to bankers. Bankers say that because most loans are repaid, they only need enough deposits to cover the normal ebb-and-flow of the cash demands on the institution. So they feel comfortable loaning out 2 or 3 dollars for every dollar of deposit. Of course, the more loans the banker makes and the rarer defaults occur, the more likely the banker will start to give loans that are 4 times the amount on deposit. Where does this stop? We know with Lehman Brothers the leverage reached 30 to 1 (read about financial institution leverage and regulatory recommendations here)!!! It didn’t take many defaults for Lehman to suddenly find itself unable to meet its obligations and disappear.
The bankers at Lehman Brothers learned not to fear what they knew. Not only that, but they hired immensely smart mathematicians and physicists to try calculating the amount of risk they were taking on with their leverage and their obligations. Using mathematics far beyond the grasp of all but a fraction of the population, they asked scholars to try calculating the risk in the loan packages they sold, and the credit default swaps. They continuously studied the risk. The more they studied the easier it was to take on more risk. The longer they kept doing what they had always done, and the more knowledgable they became, the less risky they perceived their behavior. Of course, as we now know, Lehman Brothers took on far more risk than the company, its investors and its regulators could afford.
The other side of this coin is how we perceive things we don’t know. Almost none of the buggy manufacturers in the early 1900’s transitioned to making automobiles. To them automobile manufacturing involved engines, and that was too risky. By the time buggy manufacturers felt they had to change, it was too late. When we are brought new opportunities to evaluate we don’t evaluate the real merits of upside and downside. Instead, we first question if the opportunity falls into our realm of expertise. If not, we deem it too risky. Because we don’t know much about it, we choose to think it’s too risky for us. Yet, the risk might be quite low.
Take for example buying Microsoft stock in the early 1990s as PC sales skyrocketed and Microsoft already had a monopoly on operating systems – and was building its monopoly in office software. The risk was quite small, since all Microsoft needed was for PCs (PCs made by anybody – it didn’t matter) to continue selling. That was not a high-risk bet. Yet most investors shied away because they didn’t understand tech stocks – including Warren Buffet who famously bought a mere 100 shares, declaring he didn’t understand the business! (Just think, if Warren Buffet had bought a large chunk of early Microsoft, he’d be as rich as himself plus Bill Gates today – now that’s a mind-boggler.)
When markets shift, relative risk can be deadly. If we continue to perceive things we know as low risk, we will "double down" our bets on customers, market segments, technologies and products that have declining value. If we think that doing what we always did will produce old returns we will do what’s comfortable, even when the market is moving headlong toward new solutions. Look at U.S. manufacturers of televisions (remember Quasar, Magnavox and Philco?). Experts in vacuum tubes and other analog technologies, plus the manufacturing expertise for those components, they were all late seeing the shift to solid-state electronics and all ended up out of business. All that expertise in the old technology simpy wasn’t worth much when the markets shifted – even though the new technology seemed risky while the old technology seemed familiar, and reliable.
When markets shift, the greatest risk is the "do what we know" scenario. Although it’s the easiest to approve, and the most comfortable – especially at times of rapid, dynamic change – it is the one scenario guaranteed to have worsening results. There’s an old myth that the last buggy whip manufacturer will make huge profits. Guess again. As buggy whip demand declines everyone loses money until most are gone. But there isn’t just one remaining player. The few who remain constantly see prices beaten down by the excess capacity of buggy whip designers, manufacturers and parts suppliers ready to jump in and compete on a moment’s notice. Trying to be last survivor just leaves you bloody, beaten up and without resources to even feed yourself.
It’s not worth spending a lot of time trying to evaluate risk. Because rarely (maybe never) in business is there such a thing as "absolute risk" you can measure. Risk is relative. What might appear risky could well be merely a perception driven by what you don’t know. What might appear low risk could be incredibly risky due to market shifts. So the real question is, are you Disrupting yourself so you are investigating all the possibilities – good and bad? And are you keeping White Space alive so you are experimenting, testing new ideas? New products, new technologies, new markets, new distribution systems, new components, new pricing formulas, new business models —- new Success Formulas? The only way to avoid arguments of risk is to get out there and do it – so you can get a good handle on what works, and what doesn’t, in order to make decisions based on opportunity assessment rather than Lock-in.
by Adam Hartung | Oct 14, 2008 | Uncategorized
On Monday the Dow Jones Industrial Average jumped almost 1,000 points. Just as I was saying most investors should be selling equities. Do I wish I hadn’t said that? Well………no.
We’ve seen a lot of things change the last 8 years as globalization has impacted everyone. We saw a "crisis" in manufacturing as the offshore trends of the 1980s became a wholesale exodus of manufacturing from the developed to the developing world. We saw one of the largest white collar occupations in the developed world, IT services, undergo a crisis as everything from programming to data center management underwent wrenching change. Even the largest players shifted from EDS and Accenture to TCS and Infosys (both of which keep wracking up double digit quarterly growth along with 40% margins!) And more recently we’ve seen financial services start the shift from national to global as large American (and some large European) banks, insurance companies and investment banks are seeing their assets and reserves dwindle and governments are stepping in with quasi-nationalization programs.
There are still many industries that will see several more shifts. Today the "medical tourism" market is in its humblest beginnings – yet the trend toward people flying from the developed countries to less developed for everything from hip replacements to heart surgery is happening (read article here). And bio-engineering research has flourished outside the U.S. while domestic bans and grant-letting risk aversion has led to reductions in everything from stem-cell research to human application of bio-engineered products. Big changes are still in front of us. As are changes in who makes automobiles and airplanes – as well as who builds national or state infrastructure (in the USA and in the developed world) – and what brands remain leaders and which emerge.
So if the 900+ point jump in the DJIA made you more comfortable, it’s just the calm before the storm – or maybe the eye of the hurricane. More is coming. The jump did not indicate a "return to normal", but rather simply a daily reaction to events – in this case global action to shore up bank reserves with public money. From 1980 through 2000 was the greatest run in the history of American equities. It was possible to make money simply by purchasing index funds (baskets of equities) and holding them. But that era has passed. And things are going to change. Global market shifts cannot be ignored even by large American institutions – be they governmental (the SEC or FDIC), quasi-governmental (Freddie Mac and Fannie Mae) or non-governmental (Bear Sterns, Lehman Brothers, AIG, etc.). Now that the world has been populated with a large number of private equity funds and hedge funds, the landscape has changed for investors – in the USA and around the world.
Does that mean all equities will do poorly? Of course not. But only those who adjust to market shifts will do well. Johnson & Johnson has long been a company that uses internal Disruptions and maintains White Space to find opportunities for global growth. And we’re seeing that amidst the recent market problems J&J is announcing it will continue to grow sales and profits through its combination of consumer goods, medical devices and prescription drug products sold in the USA and around the world (read article here.) Meanwhile PepsiCo – one of the globe’s best known branded goods companies – announced it sees itself tied up in knots by fluctuating commodity prices and softening of beverage and snack sales. PepsiCo is expecting a profit problem, and is planning layoffs (read article here.) Even though Pepsi was the first soft drink company to globalize, it’s not adjusting fast enough and effectively enough to market shifts.
So, it will be up to investors to be a lot more careful about investing in the future. What used to portend high rates of return cannot be depended upon any longer. For many Americans, they will for the first time have to get a lot smarter about non-U.S. companies. And they will have to invest based upon future market positions – which could change rapidly – not based upon company legacies. Because overall, we can expect a lot of change among the market leaders as this shifting economy accelerates.
In the end, those businesses that spend a lot of time scenario planning the future will do better than those who try to focus on past "core" businesses. Those who obsess about competitors will do a lot better than those who obsess about "execution." Those who frequently Disrupt themselves in order to avoid Defending & Extending the past will do better than those who seek to reinforce Lock-in. And those who keep White Space alive with new projects that have the permission and resources to define a new Success Formula will do the best of all. And finding these companies will be harder and harder in a world where the private equity and hedge fund managers can create their own deals (like the recent Berkshire Hathaway investment in GE) than individuals will be able to do – because the investment banks are rapidly losing their positions as the brokers.
by Adam Hartung | Oct 10, 2008 | Defend & Extend, General, Leadership, Lifecycle, Openness
We talk a lot about evolving markets. When we use that phrase, evolving, we think of gradual change. In reality, evolutionary change is anything but gradual.
People think of change as happening along the blue line to the left. A little change every year. But what really happens is like the red line. Things go along with not much change for a very long time, then there’s a dramatic change, and then an entirely new "normal" takes hold. This big change is what’s called a "punctuated equilibrium."
What we’ve recently seen in the financial services industry is a punctuated equilibrium. For years the banks went along with only minor change. They kept slowly enhancing the products and services, a little bit each year. Regulations changed, but only slightly, year to year. Then suddenly there’s a big change. Something barely understood by the vast majority of people, credit default swaps tied to subprime mortgage backed securities, became the item that sent the industry careening off its old rails. That’s because the underlying competitive factors have been changing for years, but the industry did not react to those underlying factors. Large players continued as if the industry would behave as it had since 1940. Now, suddently, the fact that everything from asset accumulation to liability management and regulation will change – and change rapidly.
When punctuated equilibrium happens, the old rules no longer apply. The assumptions which underpinned the old economics, and norms for competition, become irrelevant. Competition changes how returns will be created and divvied up. Eventually a new normal comes about – and it is always tied to the environment which spawned the big change. The winners are those who compete best in the new environment – irrespective of their competitive position in the old environment. The one thing which is certain is that following the old assumptions is certain to get you into trouble.
I’ve been surprised to listen to "financial experts" on ABC and CNBC advising investors since this financial services punctuated equilibrium hit. Consistently, the advice has been "don’t sell. Wait. Markets always come back. You only have a paper loss now, if you sell it becomes a real loss. Just wait. In fact, keep buying." And I’m struck as to how tied this advice is to the old equilibrium. Since the 1940s, it’s been a good thing to simply ride out a downturn. But folks, we ain’t ever seen anything like this before!! This isn’t even the Great Depression all over again. This is an entirely different set of environmental changes.
In reality, the best thing to have done upon recognizing this change would be to sell your equities. The marketplace is saying that global competition is changing competition. How money will be obtained, and how it will be doled out, is changing. Old winners are very likely to not be new winners. Competitive challenges to countries, as well as industries and companies, means that fortunes are shifting dramatically. No longer can you consider GM a bellweather for auto stocks – you must consider everyone from Toyota to Tata Motors (today the total equity value of Ford plus GM is 1/10th the value of Toyota). No longer can you assume that real estate values in North America will go up. No longer can you assume that China will buy all the U.S. revolving debt. No longer can you assume that America will be the importer of world goods. How this economic change will shake out – who will be the winners – is unclear. And as a result the Dow Jones Industrial Average has dropped 40% in the last year.
To all those television experts, I would say they missed the obvious. How can it be smart to have held onto equities if the value has dropped 40%? Call it a paper loss versus a real loss – but the reality is that the value is down 40%! To get back to the original value – to get your money back with no gain at all – will take a return of 5% per year (higher than you could have received on a guaranteed investment for the last 8 years) for over 10 years! That’s right, at 5% to get your money back will take 10 years!! Obviously, you would have been smarter to SELL. And every night this week, as the market fell further, these gurus kept saying "hold onto your investments. It’s too late to sell. Just wait." Give me a break, if the market is dropping day after day, how is it smart to watch your value just go down day after day! You should quote Will Rogers and say to these investment gurus "it’s not the return on my money I’m worried about, it’s the return of my money"!!
Or read what my favorite economist, Mr. Rosenberg of Merrill Lynch wrote today "There is no indication…that the deterioration in the fundamentals is abating…all the invormation at hand suggests that the risk of being underinvested at the bottom is lower than the risk of being overexposed to equities….in other words, the risk of geing out of the market right now is still substantially less than the risk of continuing to overweight stocks…what matters now is to protect your investments and preserve your capital." (read article here)
The world is full of conventional wisdom. Conventional wisdom is based on the future being like the past. But when punctuated equilibrium happens, the future isn’t like the past. And conventional wisdom is, well, worthless. What is valuable is searching out the new future, and learning how to compete anew. Right now it’s worth taking the time to focus on future competitors and figure out how you can take advantage of serious change to better your position. You can come out on top if you head for the future – but not if you plan for a return to the past.
by Adam Hartung | Oct 9, 2008 | Defend & Extend, General, In the Swamp, Leadership, Lifecycle, Lock-in
The news is really bad in the auto business. For the first time since 1993 the number of cars sold in the USA in a month has declined to below one million. Sales are down over 25% from the previous year. And sales are predicted to decline considerably more in 2009. The value of General Motors (chart here) has declined to what it was in 1950 – when the Dow Jones Industrial Average was about 269 (GM is a component of the DJIA). (Read article here.) In the 1960s, when GM was king of the industrial companies, a popular phrase was "As goes GM, so goes America." This was based on the notion that GM was a microcosm of the American industrial economy. Is this still true – does GM portend the future of America?
A lot has changed in the last 40 years. Most importantly, the globe is no longer dominated by an industrial economy. Fewer and fewer people are employed in industrial production. We see it all around us as we realize that there are more people writing computer code than making computers. We’ve shifted to an information economy. Companies that ignored this shift, like GM, without finding opportunities to get into the growth economy are now suffering. GM started down the new road once, in the 1980s, by purchasing EDS and Hughes electronics. But later GM leadership sold those businesses in order to "focus" on the auto business. So now it’s only natural to recognize that the most industrial of the industrial companies are at the greatest risk of failure. No longer is GM a microcosm of any economy – including America. As GM goes so goes GM – but that doesn’t say anything about the future of America.
Some companies have shifted. They find new opportunities for growth. Today, wind energy is getting a big lift due to higher costs for petroleum fuels and increasing restrictions on greenhouse gases from using fossil fuels. Wind farms already exist offshore European countries, producing over 1,100 megawatts of power. Now such farms are being built not only on the great prairies of Texas and the American plains, but off the eastern U.S. coastline (read article here.) While there isn’t much interest for investing in auto manufacturing, there is lots of interest for investing in these wind farms to produce electricity – especially in high-cost electricity locations along the eastern seaboard.
And in the middle of this market we find – General Electric (see chart here). GE is the only U.S. company that makes wind turbines, and is a leader in promoting the new source of power. While many people have fixated on GE Financial and its woes, they have ignored the fact that GE is an American leader in many markets seeing rapid growth globally – such as wind power, water production, health care equipment and municipal infrastructure development. These markets are benefitting from the ecomomic boom in China, India and other developing countries, as well as emerging growth in the USA.
Any country’s economy can continue growing if it develops Phoenix companies that keep their eyes on the future and create White Space projects to keep them moving toward growth. These companies don’t fall into the trap of being "focused" on a single business, and dependent upon growth within that historically defined market. They constantly look for places to grow, regardless of what the company has previously done, and develop opportunities to learn in those new markets so they can create a new Success Formula maintaining growth. As long as America has companies that keep repositioning themselves for growth – such as GE, IBM, Cisco Systems, Apple, Google, Genentech, Johnson & Johnson, Baxter, etc. – America can have a great future.
by Adam Hartung | Oct 9, 2008 | General, Leadership, Quotes
Here’s some quotes issued today (October 9, 2008) by Merrill Lynch’s top economist, David Rosenberg (see full article here) :
"Desperate times require desperate actions and it is possible Ben Bernanke, despite his expertise in how to tap the entire toolbox of the central bank, hasn’t experimented enough… Perhaps the Fed should do something even more dramatic… To be sure, monetary policy isn’t the only answer. A large-scale fiscal stimulus, a giant spending package on infrastructure, for example, would be useful to reverse the downtrend in employment and personal income…Our question is if the UK can manage to embark on this quasi-nationalization quest of its banking system, why can’t we?"
Here’s an economist in the largest U.S. brokerage, a very conservative organization, asking why we can’t nationalize banks, or pass a massive public works program. And he wonders why not?
The USA has been dominated by the conservative economic agenda since the landslide victory of Ronald Reagan. At a time of stagflation (no growth yet high inflation and record high interest rates) President Reagan set forth an agenga which changed the economic direction. Since then, the USA has been moving further and further along that agenda. Spending on defense skyrocketed, entitlement programs were cut, industry regulations laxed (including the movement to self-regulate within industries), and taxes reduced. For many people and politicians the objective became less about the results, and instead doing more. Planks of that agenda have been extended for 25 years as the focus has become not on the results – but rather on operating within the parameters of that agenda. Simply put, people believed if we did more, faster of the same things then the original would return.
But this isn’t 1980. And circumstances are far different. Nothing today looks like it did then. Yet, most people are blinded by Lock-in to doing what previously worked, rather than experimenting and trying new things. As serious as the market shift has been, and as great as the Challenges have become, people still have not Disrupted their awareness of the environmental shift. They are trying to use the tools of the last war to fight this new war. Lock-in is keeping them from considering other options.
It’s easy to be reminded of the economist John Keynes, a great influencer of the The New Deal policies of the 1930s. As he proposed the greatest use of debt ever by a government, he was seriously challenged. Leaders asked of him "won’t this debt inevitably lead, in the long-run, to runaway inflation and higher taxation that will cripple the economy?" As he pondered the 20% national unemployment and accelerating bankruptcies he replied "in the long-run, we’re all dead." What Dr. Keynes summed up was that beliefs, theories and assumptions weren’t terribly important. What mattered were results. The traditional economic approaches had led to the 1920s runaway market and resultant collapse – and what he felt the country needed was to put people back to work immediately. He was ready to create some White Space to try something new in search of better results.
Similarly, in the 1970s Dr. Laffer proposed a different approach to economic thinking. Creating something he called the "Laffer Curve" he said that if you cut taxes enough it would spur new investment and ecomomic recovery. Although this had no experiential basis, he felt it was worth a try. And President Reagan, facing the country’s problems proposed an idea that seemed heresy to most – cutting taxes by 50% or more! He was ready to try White Space in the face of an economic Challenge rather than continue the practices which had not improved the economy during the prior 2 administations (Ford and Carter.)
It is very easy to Lock-in on something that works. Once you see it work, you become confident it will work in the future. You start thinking if you do enough of it, it has to work. But markets shift. The marginal value of doing more simply declines. Like eating pie, the first piece is unbelievably good. The second good, but by the fourth you’re not particularly interested any more. While I can be enticed to do a job I don’t like for a piece of pie, after a few pieces I don’t see the value in more pie so I don’t have the same positive reaction. And that is true of Success Formulas. Competitors see the early results. They mimic the behavior, and they work to surpass it. Pretty soon, they offer not only pie, but cake and cookies and lots of competitive ideas. The pie simply doesn’t produce the benefit it once did. And we have to realize that it’s time to experiment and try something new. To do things that may even seem heretical at the time – but which open the doors to potentially new results that get us back on the competitive track.
by Adam Hartung | Oct 8, 2008 | Defend & Extend, General, Leadership, Lifecycle
Today Walgreen’s (see chart here) announced it was dropping its plan to purchase Long’s Drugs (see chart here). (Read article here.) This means a lower offer to buy Long’s from CVS (see chart here) now comes to the forefront. Yet, some of Long’s big shareholders are balking that the CVS bid is too low. And all this amid the most dynamic set of economic circumstances since the 1930s. So, who’s right?
As you might expect, it all depends on your scenario about the future. Walgreen’s has seen it’s equity value fall 50% in the last 2 years. Pretty amazing given that the "core" business is considered highly resistant sales of necessary drug items – after all regardless the economy people get sick and they need medicine. But the reality is that Walgreen’s built its reputation on its Success Formula the last decade of being able to open a new store every 20 hours or so. That’s an easy to understand Success Formula, but it has the obvious downside of identifying the weakness of saturation. To maintain growth, Walgreen’s requires opening more and more stores. But there are markets (like the hometown Chicago area) where stores are getting almost every block! People started wondering if Walgreen’s could keep growing once it had to drive more revenue out of existing stores – rather than just opening new ones.
But now real estate is falling in value. And we all know debt is getting harder and more expensive to obtain. It’s going to be harder and harder to borrow money to buy land and put up buildings. We’re also hearing that pension payments are going to be cut, due to lower stock valuations, and money for health care could be harder to come by. Looking forward, Walgreen’s decided it was smarter to focus on its existing stores than taking on a slug of new debt and a bunch of new stores. Especially given that many of these new stores (at Long’s) would be redundant to existing Walgreen’s in California — and who’s going to buy the land and buildings or leases for those stores if the economy going forward is as bad as being predicted? Sears (see chart here) buyer Ed Lampert was supposed to make a fortune selling all those Sears buildings – and that hasn’t exactly worked out (to put it mildly).
You have to hand it to a leadership team willing to change course. The good news is that for the last several years Walgreen’s hasn’t just opened new stores. The company has experimented with all kinds of new sales initiatives – from printing photos to refilling ink cartridges to selling groceries and even clothing. Unfortunately, many of those efforts took a back seat to new store openings. Walgreen’s didn’t see them as Disruptive growth opportunities, and they weren’t given White Space with permission to do whatever was necessary to succeed, nor the dedicated resources to really develop an alternative Success Formula. So they were just experiments with minimal impact. But now, for Walgreen’s to keep growing, it will have to do some Disrupting and put those projects front and center. The company will have to put some serious energy into learning if it can bring out its own high-end cosmetics line (aborted), or it’s own designer clothing (aborted) or capture decent share in selected office supplies versus Staples (aborted).
It’s hard for a Locked-in organization to change course. The momentum to keep doing what was always done is enormous. For Walgreen’s it must have appeared oh-so-tempting to buy Long’s. "Damn the Torpedos, full speed ahead" is such an easy cry for the company skipper to make. But here it really appears that some good scenario planning has kept the company from running headlong into a deal that could bankrupt the business if things do go southward economically (as it appears).
But to regain its previous success, Walgreen’s now has to change its Success Formula. And that requires more than walking away from a deal. It requires implementing a Disruption and getting serious about White Space to figure out what will make Walgreen’s the super-retailer of 2020. The company made a good move today, and now we’ll have to see if they can follow through.
Meanwhile, if you own Long’s Drug you should sell as fast as possible. The company value has increased 4x in the last 4 years – with a huge pop based on the acquisition discussions. And the company has no plan for how to grow enough to maintain the recent value. If CVS is willing to purchase Long’s, sell to them. What we can be sure of is that the saturation of drug stores has already begun, and any business that has too many assets, and too much debt, is not a good place to be invested. Better to have the cash.
by Adam Hartung | Oct 7, 2008 | General, In the Swamp, Lifecycle, Lock-in
So the stock market is crashing. Is now the time to buy? Many CEOs are asking this question.
The problem is that too often people try to buy a company that’s "cheap", using its past history as the basis. Take Bank of America (see chart here). BofA earlier this year bought the most troubled of all the mortgage companies Countrywide Financial. And then when Lehman Brothers was falling into bankruptcy BofA purchased Merrill Lynch, a retail stock brokerage that has been realing from on-line competition since e*Trade started in the 1990s, has one of the weakest mutual fund departments, one of the weakest research departments and a weak investment bank. BofA’s view was that based upon history, these companies were very cheap. But now, shortly after the acquisitions, BofA is announcing that it must halve its dividend, and raise additional equity through a new stock sale in order to shore up its balance sheet. And on top of this, earnings are down for the quarter and the year as the CEO starts claiming that estimates are pretty meaningless (read article here). Should you buy the new stock offering?
When markets shift, the value of assets tied to old Success Formulas decline. In the new market, the old Success Formula produces weaker returns and thus it is worth less. Too many people see this lower value as being a chance to "buy on the cheap." But far too often value will continue to decline because the old business simply isn’t worth as much. In Bank of America’s case, it bought extremely large players, but those that are inexorably linked to the old markets with old Success Formulas that are fast becoming out of date. While Merrill Lynch may be a great old name, the company itself has never been able to produce its old level of returns since brokerage markets shifted over a decade ago. Increasingly, it looks like BofA simply bought out-of-date competitors that were finding themselves on the rope as this market shift happened. And the BofA leadership is even leaving the old leaders in place after the acquisition.
Just in case you think that all the strategy and finance brains in big corporations means they are better judges of company value than yourself, remember that very rarely does any acquisition become worth what it cost. All finance academicians point out that buyers overvalue acquisitions in the process. In the end, it’s the buyers that see valuations suffer due to lower than anticipated earnings. In this case, BofA has bought large – but weak – competitors in markets reeling from shifts. And BofA has shown no proclivity to take dramatic changes to alter the Success Formulas (which JPMorgan Chase did upon acquiring Bear Sterns for almost nothing). This is a recipe for weak future performance.
Those companies that will benefit from acquisitions in this turmoil will have to purchase companies that better position the acquirers for future growth. Leaders not necessarily in size, but in the ability to produce growing revenues and profits. And acquisitions which can help migrate the acquirer’s Success Formula forward toward better competitiveness and higher returns – not just adding immediate (but declining) revenue. What’s going on at BofA may look like an effort to "buy on the cheap," but it’s more likely to end up "a pig in a poke."
