Like The Best Tech Companies, Publicis Launches A Great Strategic Pivot

Like The Best Tech Companies, Publicis Launches A Great Strategic Pivot

by | Jun 23, 2017 | Disruptions, Innovation

People like to discuss “strategic pivots” in tech companies.  The term refers to changing a company’s strategy dramatically in reaction to market shifts. Like when Apple pivoted in 2000 from being the Mac company to its focus on mobile, which lead to the iPod, iPhone, and other mobile products.  But everyone needs to know how to pivot, and some of the most important pivots haven’t even been in tech.

Take for example Netflix.  Netflix won the war in video distribution, annihilating Blockbuster.  But then, when it seemed Netflix owned video distribution, CEO Reed Hastings pivoted from distribution to streaming.  He cut investment in distribution assets, and raised prices.  Then he spent the money learning how to become a tech company that could lead the world in streaming services.  It was a big bet that cannibalized the old business in order to position Netflix for future success.

Analysts hated the idea, and the stock price sank.  But CEO Hastings was proven right.  By investing heavily in the next wave of technology and market growth Netflix soared toward far greater success than had it kept spending money in lower cost distribution of cassettes and DVDs.

(From L to R) Philippe Dauman, US actress and singer Selena Gomez, MTV President Stephen Friedman and US director Jon Chu attend a Viacom seminar during the 59th International Festival of Creativity – Cannes Lions 2012, on June 21, 2012 in Cannes, southeastern France. The Cannes Lions International Advertising Festival, running from June 17 to 23, is a world’s meeting place for professionals in the communications industry.  (VALERY HACHE/AFP/GettyImages)

This week Arthur Sadoun, the CEO of the world’s third largest advertising agency (Publicis) announced he was betting on a strategic pivot.  And most in the industry questioned if he made a good decision.

Simply put, CEO Sadoun announced at the largest ad agency awards conference, the Cannes International Festival of Creativity, that Publicis would no longer participate in Cannes.  Nor would it participate in several other conferences including the very large South by Southwest (SXSW) and Consumer Electronics Show (CES.)  Instead, he would save those costs to invest in AR (artificial or augmented reality.)

In an industry long dominated by highly creative people who love mixing with other agency folks and clients, this was an enormous shock.  These conferences were where award winners marketed their creative capability, showing off how much they were admired by peers.  And they wined and dined clients seeking to build on awards to gain new business.  No one would expect any major agency to drop out, and most especially not an agency as large as Publicis.

In changing markets strategic pivots make sense.

And strategically this pivot makes a lot of sense.  The ad industry was once dominated by ads placed in newspaper, magazines and on TV.  But today print journalism is almost dead.  The demand for print ads is a fraction of 20 years ago.  And TV is no longer as prevalent as before.  Today, people spend more time looking at their smartphone than they do their TV.  The days of thinking high creativity would lead to high sales are in the past.  Fewer and fewer big advertisers care about who wins awards, and fewer are going to these conferences to decide who they would like to hire.

Today advertising is going “programmatic.”  Increasingly ads are placed by computers, on web and mobile sites.  Advertising is about finding the right eyeballs, at the right time, next to the right content in order to find a buyer.  Advertisers no longer spend money lavishly on mass media hoping for good results.  Instead ads are targeted, measured for response and evaluated for ROI based on media, location, user and a raft of other metrics.

And the industry has changed.  There still is an advertising agency business.  But it is under attack from tech companies like Google, Facebook, Twitter and Snap that promote to advertisers their ability to target the right clients for high returns on money spent.  The content is important, but today almost everyone in the industry will tell you success depends on your budget and how you spend it, not the creative.  And that is a lot more about understanding how we’re all interconnected, knowing how to measure device usage, profiling user behavior and programming the computers to put those ads in the right place, at the right time.

To pivot you must stop doing the old to start doing the new

Publicis has something like $10B in revenue.  Thus, dropping $20M on filing award applications at events like Cannes, and sending a contingent of employees to receive awards, meet people and have fun doesn’t sound like a lot.  But multiple that across the year and the total amount could well come to $100M-$200M.  That’s still only 2% of revenues – at most.  It would seem like not that much money given what has been a core part of historical marketing.

But, if Publicis is to compete in the future with the tech leaders, and emerging digital-oriented agencies, it has to develop technology that will make it a leader.  Publicis can’t invent money out of thin air, so it has to stop doing something to create the funds for investing in what’s coming next.  And stopping investing in something as “old school” as Cannes actually sounds really smart.  As boomer ad execs retire the newer generation is not going to conventions to find agencies, they are looking under the hood at the technology engines these companies provide.

In new strategic areas a little money can go a long way

And while $100M to $200M may not sound like a lot, it is enough money to make a difference in creating a tech team that can work on future-oriented technology like AI.  If spent wisely, that could truly move the needle.  If Publicis could demonstrate an ability to use proprietary AI technology to better place ads and manage the budget for higher returns it can survive, and perhaps thrive, in a digitally dominated ad industry future.  At the very least it can find its place next to Facebook and Google.

WPP, Omnicom and Interpublic should take serious notice.  Will they succeed in 2025 if they keep marketing the way they did in 1985?  Will this spending grow revenues if customers really don’t care about creative awards?  Will they remain relevant if  they lack their own technology to develop ads, campaigns and demonstrate positive rates of return on ad dollars spent?

CEO Sadoun’s approach to make the announcement without a lot of preliminary employee discussion shocked a lot of folks.  And it shocked the festival owners who now have to wonder what the future of their business will be.  But strategic pivots are shocking.  They demonstrate a dramatic shift in how resources are deployed to position a company for the future, rather than simply trying to defend and extend the past.

It’s a lot smarter to try what you don’t know than hope everything will stay the same.

Will this work?  There is no way to know if the Publicis leadership team can maneuver through the technology maze toward something great.  But, at least they are trying.  And that alone gives them a lot better shot at longevity than if they simply decided to do in 2018 what  they have always done.  Is your company ready to reassess its preparation for the future and address your strategy like you’re a tech company?  Are you spending money on market shifts, or simply doing the same thing you’ve always done?

The 9 Reasons Why Amazon Buying Whole Foods Is A Good Idea

The 9 Reasons Why Amazon Buying Whole Foods Is A Good Idea

by | Jun 16, 2017 | Disruptions, Innovation

Whole Food flagship store in Austin, Texas.

Amazon announced it was paying $13.7B to buy Whole Foods.  While not without risks, there are a lot of reasons this is a great idea:

1 – It makes Amazon a national grocery competitor overnight

Building any retail chain takes a long time.  Due to the intensity of competition, and low margins, building a grocery chain takes even longer.  Amazon would have spent decades trying to create its own chain.  Now it won’t lose all that time, and it won’t give competitors more time to figure out their strategies.

2- Now Amazon can get the necessary “deal dollars” to compete in groceries

Few people realize that no grocer makes money selling groceries. Revenues do not cover the costs of inventory, buildings and labor. On its own, selling groceries loses money.  Grocers survive on manufacturer “deal dollars.”

Companies like P&G, Nabisco, etc. pay grocers slotting fees to obtain shelf space, they pay premiums for eye level shelves and end caps, they pay new product fees to have grocers stock new items, they pay inventory fees to have grocers keep inventory on shelf and in back, they pay advertising fees to have signs in the stores and products in circulars, and they pay volume rebates for meeting, and exceeding, volume goals.  It is these manufacturer “deal dollars” that cover the losses on the store operations and create a profit for investors.

One reason Whole Foods prices are so high is they stock less of the mass market goods and thus receive fewer deal dollars.  Now Amazon can use Whole Foods to increase its volume in all products and dramatically increase its deal dollar inflow.  Something that Amazon sorely missed as a “delivery only” grocer.

3 – Amazon obtains a grocery distribution system

Grocery distribution is unique.  For decades grocers have worked with manufacturers, cooperatives, growers and other suppliers to create the shortest, most efficient distribution of food with the lowest inventory. In many instances replenishment quantities are shipped based on manufacturer access to real grocer sales data. Amazon is the best at what it does, but to compete in groceries it needed a grocery distribution system – and with Whole Foods it obtains one at scale without having to create it.

Additionally Amazon will obtain the corporate infrastructure of a grocer, without having to build one on its own.  All those buyers, merchandisers, real estate professionals, local ad buyers, etc. are there and ready to execute – something building would be very hard to do.

4 – Amazon obtains great locations

Whole Foods has 460 stores, and almost all are in great locations. Whole Foods focused on upscale, growing and often urban or suburban locations – all great for Amazon to grow its distribution footprint.  And hard sites to find.

These can be used to sell other products, such as other grocery items, or some selection of Amazon products if that makes sense.  Or these can be used to augment Amazon’s distribution system for local delivery – or as neighborhood drop-off locations for people who don’t want at-home delivery to pick up Amazon-purchased products. Or they can be sold/leased at very attractive prices.

5 – Amazon can change the Whole Foods brand in important, positive ways

“Whole Paycheck” has long been the knock on Whole Foods.  As mentioned before, the lack of mass market items meant their products lacked deal dollars and thus had to be priced higher. And their stores are large, and not the best use of space. The result has been a lot of trouble keeping customers, and one of the lowest sales per square foot in the grocery industry.

Amazon can easily use its low-price position to alter the Whole Foods brand concept to include things like Pepsi, Coke, Bounty, Gain – a slew of branded consumer goods previously eschewed by Whole Foods.  Adding these products could make the stores more useful to more customers, and greatly lower the average cost of a cart full of goods.  On its own, this brand transition has been impossible for Whole Foods.  As part of Amazon remaking the brand will be vastly easier.

6 – Amazon can personalize grocery shopping like it did general merchandise

If you shopped Amazon you know they really figure out your needs, and help you find what you want.  Amazon keeps track of your searches and purchases, and makes recommendations that often help the shopping experience and delight us as customers.

But today all that information on grocery shopping is un-mined.  Despite using a loyalty card, traditional grocers (and WalMart) have been unable to actually mine that information for better marketing. Now Whole Foods will be able to use Amazon’s incredible technology skills, including big data mining and artificial (or augmented) intelligence to actually help us make the grocery shopping experience better – less time intensive, and most likely less costly while still allowing us to fill our carts with what we need and what makes us happy.

7 – The deal is cheap

$13.7B is only 65% of the cash Amazon had on hand end of last quarter.  And Amazon has only $7.7B in long-term debt.  With a $460B market cap Amazon could easily take on more debt without adding significant financial risk.

But even more important, Amazon has the amazingly cheap currency that is Amazon stock.  Even at the offering price, Whole Foods trades at 34x earnings.  Amazon trades at 185x earnings.  Thus by swapping Amazon shares for Whole Foods shares Amazon lowers the price 80%!  Amazon isn’t spending real dollars, it is using its stock – which is an incredibly valuable move for its shareholders.

8 – This is a serious attack on WalMart

For the last several years WalMart’s general merchandise sales have been declining due to the Amazon Effect and growing on-line competitor sales.  For the last 3 years overall revenues have not grown at all.  To maintain revenue Walmart has shifted increasingly to groceries – which account for well over half of all WalMart revenues. By purchasing Whole Foods, Amazon takes direct aim at the only part of WalMart’s “core” business that it has not attacked.

Walmart’s net profit before taxes is ~4%. If Amazon can use Whole Foods to combine stores and on-line sales to take just 3% of WalMart’s grocery business away it could remove from Walmart ($485B revenues * 60% grocery * 3% market share loss) a net revenue decline of ~$9B.  Given that the cost of grocery goods sold is about 50% – that would mean a net loss in contribution of $4.5B – which would cut almost 25% out of Amazon’s $20B pre-tax income.  Raise the share taken to 5% and Amazon could cut WalMart’s pre-tax income by $7.25B, or ~35%.

The negative impact of declining store sales on the fixed costs of WalMart is atrocious. Even small revenue drops mean cutting staff, cutting inventory, cutting store size and eventually closing stores.  Look at how fast Sears and Kmart fell apart when sales started declining.  Like dominoes falling, declining sales sets off a series of bad events that dooms almost all retailers – as the quickened pace of retail bankruptcy filings has proven.

9 – This could be a huge win for Amazon shareholders

The above analysis, taking 3-5% out of Walmart’s grocery sales, say over 3 years, would be a huge gain attributed to the creation of a new Whole Foods combined with Amazon’s e-commerce.  Growing grocery revenues by $9-$14B would mean practically a doubling of Whole Foods.  Which sounds enormous – and most likely impossible for Whole Foods to do on its own, even if it did launch some kind of e-commerce initiative.

But this is not so unlikely given Amazon’s track record.  Amazon has been growing at over 25%/year, adding between $20-$25B of new revenues annually. In 3 years between 2013 and 2016 Amazon doubled its revenues.  So it is not that unlikely to expect Amazon puts forward an extremely ambitious push to turn around Whole Foods, increase store sales and use the combined entities to grow delivery sales of groceries and other general merchandise.

Is there risk in this acquisition?  Of course.  Combining any two companies is fraught with peril – combining IT systems, distribution systems, customer systems and cultures leaves enormous opportunities for missteps and disaster.  But the upsides are enormous.  Overall, this is a bet Amazon investors should be glad leadership is making – and it is a great benefit for Whole Foods investors.

As Immelt Leaves GE, Investors And Employees Have Little To Cheer

As Immelt Leaves GE, Investors And Employees Have Little To Cheer

by | Jun 12, 2017 | Defend & Extend, Innovation, Leadership

GE Chairman and CEO Jeff Immelt walks off stage after being interviewed during the Washington Ideas Forum at the Harmon Center for the Arts September 28, 2016 in Washington, DC. A proud Republican, Immelt said it would hurt the United States and cripple President Barack Obama — and the next president of the U.S. — not to agree to trade deals like theTrans Pacific Partnership (Photo by Chip Somodevilla/Getty Images)

Readers of this column know I’m not a fan of General Electric’s CEO, Jeffrey Immelt.  In May, 2012 I listed CEO Immelt as the 4th worst CEO of a large publicly traded American company.  Unfortunately, his continued tenure since then did nothing to help make GE a stronger, or more valuable company.  GE’s lead director says this is the culmination of a transition plan first developed in 2011.  One can only wonder why it took the board so incredibly long to replace the feckless CEO, and why they allowed GE’s leadership to continue destroying shareholder value.

The longer back you look, the worse Immelt’s performance appears.

Few company analysts can say they’ve followed a company for 3 years. Fewer yet can say 5 years.  Nearly none can say a decade.  Yet, CEO Immelt was in his job for 16 years – much longer than almost all business analysts or writers have followed GE.  Therefore, their lack of long-term memory often leaves them unable to give a proper overview of the company’s fortunes under the long-lived CEO.

I have followed GE closely for almost 35 years.  Ever since I graduated from HBS class of 1982 along with Mr. Immelt. Several fellow alumni worked at GE, and a large number of my BCG (Boston Consulting Group) colleagues joined GE in senior positions during the mid-1980s as GE grew exponentially. I have followed several of these alumni as the years passed allowing me to take the “long view” on GE’s performance, during Welch’s leadership and more recently since Mr. Immelt took the top job.

I was very pleased to include a positive case study of GE’s business practices in my book “Create Marketplace Distruption – How to Stay Ahead of the Competition” (Financial Times Press, 2007.)  CEO Welch used a number of internal processes to help GE leaders identify disruptive opportunities to change industries – whether markets where GE already competed or new markets.  He relentlessly encouraged entering new businesses where GE could bring something new to the game, and he put GE’s money to good use growing revenues, and market cap, enormously.  No other CEO in American history made as much value for shareholders as Jack Welch.  His leadership pushed GE to the top position in most industries, and his relentless focus on growth helped even rank-and-file employees build million dollar IRAs to go with well funded pension and retiree benefit plans.

GE’s performance could not have changed more dramatically than it has under Mr. Immelt. But there are now a number of apologists who would say GE’s smaller size, and lower valuation, are due to market conditions which were out of Mr. Immelt’s control.  They contend CEO Immelt was a good steward of the company during difficult market conditions, and the results of his tenure – notably lower revenues, lower valuation, fewer markets, fewer employees and lower community involvement – are not his fault.  They argue he did a good job, all things considered.

Balderdash. Immelt was a terrible CEO

There is an overall reluctance to say bad things about any huge American icon, and its CEO. After all, columnists and analysts who are non-congratulatory don’t usually get called by the company to be consultants, or advisors.  Or to be on the board.  And publishers of columnists who say negative things about big companies and their execs risk having ad dollars moved to more favorable journals, and often unfriendly relationships with their ad departments and agencies.  So it is far easier, and more acceptable, to sugar coat bad strategy, bad leadership and bad results.

But we should move beyond that bias. Mr. Immelt was the CEO of the ONLY company on the Dow Jones Industrial Average (DJIA) to have been on that list since it was created.  He inherited the most successful company at creating shareholder value during the 1980s and 1990s.  He surely should be held to the highest of comparative bars.

Those who say CEO Immelt was “set up to fail” are somehow making the case that Immelt would have been more successful if he had inherited a company with a bad brand image, weak history, and inadequate performance.  They are rewriting history to say Jack Welch was not a good CEO, and his outsized gains destined GE to do poorly under his successor.  That simply defies the facts – and logic.

Looking at the last 16 years of “difficult times,” when GE has struggled under Immelt’s leadership, one should ask “why did so many other companies do so well?”  After all, the DJIA has more than doubled.  The S&P 500 has almost doubled.  The Russell 2000 has almost tripled. Overall, far more companies have gone up in value than down.  Why were Immelt’s circumstances so difficult that all of those CEOs did so much better?  They dealt with the same financial meltdown, same Great Recession, same increase in regulations, same federal reserve, same government administration – yet they were able to adapt their companies, grow and increase value.

Yes, GE was huge in financial services when Immelt took the reigns, and financial services saw a major crash. But look at the performance of JPMorganChase under CEO Jamie Dimon (also a classmate of Mr. Immelt.)  JPM is stronger today than ever, growing and gaining market share and increasing its value to shareholders.  Prior to the crash, in spring 2007, GE was trading at $41/share, and now it is $29 – a decline of ~30%. Back then JPM was trading at $53, and now it is $93 – a gain of ~75%.  There obviously was a strategy to adapt to market conditions and do well.  Just not at GE.

Immelt reacted to market events, poorly, rather than having a prepared, proactive strategy

Let’s not rewrite history.  Prior to the banking crash CEO Immelt was more than happy for GE to be in the “easy money” world of finance.  Welch had created GE Capital, and Immelt had furthered its growth when lending was easy and profitable.  And he supported the enormous growth in GE’s real estate division.  When this industry faced the crash, GE faced a near-bankruptcy not because of Welch, but because of Immelt’s leadership during the over 6 years he had been CEO.  If there were risks in the system CEO Immelt had ample time to re-arrange the portfolio, reduce lending, offload financial assets and reduce exposure to real estate and mortgages.  But Immelt did not do those things.  He did not prepare for a reversal in the markets, and he did not prepare the balance sheet for a significant change of events.  It was his leadership that left GE exposed.

As GE shares fell to $7  Immelt made a famous deal with Berkshire Hathaway’s CEO Warren Buffet to increase GE’s capital base in order to stave off demise. And this deal saved GE.  But this was an extremely sweet deal for Buffett, giving Berkshire very good interest (10%) on the preferred shares and warrants allowing Buffett to buy future shares of GE at a fixed price.  Berkshire made a profit, over and above the interest, of $260M on the deal, and overall at least $1.2B.  By being prepared Buffett saved GE and made a lot of money. GE’s investors paid the price for a CEO that was unprepared.

But the changes brought about by the crash, and Dodd-Frank, were more than CEO Immelt could manage.  Thus GE exited the business selling many assets at fire sale prices.  This “turn tale and run” strategy was sold to the public as a way for GE to “focus” on its “core manufacturing business.”  Rather, it was a failure of leadership to understand how to manage this business to future success in changed markets.  Where Welch’s GE had grasped for disruption as opportunity, Immelt’s GE gasped at disruption and fled, destroying billions in GE value.

Immelt could not grow GE’s businesses, so he divested GE of many.

GE was to be the “industrial internet giant.”  GE was to be a leader in the internet-of-things (IoT) where sensors, the cloud and remote devices created greater productivity.  And, to be sure, companies like Apple,  Google and Samsung have made huge gains in this market.  Even small companies, like Nest, were able to jump on this technology shift with new products for the residential market.  But name one market where GE is the dominant IoT player.  During 16 years the internet and remote services markets have exploded, yet GE is not the market leader.  Rather it is barely recognized.

Rather than growing GE with disruptive innovations and visionary products in emerging technology markets, Immelt’s GE was primarily shrinking via divestitures. In dismantling GE Capital he eliminated the lending and real estate operations.  After decades as a leader in appliances, that division was sold. Welch built the extremely successful entertainment division around NBC/Universal, which Immelt sold.

The water business that was to be a world leader under Immelt’s vision, likewise sold – and largely to make sure GE could close the deal on selling its oil & gas unit.  Even the famed electrical distribution business, going back to the start of GE, is now close to being sold.

And what happened to all this money?  Well, about $50B went into share buybacks – which ostensibly would help shareholders.  Only it didn’t, because GE is still worth less than when buybacks started. So the money just disappeared.  At least Immelt could have paid it to shareholders as a dividend – but then that would not have boosted his bonuses.

GE’s website says Mr. Immelt wanted to create a “simpler, more valuable industrial company.”  Mr. Immelt is definitely leaving behind a simpler, much smaller and weaker company.  The brand is gone from consumer products, and severely tarnished in commercial products.  GE lacks a great product pipeline, and even a strong development pipeline due to the rampant divestitures.  When Mr. Flannery takes over as CEO he will not inherit a powerhouse company.  He will inherit a company that is shrinking and rudderless, and disconnected from most growth markets with almost no product, technology or brand advantages.  And he will report to the Chairman that created this mess, Mr. Immelt.

The most likely outcome is that Mr. Peltz and his firm, Trian Partners, will buy more GE shares and seek directorships on the board.  Then, in a move not unlike the deaths of DuPont and Dow, there will be a massive cost cutting effort to bring expenses in-line with the shrunken GE business.  R&D will be discontinued, as will product development.  Support groups will be shredded.  Customer service will be downsized.  Then the remaining pieces will be sold off to buyers, or taken public, leaving GE a dismantled piece of history.

While that may work for the capital markets, and some short-term investors will share in the higher valuation, what about the people?  People who dedicated their careers to GE, and are pensioners or current employees?  What about cities and counties where GE has been a major employer, and civic contributor?  What about customers that bought GE industrial products, only to see those products dropped due to low profitability, or little growth opportunity?  What about suppliers that invested in developing new technologies or products for GE to take to market?  What will happen to the people who once relied on GE as America’s largest diversified industrial company?

These people all have an ax to grind with the very wealthy, and now departing, CEO Immelt.  He inherited what may well have been the most successful company on earth.  He leaves behind a far weaker company that may not survive.

Why the ‘Amazon Effect’ Is So Huge In The USA, And Not In Other Countries

Why the ‘Amazon Effect’ Is So Huge In The USA, And Not In Other Countries

by | May 31, 2017 | Disruptions, Innovation

Originally posted: May 31, 2017

On the day after Memorial Day Amazon stock hit $1,000/share — a new record high. Amazon is up about 40% the last year. It’s market capitalization doubles Wal-mart. And the vast majority of investment analysts expect Amazon to rise further.

The Amazon logo is displayed at the Nasdaq MarketSite, in New York’s Times Square, Tuesday, May 30, 2017. Online retail giant Amazon.com traded above $1,000 a share for the first time. (AP Photo/Richard Drew)

Amazon competes in dozens of international markets, as do many on-line retailers, yet the ‘Amazon Effect’ is far greater in the USA than anywhere else. And there’s a good reason — America is vastly over-served when it comes to traditional retail.

Retail space of various countries adjusted for population

Chart courtesy of Felix Richter, Statista.com https://www.statista.com/chart/9454/retail-space-per-1000-people/

Retail space of various countries adjusted for population

America is enormously over-built with retail space

Looking at square feet of retail space per 1,000 people, this infographic shows that, adjusted for population size, the USA has 8x the retail of Spain, 9x the retail of Italy, 11x the retail of Germany, 22x the retail of Mexico, 51x the retail of China and 400x the retail of India! Overall, this is remarkable. I’ve been to all of these countries, and in none did I feel that I was unable to buy things I needed. Clearly, the USA has had such a robust retail sector that it has dramatically over-expanded – with individual stores, suburban strip malls, elaborate horizontal malls, vertical urban malls and multi-floor urban retail complexes far outpacing the needs of American shoppers.

All these stores created a very competitive retail environment. This competition, and the lack of any sort of national value added tax (VAT,) kept prices for most things in America among the lowest in the world. Simultaneously according to the Department of Labor, Retail is the third largest employer in America. Couple that with the enormous wholesale distribution networks of warehouses and truck fleets — and selling things becomes the country’s largest employer — even bigger than the sum total of all federal, state and local government employees .

Additionally, retail has produced the largest local taxes of any industry, combining local sales taxes with property taxes, which has funded schools and public works projects for decades. And this retail space has helped drive demand for all kinds of support services from utilities to maintenance.

U.S. retail consumers are tremendously over-served, and the market is set to collapse

But now retail is wildly overbuilt. Organic demand for all retail grows about equal to population growth, so about 3%/year.  But retail real estate grew far faster since World War II as developers kept building more malls, and large retailers like Sears, KMart, Walmart, Target, Lowe’s and Home Depot built more stores. Now demand for products through traditional retail is declining. People are simply ordering on-line.

Net/net, America’s consumers are now over-served by retailers. There is too much space, and inventory. And now that store-to-home distribution has faded as a problem, with multiple carriers offering overnight service, people are increasingly happy to avoid stores altogether, greatly exacerbating the overcapacity problem. Thus, the ‘Amazon Effect’ has emerged, where stores are closing at a rapid rate and many retailers are failing altogether leaving vast amounts of empty retail space.

Foreign markets are under-served, and benefit from Amazon’s entry

Contrarily, in other countries consumers were to some extent under-served. They actually dealt with local stock-outs on desirable items. And frequently lived in a world with a lot less product choice. And, generally, international consumers expected to travel farther to shop at the few larger stores, malls and urban shopping centers with greater selections.

In those countries local economies became far less dependent on retail real estate for jobs — and for taxes. Most have little or no property taxes as deployed in the USA. Additionally, rather than adding a local sales tax to the price of goods, most countries use some sort of national VAT to collect the tax during distribution. When Amazon starts distributing in these markets it is seen as a good thing! Consumers have more choice, less hassle and often better service. Also, Amazon collects the VAT so no taxes are lost.

Contrarily, American communities could never stop adding retail space. Whenever Walmart or Best Buy wanted a new store, no community leaders turned down the potential local economic gains. But it led to too much space being built for a healthy sector, and certainly far too much given the market shift to on-line retail. Now retail is a classic over-served market, sort of like the need for stagecoaches and livery barns after the railroads were built.

Expect 50-67% of retail space to go vacant within a decade

How much retail space could go vacant in the USA?  Just invert the multiples from above. For the USA to have the same retail space as Spain implies an 87.5% reduction, Italy -89%, Germany -91%, Mexico -95.5%. Thus it is not hard to imagine a full 50-67% of America’s retail space to be empty in just 5 or 10 years. Americans would still have 2-3 times the retail space of other developed markets.

There is no doubt Amazon is a good employer, and on-line sales growth will employ hundreds of thousands at Amazon, and millions across the marketplace. Further, most of those jobs will pay a lot better than traditional retail jobs. But there is no sugar-coating the huge impact the ‘Amazon Effect’ will have on local economies and jobs. America is vastly overbuilt and over-supplied by retailers. There will be a huge shake-out, with dozens of retail failures. And there will be enormous amounts of vacant property sitting around, looking for some kind of alternative use. And local communities will find it difficult to meet constituent needs as sales tax and property tax receipts fall dramatically.

As I wrote in my column on February 28, this is going to be an enormous shift. Far bigger than the offshoring of manufacturing. The ‘Amazon Effect’ is automating retailing in ways never imagined by those who built all that retail space. As people keep buying on-line there will be a collapse of retail space pricing, and a collapse of industry participants.  Industry players always greatly under-estimate these shifts, so they aren’t projecting retail armaggedon. But in short order the need for retail will be like the need for dedicated, raised-floor computer centers to house mainframes, and later network hubs. It’s just going to go away.

Are The Cloud And IoT Making PCs, Laptops And Tablets Irrelevant?

Are The Cloud And IoT Making PCs, Laptops And Tablets Irrelevant?

by | May 30, 2017 | Innovation, Lifecycle

Last week Microsoft announced its new Surface Pro 5 tablet would be available June 15.  Did you miss it?  Do you care?

Do you remember when it was a big deal that a major tech company released a new, or upgraded, device?  Does it seem like increasingly nobody cares?

Non-phone device sales are declining, while smartphone sales accelerate

This chart compares IDC sales data, and forecasts, with adjustments to the forecast made by the author. The adjustments offer a fix to IDC’s historical underestimates of PC and tablet sales declines, while simultaneously underestimating sales growth in smartphones.

Since 2010 people are buying fewer desktops and laptops.  And after tablet sales ramped up through 2013, tablet purchases have declined precipitously as well. Meanwhile, since 2014 sales of smartphones have doubled, or more, sales of all non-phone devices. And it’s also pretty clear that these trends show no signs of changing.

Why such a stark market shift? After all desktop and laptop sales grew consistently for some 3 decades. Why are they in such decline? And why did  the tablet market make such a rapid up, then down movement? It seems pretty clear that people have determined they no longer need large internal hard drives to work locally, nor big keyboards and big screens of non-phone devices. Instead, they can do so much with a phone that this device is becoming the only one they need.

Today a new desktop starts at $350-$400. Laptops start as low as $180, and pretty powerful ones can be had for $500-$700. Tablets also start at about$180, and the newest Microsoft Surface 5 costs $800. Smartphones too start at about $150, and top of the line are $600-$800. So the purchase decision today is not based on price. All devices are more-or-less affordable, and with a range of capabilities that makes price not the determining factor.

Smartphones let most people do most of what they need to do

Every month the Internet-of-Things (IoT) is putting more data in the cloud. And developers are figuring out how to access that data from a smartphone. And smartphone apps are making it increasingly easy to find data, and interact with it, without doing a lot of typing. And without doing a lot of local processing like was commonplace on PCs. Instead, people access the data – whether it is financial information, customer sales and order data, inventory, delivery schedules, plant performance, equipment performance, maintenance specs, throughput, other operating data, web-based news, weather, etc. — via their phone. And they are able to analyze the data with apps they either buy, or that their companies have built or purchased, that don’t rely on an office suite.

Additionally, people are eschewing the old forms of connecting — like email, which benefits from a keyboard — for a combination of texting and social media sites. Why type a lot of words when a picture and a couple of emojis can do the trick?

And nobody listens to CD-based, or watches DVD-based, entertainment any longer. They either stream it live from an app like Pandora, Spotify, StreamUp, Ustream, GoGo or Facebook Live, or they download it from the cloud onto their phone.

To obtain additional insight into just how prevalent this shift to smartphones has become look beyond the USA. According to IDC there are about 1.8 billion smartphone users globally.  China has nearly 600M users, and India has over 300 million users — so they account for at least half the market today. And those markets are growing by far the fastest, increasing purchases every quarter in the range of 15-25% more than previous years.

Chinese manufacturers are rapidly catching up to Apple and Samsung – there will be losers

Clayton Christensen often discusses how technology developers “overshoot” user needs. Early market leaders keep developing enhancements long after their products do all people want, producing upgrades that offer little user benefit.  And that has happened with PCs and most tablets. They simply do more than people need today, due to the capabilities of the cloud, IoT and apps. Thus, in markets like China and India we see the rapid uptake of smartphones, while demand for PCs, laptops and tablets languish. People just don’t need those capabilities when the smartphone does what they want — and provides greater levels of portability and 24×7 access, which are benefits greatly treasured.

And that is why companies like Microsoft, Dell and HP really have to worry. Their “core” products such as Windows, Office, PCs, laptops and tablets are getting smaller. And these companies are barely marginal competitors in the high growth sales of smartphones and apps. As the market shifts, where will their revenues originate? Cloud services, versus Amazon AWS?  Game consoles?

Even Apple and Samsung have reasons to worry. In China Apple has 8.4% market share, while Samsung has 6%. But the Chinese suppliers Oppo, Vivo, Huawei and Xiaomi have 58.4%. And as 2016 ended Chinese manufacturers, including Lenovo, OnePlus and Gionee, were grabbing over 50% of the Indian market, while Samsung has about 20% and Apple is yet to participate. How long will Apple and Samsung dominate the global market as these Chinese manufacturers grow, and increase product development?

When looking at trends it’s easy to lose track of the forest while focusing on individual trees. Don’t become mired in the differences, and specs, comparing laptops, hybrids, tablets and smartphones. Recognize the big shift is away from all devices other than smartphones, which are constantly increasing their capabilities as cloud services and IoT grows. So buy what suits your, and your company’s, needs — without “overbuying” because capabilities just keep improving. And keep your eyes on new, emerging competitors because they have Apple and Samsung in their sites.

The Trend To Facebook Referrals Is A Risk To Google Search

The Trend To Facebook Referrals Is A Risk To Google Search

by | May 26, 2017 | Disruptions, Marketing, Web/Tech

The words “search” and “Google” are practically synonymous.  We’ve even turned the name of the ubiquitous web application into a verb by telling people to “Google it.”  And that’s good, because Alphabet’s revenue (that’s Google’s parent company) soared more than 25% in the last quarter, and over 90% of Alphabet’s revenue comes from Google AdWords.  The more people search using Google, the more money Alphabet makes.

Image from B2B Community, www.business2community.com

facebook vs google search statista

Chart courtesy of Martin Armstrong at Statista.com

 

But ever since Facebook came along, a new trend has started emerging.  People often want answers to their questions within the context of their community.  So “searches” are changing.  People are going back to what they did before Google existed – they are asking for information from their friends.  But online.  And primarily using Facebook.

There is no doubt Google dominates keyword searching.  But that type of searching has its shortcomings.  How often have you found yourself doing multiple searches — adding words, adding phrases, dropping words, etc. trying to find what you were seeking?  It’s a common problem, and we all know people who are better “Googlers” than others because of their skill at putting together key words to actually find what we want.  And how often do we find ourselves lost in the initial batch of ads, but not finding the link we want?  Or going through several pages of links in search of what we seek?

Context often matters.  Take the classic problem of finding a place to eat.  Googling an answer requires we enter the location, type of food, price point, and other info — which often doesn’t lead us to the desired information, but instead puts us into some kind of web site, or article, with restaurant review.  What seems an easy question can be hard to answer when relying on key words.

But, we know how incredibly easy it is for a friend to answer this question.  So when seeking a place to eat we use Facebook to ask our friends “hey, any ideas on where I should eat dinner?” Because they know us, and where we are, they fire back specific answers like “the Mexican place two blocks north is just for you,” or “spend the money to eat at that place across the street – pricey but worth it.”  Your friends are loaded with context about you, your habits, your favorites and they can give great answers much faster than Google.

facebook screens with restaurants

Think of these kind of referrals – for food, entertainment, directions, quick facts, local info — as “context based searches” rather than referrals.  Instead of making a query with a string of key words, we use context to derive the answer — and our friends.  Most people undertake far more of these kind of “searches” than keywords every day.

Even though Google is still growing incredibly fast, context searching — or referrals — pose a threat.  People will use their network to answer questions.  The web birthed on-line data, and we all quickly wanted engines to help us find that data.  We were excited to use Excite, Lycos, InfoSeek, AltaVista and Ask Jeeves to name just a few of the early search engines.  We gravitated toward Google because it was simply better.  But with the growth of Facebook today we can ask our friends a question faster, and easier, than Google — and often we obtain better results.

Digital Ad Revenue Mar 2017 DazeInfo

Both Google and Facebook rely on ads for most of their revenue.  But if consumer goods companies, event promoters, apparel manufacturers and other “core advertisers” realize that people are using Facebook to ask for information, rather than searching Google, where do  you think they will spend their on-line ad dollars?  Isn’t it better to have an ad for diapers on the screen when someone asks “what diapers do you like best?” than relying on someone to search for diaper reviews?

This is why Google+ with its Groups and Google Hangouts was such a big deal.  Google+ allows users to come together in discussions much like Facebook.  But Plus, Groups and Hangouts never really caught on, and Plus isn’t nearly as popular as Facebook discussions, or Instagram picture sharing or WhatsApp messaging.  Today, when it comes to referral traffic Facebook has eclipsed Google. Five years ago most people would have guessed this would never happen.

I’m not saying that Google searches will decline, nor am I saying Google will stop growing, nor am I saying that Google’s other revenue generators, like YouTube, won’t grow.  I am saying that Facebook as a platform is growing incredibly fast, and becoming an ever more powerful tool for users and advertisers.  Possibly a lot more powerful than Google as people use it for more and more information gathering — and referrals. The more people make referrals on Facebook, the more it will attract advertisers, and potentially take searches away from Google.

By comparison, this moment may be like the late 1980s when PC sales finally edged ahead of Apple Mac sales.  At the time it didn’t look deadly for Apple. But it didn’t take long for the Wintel platform to dominate the market, and the Mac began its slide toward being a submarket favorite.

IBM PC AT 1990
Apple Mac LC II
The #1 Real Estate Stock To Own Is Built On Trends – Alexandria Real Estate Equities (NYSE:ARE)

The #1 Real Estate Stock To Own Is Built On Trends – Alexandria Real Estate Equities (NYSE:ARE)

by | May 20, 2017 | In the Rapids, Innovation, Investing, Trends

Writing on trends, I frequently profile tech companies that use trends to outperform competitors. But using trends is not restricted to tech companies.

By following trends, since 1998 Alexandria Real Estate Equities has tripled the performance of the NASDAQ, quadrupled returns of the S&P 500, and quintupled the Russell 2000.  Alexandria has even outperformed technology stalwart Microsoft, and investment guru Berkshire Hathaway by 230%.

alexandria return comparisons

Although you probably never heard of it, Alexandria has trounced its real estate peers.  Over the last three years Alexandria has returned double the FTSE NAREIT Equity Office Index, and double the SNL US REIT Office Index.  Alexandria’s value has almost doubled during this time, and produced returns 2.3 times better than such well known competitors as Vornado Realty Trust and Boston Properties.

alexandria real estate three year shareholder return is

In 1983, Joel Marcus was a lawyer in the IPO market when he noticed the high value launch of biotech firms like Amgen and Genentech.  He began tracking the growth of biotechs to see what kind of opportunity might appear to serve these high growth companies.

By 1994 Marcus realized that these companies were struggling to find appropriate real estate to serve their unique needs for laboratory space, and the infrastructure these labs require.  It was a classic under-served market, and it was growing fast.

Jacobs Engineering (NYSE:JEC) was serving some of these companies’ needs, including erecting structures for them.  But Jacobs did not own any buildings or consider itself a real estate developer.  So Marcus approached Jacobs about starting a company to meet the real estate needs of this high growth biotech industry.  Marcus put up some money, Jacobs put up some money, and other friends/associates combined to raise $19 million.  There was no professionally managed money involved – and no real estate developers.

Biotech industry wordle

Focusing on the rapidly expanding biotech scene in San Diego, the newly created Alexandria bought 4 buildings.  They refocused the buildings on the unserved needs of local biotech companies and did a quick flip, breaking even on the transaction.  With just a bit of money Alexandria had proven that the market existed, the trend was real and users were under-served.

But, like any idea based on an emerging trend, growing was not easy.  Using their first transaction as “proof of concept” CEO Marcus and his team set out to raise $100 million. Quickly Paine Webber (now UBS) secured $75 million in debt financing.  But moving forward required raising $25 million in equity.

Over the next few weeks Alexandria pitched a slew of nay-sayers.  From GE Capital to CALPERS investors felt that their first deal was a “1-trick pony,” and this “niche market” was not a sustainable business.  Finally, after 29 failed pitches, the AEW pension fund, an early stage real estate investor, saw the trend and invested.

The Alexandria team realized that fast client growth meant there was no time to develop from ground up. They focused on high growth geographies for biotech, places where the trend was more pronounced, and bought 11 existing properties:

  • In Seattle they found a cancer center they could buy, improve and do a sale-leaseback
  • In San Francisco they identified a portfolio of properties in Alameda they could improve, lease to biotech companies and even suit the needs of the FDA as a tenant
  • In Maryland they identified opportunities to support the lab needs of the Army Corps of Engineers forensic research lab, and ATF testing lab for imported vodka, and a medical testing lab near Dulles – which is now leased to Quest Diagnostics

Realizing that companies needing labs tended to cluster, leadership focused on finding locations where clusters were likely to emerge.  They bought land in San Francisco, San Diego, New York and Worcester, MA. What looked like risky locations to others looked like profitable opportunities to Alexandria due to their superior trend research.

Historically pharma companies built their headquarters, and labs, in suburban locations where development was easy, and labs were welcome. Alexandria realized the new trend for emerging companies was to be near universities in urban environments, and although land was costly — and development more difficult — this was the right place to leverage the trend.

Today Alexandria is the bona fide market leader in labs and tech facilities in the USA. By seeing the trend early they bought land which is now so expensive it is practically untouchable – even for $1 billion. Their development pipeline includes Mission Bay, Kendall Square, the Manhattan borough of New York City and RTP (Research Triangle Park.) Today companies want to be where the lab is — and frequently the lab space is now owned, or being developed, by Alexandria.

alexandria real estate Campus Pointe, California
alexandria real estate equities Research Triangle Park
alexandria real estate equities new york

This didn’t happen by accident. Not at the beginning nor as Alexandria plans its future growth.  The company maintains a team of 13 researchers studying market trends in technology, and under-served real estate needs. They constantly track employers of tech/research people, competitors, historical and emerging customers — and identify prospective tech tenants who will need specialized real estate.  A few of the leading trends Alexandria follows include:

  • Urbanization — The siloed campuses set in bucolic suburbs is the past
  • Innovation externalization — Over 50% of innovation in big pharma is now outsourced. And universities are spinning out innovations faster than ever into development centers for testing and commercialization
  • Nutrition and disease management — These are emerging markets ripe with new products making their way to commercialization, and needing space to grow

Alexandria’s historical and ongoing successes relied first and foremost on using trends to understand underserved markets where needs will soon be the greatest.  This is an important lesson for all businesses. No matter what you do, what you sell, or your industry you can generate higher returns, outperform your peers, and outperform the market rewarding investors by identifying trends and investing in them.

Thanks to Joel Marcus for providing an interview to explain the history and current practices at Alexandria.

Why You Should Own Facebook And Not Snapchat

Why You Should Own Facebook And Not Snapchat

by | Apr 27, 2017 | Investing, Mobile, Web/Tech

People love to watch tech stocks, because there is so much volatility. Just today (April 27, 2017) Alphabet beat expectations and its shares rose $34 (about 4%) after hours. GOOG is up 15.5% in 2017, and 31% for the year. But not all tech stocks do this well. Twitter, for example, had a nice increase of late — but TWTR is down 33% since peaking in early October, and it is down 69% from 10/2014 highs.

So how is an investor to know which tech stocks to own, and which to eschew?

They key, of course, is to watch trends. And to recognize who absolutely dominates those trends. When it comes to the rapidly growing world of social media, it is increasingly clear there is only one Goliath — and that is Facebook.

Snapchat created a lot of interest when it hit the scene. A darling of the most youthful set, it was growing very fast and had exceeded 100 million users by January 2016. By January 2017 Snapchat added another 60 million users — growing 60%. But since going public the stock has dropped about 10%.  And according to Marketwatch only 12 analysts rank it a “buy” while 23 rank it a “hold,” “underweight” or “sell.”

Should you buy Snapchat? After all, Facebook dropped after its IPO

As the chart from Statista shows, in just eight months Instagram Stories has blown way past the user base of Snapchat. In April 2012 Facebook paid $1 billion for Instagram, then a popular photo-sharing app, which had no revenues. The idea was to leverage Facebook’s installed base to grow the app.  Since September, 2013 Instagram has been adding 50 million users per quarter. Instagram now has 600 million active users and became one of the five most popular mobile apps in the world.

The Facebook App Ecosystem Totally Dominates Mobile. Chart reproduced courtesy of Felix Richter at StatistaFelix Richter, Statista, https://www.statista.com/chart/5055/top-10-apps-in-the-world/

The Facebook App Ecosystem Totally Dominates Mobile. Chart reproduced courtesy of Felix Richter at Statista

Looking at Facebook, one has to marvel at how the company has kept users in its ecosystem. As the Statista chart shows, since 2016 Facebook has had four of the top five mobile app downloads. Now that Instagram Stories has blown past Snapchat, Facebook holds all four top positions.

Does anyone remember when Facebook purchased Beluga in 2011 for about $20 million? That is now Messenger, and it opened the door for sending pictures and video.  Do you remember the $19 billion acquisition of WhatsApp — which had only $10 million in revenues? Both have added multiple capabilities, and now Messenger has 1 billion active users, and WhatsApp has 1.2 billion users.

In fiscal 2012 Facebook hit $1 billion in quarterly revenue, and ended the year with just over $4 billion in annual revenues. Q4 2016 exceeded $8.8 billion, and for the year $27.6 billion.

It is for good reason that almost twice as many analysts are skeptical of Snapchat’s future value as those who think it will go up.

Snapchat is competing with Facebook, a company that has shown time and again it can watch the trends and put in place products that initially meet, but then eventually exceed customer expectations.  One might like to think Snapchat is a good David, putting up a good fight. But this time, investors are likely to be much better off betting on Goliath.  Facebook still has a lot of opportunity to grow.

Stop Throwing Your Company’s Resources Away

by | Apr 24, 2017 | Newsletter Post

The newsletters of Adam Hartung.

Keynote Speaker, Managing Partner, Author on Trends

Adam Hartung photo

Stop Throwing Your Company’s Resources Away

Is your organization stuck in the Flats of the River Lifecycle River Lifecycle showing Innovation Gap and riskwhile the Innovation Gap grows? Are you pouring your resources into doing more of what you’ve done, even though you aren’t achieving the results you want – and need?  Are competitors outflanking you with innovations? Are your customers telling you everything is fine, then buying from competitors?  OUCH!!!

You need to change how you use your resources.  You need to figure out how to put more resources into new products and customers, and less into trying to defend & extend sales of current products to current customers.

You need to change how you use your resources.  You need to figure out how to put more resources into new products and customers, and less into trying to defend &extend sales of current products to current customers.

For established companies, the investment mix often looks like this.

But for start-ups would you be surprised to know their resources are allocated more like this?

innovation investment comparison established versus start-up

Our experience taught us that when the Current/Current investment exceeds 40% the company is “Stuck in the Flats;” over-resourcing slow growth business while under-resourcing new opportunities.  After the frenzied growth in the Rapids, it feels like a relief to reach the Flats – where leadership would love to cruise along on auto-pilot, fine-tuning a few things and watching costs.  But, the drift into decline begins at that moment-  because the focus shifts to internal process optimization at the expense of monitoring external market trends. (Click here for last month’s newsletter on the River.)

Remember, the Ansoff matrix doesn’t just apply to where you put the money.  As the Bain alums wrote in “Time,Talent, Energy” (see my review here,) you can use the Ansoff matrix to manage your talented people. In the Flats, leadership puts the best people in the Existing/Existing corner – optimizing the OLD business.  The unintended effect is to dry up the Wellspring of new ideas, and leave precious little talent available for focusing on new growth.

To remain on the growth curve, companies need to put their best people onto new efforts, including projects in the New/New corner!  By moving more investment capital, and talent clusters, into other cells any company can keep the Wellspring flowing with ideas and find The Next Big thing.

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“Knowing your purpose helps you in using all available resources  in achieving your goals.”

Sunday Adelaja   

Pastor and Author

Actions you can take

Examine or audit your investment in innovation.  Try to assess the investment in each cell of the Ansoff matrix. Be rigorous about your classification because your competitors may be innovating or “pivoting” just to survive.  Look for an outside source to provide some objective feedback on investment of people, funds and assets. Don’t hesitate to ask for help in making your organization more adaptable, and your strategy embedded with options to pivot based on market shifts. You could start with an underperforming product or brand.

How we can help

We are your experts at identifying trends, creating scenarios and building monitoring systems.  We’ve done this kind of work for over 20 years, and bring a wealth of experience, and tools, to the task.  You don’t have to go into scenario planning alone; we can be your coach and mentor to speed learning, and success.

For more on how to include trends in your planning, I’ve created a “how-to” that you can adapt for your team.  See my Status Quo Risk Management Playbook.

Give us a call today, or send an email, so we can talk about how you can be a leader, rather than follower.  Or check out the rest of the website to read up on what we do so we can create the right level of engagement for you.

Forbes Posts- Hartung on Leadership, Investing, Trends

Take time to read, “Time Talent Energy” by Mankins and Garton 

How HR Best Practices Kill Innovation

Dow and DuPont – Nobody wins when transactions replace leadership

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Why You Do Not Want To Own IBM: Growth Stalls Are Deadly

by | Apr 21, 2017 | Boards of Directors, Investing, Leadership

When I was young, IBM dominated computing. In the tech world, when comparing platforms, everyone said, “Nobody ever got fired for buying IBM.” IBM was a standout role model for sales success, product leadership and investor returns.

Now, not so much. IBM’s stock fell almost 5% on Wednesday after the company reported “lackluster” results. For the week IBM lost about $20 per share – almost 12%. Quarterly revenue last quarter fell 3%, making 20 consecutive quarters of declining revenue for the once-dominant behemoth and Dow Jones Industrial Average (DJIA) component.

CEO of IBM Ginni Rometty (Photo by Neilson Barnard/Getty Images for New York Times)

The stock is still up from January 2016 lows of $125, and you might think this pullback is a buying opportunity. But you would be wrong. For long-term investors the stock has fallen from about $194 when CEO Ginni Rometty took control to the recent $160 — a 17.5% decline over five years. And that is after spending $9 billion on payouts (mostly share buybacks) to prop up the stock!

 But because of its long-term “growth stall” the odds are almost a certainty things will continue to worsen for IBM.
Growth Stalls are Deadly Accurate Predictors of Future Value Declines(c) Adam Hartung and Spark Partners

Growth Stalls are Deadly Accurate Predictors of Future Value Declines

When a company has two consecutive declining quarters of revenue or earnings, or two consecutive quarters of revenue or earnings lower than the previous year, that company is in a “growth stall.” After stalling, 93% of companies will struggle to consistently grow a mere 2%. Seventy percent will lose more than half their market cap.

 I made this same call, to not own IBM, in May 2014. Then IBM had registered a stall on both the quarter-to-quarter metric, and on the year-over-year quarterly metric. IBM was clearly in a “growth stall” and showed no signs of turning around its fortunes. Now IBM has failed to grow quarterly revenue for five years!

Supported by the company PR and investor relations departments, optimists will claim there is reason to think things will improve. For example, in September 2015 IBM executive John Kelly predicted that Watson would be the next “huge engine” for growth. Today the Cognitive Computing segment that is Watson is about the same size it was then. In fact none of the five IBM segments are showing strong growth.

The reason a “growth stall” is such an accurate predictor of future bad results is its ability, in a very simple way, to describe when a company falls out of step with its customers/marketplace. The market went one way — in this case to mobile apps, mobile devices and cloud computing — while the company remained in outdated businesses and launched competitive offerings too late to catch the early market makers. At IBM, Cognitive has not become a big new market, while the historical Business Services and Systems segments keep shrinking, and Cloud Services is simply out-gunned by competitors like Amazon.

Rometty should be replaced by someone from outside IBM.

Meanwhile, the CEO keeps her job and even achieves pay raises! In 2016 IBM’s stock had dropped 36% since Rometty took the CEO position, yet the board of directors payed out the max bonus, leading the LA Times to headline “IBM’s CEO Writes a New Chapter on How To Turn Failure Into Wealth.” Last year the company share price bounced of its lows, but still far below what it was when she took the job, and in 2017 the Board increased her bonus from 2016! And the CEO will be granted a long-term pay incentive of $13.3 million in June (to be paid in 2020).

Like Immelt at GE, Rometty should be fired. If there were an updated list of the “5 Worst CEO’s Who Should Have Already Been Fired,” CEO Rometty surely deserves to be on it. And a new leader needs to implement an entirely new strategy if IBM is ever to regain its lost glory.

IBM’s stock may bounce around quite a bit. It’s shareholder base is very large. And really big investors, like pension funds and mutual funds, are very slow to dump their positions. But, eventually, everyone realizes that a shrinking company is not a value creation company, and they keep selling shares into any sign of strength. Big investors eventually recognize when a Board is unwilling to actually help lead a company, and unwilling to face down a bad CEO and replace her with someone more competently able to turn around a perennial terrible performer. So they start selling before the bottom falls out — like Sears and AT&T after they were removed from the DJIA.

There’s a lot more downside potential for IBM’s valuation.

In IBM’s case, the shares are at about $195 when the first data indicating a growth stall were evident (Q3 2012). They then peaked at $213 in March 2013. And it has been an ugly ride since.  he “bounce” in 2016 from $125 to $180 was actually the best selling opportunity since September 2014 (just after I made the call to get out). At $160, IBM is down about 18% since the growth stall started (largely due to share buybacks) and revenues have kept dropping. According to “growth stall” analysis there is a 69% probability IBM’s shares will fall to $85 per share — or less — before the company fails, or starts a true, long-term recovery under new leadership.