by Adam Hartung | Jun 22, 2007 | Defend & Extend, Leadership, Lock-in, Quotes
This week Blackstone, one of the world’s largest private equity firms announced it was likely to soon go public. Ironic that a business based upon taking companies private is now going public… Reflecting upon this, Merrill Lynch today ran the following quote (see page 5 of report here) in it’s daily North America Morning Market Memo by David Rosenberg. His topic is what happens after a business is purchased by a private equity firm:
"All of a sudden managment is focused and will do anything to maintain or increase cash flow. Here’s the usual list: Cut spending, workers, officeds, factories and advertising, and with tech companies now in play cut R&D, their lifeblood. Don’t mistake financial engineering for company building."
Well said Mr. Rosenberg.
by Adam Hartung | Jun 13, 2007 | Defend & Extend, In the Swamp, Leadership, Lifecycle, Lock-in
Too often Locked-in companies literally race toward the exit of their business. And such seems to be the case with Ford (see chart here). Back on 3/15/07 I blogged that Ford was Defending and Extending its bad business by selling one of its good businesses, Aston Markin (link here). Now the company is following that same destructive path as it considers selling both Jaguar and Land Rover (see article here.)
From the late 1980s into the 1990s Ford started to develop a new future via acquisition of Aston Martin, Jaguar, Land Rover and Volvo. These were combined into its Premier Auto Group, which could have served as White Space for developing a new Success Formula that would effectively compete with Toyota, Honda, and BMW. But instead of letting this be White Space, with funding and resources to develop a new Success Formula, Ford tried to force its old Success Formula onto this group. Executives at Ford pushed to have these new acquisitions "leverage" Ford by using common parts, common engineering and common approaches. The result was a negative impact on Jaguar and Land Rover, as the old Ford Success Formula drove down the value of these brands. Instead of migrating Ford toward a new Success Formula, leadership tried to integrate these premier brands into the old Success Formula focused upon supply chain optimization and cost reduction.
Instead of becoming a great new company that led the market, Ford leadership turned Premier Auto Group into another Edsel. Something intended to be valuable, but not coming close to meeting anyone’s goals.
Jacque Nasser had an idea of how to transform Ford when he made several of these acquisitions and kept them outside of Ford. But William Ford, Jr. started the process of destroying long-term shareholder value when he rejected learning from these acquisitions and instead put company focus on old fashioned "big iron" – a claim he bragged about in ads for the Mustang. The new CEO appears to be a man after the Chairman’s heart as he tears apart the future opportunities of the company in search of cash to Defend & Extend the low-yielding Ford Success Formula. Too bad for investors and employees.
by Adam Hartung | Jun 12, 2007 | Uncategorized
Very little is really known by most managers and investors about how Boards of Directors operate. There is knowledge that Boards are the investor representatives, and that they have some legal authority to oversee management. But what a Board actually does, and how it operates, is largely unknown by the vast majority of us. But, every once in a while a glimpse is offered – usually through a lawsuit.
And that has been true of the Board at Hollinger International (now called the Sun Times Group). The Chairman/CEO and his CFO were sued for creating self-dealing agreements that looted the company of money, at shareholder expense. The suit took years to get to trial in Chicago, but now it is up (see article here). And testimony has been revealing about just how little a Board of Directors actully oversees management. Caught in the crossfire has been the former very popular governor of Illinois, Jim Thompson, who was on the Hollinger Board and chairman of its audit committee.
Testimony in this case, as in Tyco, Enron and WorldCom, has revealed that Boards are one of the more Locked-in work groups in business. Often, the Chairman invites people onto the Board not because they bring particular insight to the most critical issues of the company – but rather as a personal relationship or based upon fame. And rarely are Board members given all the information in the company. Rather, it is a management selected subset intended to aid the Chairman and CEO in achieving agreement to their desires. As a result, members, such as Governor Thompson, end up with lofty titles and responsibilities but little more than a rubber stamp to use in wielding their power. As a result, when the wrong things are happening the Board members, such as Governor Thompson, don’t ask sufficient questions, don’t know enough about what is happening, and agree to management actions which are unethical – and in Hollinger’s case – illegal. The bad news is that investors suffer. And, as in Governor Thompson’s case, a huge credibility loss for the Board member with a possible loss of his legal license and the balance of his career.
Congress passed the Sarbanes-Oxley act in an effort to Disrupt these Board work groups. The goal was, and remains, to change what happens on Boards, and between Boards and management, in order to improve the oversight given by Boards. Of course, management has had a thunderous negative reaction. Television programs, such as on the business channel CNBC, bring on executive after executive complaining that the effort and cost to implement SarbOx (as it is nicknamed) are hurting their business. Some even complain that SarbOx is driving them to delist as a public company and consider going private.
These complaints are not really about the cost of SarbOx. Rather, they are complaints about changing the Success Formula of Boards of Directors – something that the majority of CEOs do not want. There is no doubt that the SarbOx Disruption is good for holding Directors accountable to investors. As a result, SarbOx has resulted in more and better transparency into business finances and decisions. It has not hampered competitiveness, and the argument can well be made that competitiveness has improved due to better Board involvement.
Just as companies become Locked-in, so do work groups. Boards are no exceptions. Locked-in groups do not find it easy, or often desirable, to change. Yet, new Success Formulas for groups can lead to far better performance. And that is true for corporate Boards. New Success Formulas for work groups, as for companies, require Disruptions. And that is the role of SarbOx. Once more Chairmen and CEOs take these Disruptions to heart, and begin opening up White Space for their Boards to develop a new Success Formula, we will have far more valuable and productive Boards – leading to more valuable and productive management teams – and eventually more effective companies.
by Adam Hartung | Jun 11, 2007 | Defend & Extend, General, In the Swamp, Leadership, Lock-in
My last email on WalMart prompted a comment from Barney. He asked my opinion of the 5-year, 10-year and 30-year prospects for Wal-Mart. Great question, worthy of a response to all readers.
The longer out the timeline, the more bearish I am. Strategy sees its results long-term rather than short-term, so given more time the impact becomes more evident. Predicting share prices short-term is hard, even for stock traders and mutual fund managers. But WalMart is definitely NOT a long-term buy-and-hold investment.
Five years out I believe Wal-Mart will be in a similar situation to today, but much more defensive about itself. The years of external attack will wear away the veneer and some of the barbs will lead to noticable wounds. The company will not succeed internationally, nor will the company substantially increase any new businesses. The traditional WalMart and Sam’s Club same same stores sales will not keep up with inflation, and new store growth will diminish (as management has said they intend). Management will waiver between investing in trying to maintain share, via ongoing lurches into price wars, and buying company equity stock in order to defend itself from investor attacks. There will be some ups and downs for the stock price, but it will not keep up with the market. Although WalMart will still be America’s largest retailer, it will not be competitively advantaged.
Ten years out WalMart will have taken a dramatic act, or two, to try and further Defend & Extend its Success Formula. It will start using cash to make acquisitions, in an effort to find some "retail synergy". It will buy into some area where it claims it can use its "core competency" in volume and supply chain to better serve customers – like furniture retailing. It will probably try to do something dramatic on the internet, albeit more than a decade late, like purchasing NetFlix, or Amazon, in hopes of re-positioning itself. But there will be no synergy, nor any value creation. Just lots of confusion for investors. And the company value will, again, not keep up with the economy or the market. It will have become a perennial also-ran investment.
Thirty years out, WalMart is today what General Motors was in 1977. People will talk about what once was a great company. WalMart will be trying to use size to defend itself, but finding that impossible as better competitors match WalMart’s skills with additional benefits.
WalMart is horribly Locked-in, with no signs of a meaningful Disruption on the horizon. Senior leadership is taking the opposite actions, buying back stock and otherwise using cash in efforts to Defend & Extend its outdated Success Formula. WalMart is in the Swamp, and it will stay stuck in the still water until something negative happens that pulls it toward the Whirlpool. WalMart will find lots of great retail companies there – in the Whirlpool – Woolworth’s, Montgomery Wards, S.S. Kresge, TG&Y and of course Sears and KMart.
by Adam Hartung | Jun 2, 2007 | Defend & Extend, In the Swamp, Leadership, Lifecycle, Lock-in
WalMart’s valuation has gone nowhere for more than 5 years (see chart here.)The equity today is worth 12% less than it was in 2003, meanwhile the Dow Jones Industrial Average (of which WalMart is a component) is up something like 25% (see chart here). Yesterday WalMart’s executives capitulated that their business has lower growth prospects, and the equity value jumped more than 3%. Say what?
I’ve beaten up WalMart a few times in this blog for being completely Locked In to an old Success Formula that no longer meets market requirements, allowing Target, Kohl’s, JC Penney and other competitors to eat into their growth. Yesterday the company admitted as much saying that it would scale back plans for growth (see article here). Instead of putting money into more stores, management would start buying back shares in order to reduce the size of the equity pool and thus hopefully raise its value. In other words, if the company can’t make more money for investors it will reduce the investors. Instead of growing the numerator (returns) it will decrease the denominator (investment.) This is nothing more than financial machinations intended to hide the inability to meet growth targets.
And investors said "great." With no return for several years on their investment they are happy to see someone buy them out, even if it’s just the company. The move up is not an endorsement of the company’s strategy or its leadership. It’s a sigh of relief that some investors will find it easier to get out.
WalMart is not improving its competitive position, it is further Locking-in that position. Instead of using its ample cash to open White Space and figure out new ways to compete WalMart is going to use its cash to reduce investors that aren’t happy with the current results. This does not signal a new beginning, but rather just another step in the Swamp toward the eventual Whirlpool of decline.
Interestingly, in just the last week the former head of Marketing at WalMart filed court documents (see article here.) Included are considerable allegations of insider dealing creating benefits for executives and family members of executives. Of course, amidst all the executive scandals of the last few years its doubtful if many investors would be surprised to learn that top executives were feathering their own nest using corporate power and position. It merely reinforces that the executives at WalMart are benefitted by doing more of what they’ve done, not trying to do anything new. Most telling, Ms. Roehm (the fired exec) said that "WalMart decided to fire her because executives had become increasingly uncomfortable with her ideas and cultural change adn they were looking for some way to revert back to their old, price-based approach to sales without embarrassing themselves by reversing the high-provile decision they had made to hire her just nine months earlier."
Less is not more. WalMart is horribly Locked-in and unable to meet changing market requirements. It’s growth options are slowing. It is Defending its old Success Formula with firings, lawsuits and financial machinations. All signs of a company heading toward the Whirlpool. It takes time for a ship bigger than the Titanic to sink, but there’s clearly some big gaping holes emerging in the hull of WalMart.
by Adam Hartung | May 29, 2007 | General, Lifecycle
Last week Coca Cola (see chart here) announced it was ponying up over $4 billion to buy Glaceau, a company with only $355 million in revenue (see PR announcement here, see article here). Rarely are such lofty prices paid for a company not in high tech, so investors have to wonder if Glaceau is worth it. After all, Glaceau’s products are just another form of flavored water – in this case vitamin enriched water and energy drinks.
There are two criteria which determine if the price is right on this acquisition. Firstly, where is Glaceau and its products in the life cycle? If late in the cycle, then such a premium is not warranted. But if you believe that these are a new category of drink, and that this category will have rapid growth by eating into plain water, traditional sodas and possibly sport drinks you could claim that these products are just at the beginning of their lifecycle. And this is critical. Coke has had practically no White Space, so the company has nothing early in the lifecycle. Organically, Coke could spend years trying to develop something on its own, and who knows if they could pull it off. If you believe that Energy Brands have the potential to grow like sports drinks, then this price will look absolutely cheap in just a few years.
The second criteria is how will Coke manage this acquisition? Should Coke decide to buy the company and integrate its products and marketing into Coke then this would be just $4 billion thrown down the proverbial rat hole. The Coke Success Formula is so powerful around traditional soft drinks it would kill the learning necessary to grow a new Success Formula and develop this new market. As we can read in the press release, Coke has chosen to keep Glaceau as a completely separate business unit, and the existing management team has been given 3 year contracts to stay and run the business. In a nutshell, Coke is setting up White Space for Glaceau, and that dramatically improves the chances of the acquisition fulfilling its potential and value.
If Coke can follow through on allowing Glaceau to develop its new market, this could be an important turning point for the moribund Coke organization. Glaceau could develop a new Success Formula which Coke could migrate toward. Revenue could regain old growth rates, and margins could improve as focus shifts to innovation rather price wars. Big companies need new businesses which are early in the Rapids – not just a lot of Wellspring ideas. They need to catch waves early, give the new business White Space (money and permission to try new things) and then learn how to migrate forward. And Glaceau could be just the right acquisition for Coke. If Glaceau can help migrate Coke forward, and out of it’s Locked-in ways, then $4.1 billion was not too much to pay at all.
by Adam Hartung | May 21, 2007 | General, In the Rapids, Leadership, Openness
In January of this year I blogged about the White Space prevalent in the highly Disruptive Virgin culture. Sir Richard Branson has built an empire from small beginnings by constantly Disrupting his organization and creating White Space. Many high paying jobs have been created, and lots of money made for investors, due to this Phoenix Principle culture.
But there can be a definite downside if a Phoenix Principle culture is not managed well. Disruptions and White Space can be opportunities to overspend, and overinvest, leading to losses and failure. White Space is not child’s play. It is where new Success Formulas are formed via the crucible of competition. It is critical that managers in these environments have their "feet held to the fire" to produce results. Otherwise, cash flow is negative and profits never materialize. That’s bad news.
All businesses need a mix of Explorers and Stabilizers. Explorers usually become in short supply in Locked-in cultures, because optimization of the old Success Formula says that these kinds of managers are unnecessary. So Locked-in companies have to recruit Explorers to identify and create Disruptions, and then to have the skills for managing the creation of a new Success Formula.
White Space companies, and projects, need Stabilizers as well. Activities need to be disciplined and directed toward managing for cash flow and profit in the Rapids. As we saw all too well in the 1990s internet boom, too many Explorers make short shrift of these requirements, and their businesses simply flame out.
And that risk is now at Virgin Media. Using clever planning and intense hard work, Virgin Media has built itself into a large and powerful company that delivers mobile phone service, land-line service, internet service and satellite television service across Europe and other parts of the world. The company has made several growth-oriented acquisitions in the process, and those acquisitions have saddled the company with a huge debt load (see article here). This is big trouble for a business in the media game, because assets are not long-lived. So the debt payments go on after the technology needs to change – sucking up cash that should be used for changes and growth. Virgin Media is now losing money, and forced to make debt payments, while its primary competitors (the Murdoch-controlled Sky and British Telecom) are in far healthier financial shape. This is a risky situation, that may require someone buy out Virgin Media or it risks a precipitous decline that will be bad for Virgin as well as its investors, suppliers, employees and customers.
In the headlong rush to grow at Virgin Media, the managers may have been short a sufficient number of Stabilizers. The Explorers, which are sure to be popular in the Virgin culture, have been allowed to push the company growth. But now the entire Virgin Media organization is at risk. If there had been a more balanced management, with more Stabilizers, it is very likely the company would be in better financial shape and more competitive.
Everyone loves a party. And we all want to have a good time. But, if someone gets drunk the party can come to a crashing, unpleasant end. White Space can not be run like a party. It is a business. And if there aren’t Stabilizers around to control the consumption of resources, then the White Space business can find itself crashing.
by Adam Hartung | May 12, 2007 | Defend & Extend, General, In the Swamp, Leadership, Lock-in
On May 5 the rumor hit the newspapers that Microsoft was considering buying Yahoo (see article here). Both companies insisted this rumor was unfounded. Then, on May 10 it was reported that Microsoft bought a 4% stake in CareerBuilder (see article here), competitor of Monster and Yahoo! HotJobs, for an undisclosed sum. These reports drive home the differing viewpoints between investors, who want White Space to drive value, and management, that wants to Defend & Extend the past.
Microsoft built its empire upon a Success Formula as a near monopoly. Systematically and effectively Microsoft first dominated the market for small computer operating systems with MS-DOS. They leveraged that knowledge and kept the company in the Rapids with the hugely successful Windows operating system. Then they overwhelmed all competitors making their suite of personal automation products (Word, Excel and Powerpoint supported with the Access database and a slew of supporting free products such as Internet Explorer and Outlook) a near monopoly as well. This Success Formula of building a totally dominant position in software products for PCs now dominates all decision-making.
Unfortunately, the market for personal computers no longer has the high growth rate it once did. Customers don’t feel compelled to purchase upgrades, as the recently released Vista has shown. Instead, they are doing more with other tools such as PDAs, mobile phones and even MP3 players. Additionally, the growth in PC usage has turned much more to internet environments such as search and entertainment (such as Google and YouTube) rather than the PC as a personal productivity tool. But Microsoft’s Lock-in to their old Success Formula has kept them out of these new markets.
Investors look at the slower growth and huge cash pool at Microsoft and long for the company to find new White Space. Yahoo! would be large enough and in a market with enough growth to actually represent an opportunity for Microsoft to move from its low-growth Swamp back into the high-growth Rapids. So investors are pushing the company to make moves to create and fund White Space to drive future value enhancement.
But Microsoft is so Locked-in it shows no inclination to take such a move. Dabbling into a segment such as career tools keeps the investment very low. Four percent of CareerBuilder in no way Challenges the Lock-in, and does not offer an opportunity to create a new Success Formula. By making this investment Microsoft tells investors "we have no intention of addressing new Market Challenges. We intend to remain Locked-in and hope Vista will someday give us the kind of growth we used to obtain from such new releases."
Investors will remain disappointed with Microsoft. But management, which is insulated from external investors by the large holdings of Bill Gates and its extremely large market capitalization, can ignore this disappointment. And by overlooking the White Space opportunities in favor of near meaningless small investments management signals investors the company has no intention of doing anything different any time soon.
Which should make the executives at Google extremely happy!
by Adam Hartung | May 7, 2007 | General, In the Swamp, Leadership, Lock-in
Eddie Lampert has finished yet another year at the helm of Sears Holdings. And during that time he’s proven he can cut costs. He hasn’t proven he can make money – even by selling assets. The stock remains highly priced largely on the belief he’s building a war chest to do great hedge fund deals, but so far he’s not demonstrated Sears and KMart give him the resources to pull that off. Instead of looking like Warren Buffet, his idle who turned a worn out textile company named into Berkshire Hathaway into a tremendous investment vehicle, Mr. Lampert looks more like the captain of the Titanic who kept up reassurances until imminent peril took down the ship.
Mr. Lampert was once a banker, and he’s never one to ignore the opportunities for financial machinations. Sears most recent quarterly financials show a profit. But all of that was engineered from one-time items like dividends from Sears Mexico and gains off a legal settlement with Sears Canada (see article here). Meanwhile, sales at stores open a year turned out another decline – this time of nearly 5%. Quarter by quarter Sears stores keep selling less and less. And more stores are closed. And the cash current is getting thinner and thinner.
Mr. Lampert closed the investor relations department. So to know what’s going on is opaque, to say the least. At the recent annual meeting he declared that his plan is to rebuild the Sears and KMart brands (see article here). After practically killing the previous ad budget, he intends to start new ad campaigns (although the budgets were not revealed.) His plan, or should I say hope, is that by "positioning" Sears and KMart he can improve performance. Yet, he’s said nothing about why WalMart, Target, Kohl’s, JCPenney, Loews and Home Depot would roll over and let him start eating into their market shares.
Mr. Lampert would like to make some acquisitions. But the problem is that 2007 is not 1977. Mr. Buffet started Berkshire Hathaway when the world of deal-making was still pretty small. There weren’t dozens of multi-billion dollar hedge funds with ample resources chasing every imaginable deal. Bershire Hathaway was able to pick and choose its deals, using very conservative financial analysis when valuing investments. Today, only the most aggressive investors become buyers, and that means paying a pretty price for those acquisitions. So Sears Holdings can’t generate enough cash to play into the huge deals, and the competition is so intense on smaller deals that none can be had. Mr. Lampert is reluctantly being drug into trying to keep Sears and KMart alive, but he has no idea how to do that.
Sears and KMart were companies in trouble when purchased by Mr. Lampert. But he never Disrupted them. He never set up White Space. Instead, he tried to milk them of their cash in order to buy other companies, and he’s proven he can’t do that well. So he keeps trying to string along the company another quarter, but meanwhile competitors are pounding away at the weaknesses of a company with no viable value proposition. And as a result, Sears Holdings drifts closer toward the Whirlpool.
by Adam Hartung | May 3, 2007 | Defend & Extend, General, In the Whirlpool, Lock-in
Sometimes market Challenges wipe out large numbers of businesses. As I posted in my last blog, Amazon’s approach to internet retailing of books wiped out thousands of independent booksellers, as well as most chains (anyone remember Crown Books?) When such a Challenging tsunami appears on the horizon, trying to Defend & Extend your old Success Formula simply makes no difference.
Yesterday the National Association of Recording Merchandisers met in Chicago to try and figure out how they should respond to the Challenge posted by MP3 technology. These are the people that retail CDs. Do you remember going to the "record store." Their top solution is to install machines in their stores allowing consumers to download songs onto a CD (see article here.)
Never mind that any one of us can already accomplish this task at home with an internet connection, and a computer with a CD burner. These in-store kiosks charge $.99/song (just like iTunes), then add on another $3.00 for the case and label. On top of that, the process is intentionally extended out 5 to 15 minutes to force additional time in the store and encourage shopping. So using this in-store process costs more, and takes longer than doing it in the comfort of your home. And, at the end of this you get a CD. When was the last time you saw someone on the street listening to music with a Walkman instead of an iPod or other portable MP3 player? These retailers do hope to give access to downloading songs to an MP3 player in the future, but they intend to put software on the songs so they can’t be duplicated. And the cost will remain at $.99.
Why would any music retailer think this is a good idea? Because he’s trying to find a way to Defend & Extend the Success Formula he built when music sales required a physical product. Once Locked-in, this manager is most likely to deny the depth of the Challenge, or tweak the Success Formula in hopes it will somehow work. As one retailer said "this machine…puts me back in the singles business." Oh yeah, he admitted to starting 38 years ago selling 45s (for those too young to know, those were 6 inch vinyl records with big holes in the middle.) To say he’s hoping the past will return would be an understatement.
The fact is that the percentage of people buying CDs has declined 15 percent since 2002. CD shipments in the first quarter of 2007 were down 20 percent. While digital downloading of songs keeps growing at 24%/year and greater. Trying to overlay the cost and effort of an old approach on a new solution won’t meet the market Challenge, instead it just moves the competitor another step toward the Whirlpool and disaster.
