by Adam Hartung | Oct 16, 2008 | General, In the Rapids, In the Swamp, Leadership, Lock-in, Openness
Traders help markets function. Because they take short-term positions, sometimes hours, a day or a few days, they are constantly buying and selling. This means that for the rest of us, investors who want to have returns over months and years, there is always a ready market of buyers and sellers out there allowing us to open, increase, decrease or close a position. Traders are important to having a constantly available market for most equity stocks. But, what we know most about traders is that over the long term more than 95% don’t make money. Despite all the transaction volume, their rates of return don’t come close to the Dow Jones Industrial Average – in fact most of them have negative rates of return. Only a few make money.
For investors it’s not important what the daily prices are of a stock, but rather what markets the company is in, and whether the markets and the company are profitably growing. On days like today, which saw the DJIA down triple digits and up triple digits in the same day (read article here), it’s really important we keep in mind that the value of any company in the short term, on any given day, can fluctuate wildly. But honestly, that’s not important. What’s important is whether the company can exp[ect to grow over months and years. Because if it can, it’s value will go up.
Let’s take a look at a couple of companies in the news today. First there’s Google (see chart here). Despite the recession, despite the financial sector meltdown and despite the wild volatility of the financial markets, the number of internet ads continued to go up. Paid clicks actually went up 18% versus a year ago. (read article about Google results here). Gee, imagine that. Do you suppose that given the election interest, the market interest during this financial crisis and the desire to learn at low cost more people than ever might be turning to the internet? Does anyone really think internet use is going to decline – even in this global recession? Google is positioned with a near-monopoly in internet ad placement (Yahoo! is fast becoming obsolete – and is trying to arrange to use Google technology to save itself see Yahoo! chart here]). By competing in a high growth market – and constantly keeping White Space alive developing new products in this and other high-growth markets – Google can look out 3, 5, 10 years and be reasonably assured of growing revenues and profits. And that’s irrespective of the Dow Jones Industrial Average (where Google might well replace GM someday) or whether Microsoft buys the bumbling Yahoo! brand (read about possible acquisition here).
On the other hand, there’s Harley Davidson (see chart here). Motorcycles use considerably less gasoline than autos, so you would think that people would be buying them this past summer as gasoline hit record high $4.00/gallon plus prices. Yet, Harley saw it’s sales tumble 15.5% (much worse than the heavyweight cycle overall market drop of 3%) (read article about Harley Davidson’s results here.) The problem is that Harley is an icon – for folks over 50! The whole "Rebel Without a Cause" and "Easy Rider" image was part of the 1940s post war rebellion, and then the 1960s anti-war rebellion. Both not relevant for the vast majority of motorcycle buyers who are under 35 years old! Additionally, long a company to Defend & Extend its brand, Harley Davidson has raised the average price of its motorcycles to well over $25,000 – a sum greater than most small cars! Comparably sized, and technologicially superior, motorcycles made by Japanese manufacturers sell for $10,000 and less! Worse, the really fast growing part of the market is small motorcycles and scooters that can achieve 45 to 90 miles per gallon – compared to the 30 mile per gallon Harley Davidsons – and Harley has no product at all in that high growth segment! Harley Davidson is a dying technology and a dying brand in an overall growing market. No wonder the company is selling at multi-year lows (down 50% this year and 67% over 2 years) . Even though the stock market may be down, Harley Davidson is unlikely to be a good investment even when the market eventually goes back up (if Harley survives that long without bankruptcy!)
Watching the Dow Jones Industrial Average, or the daily stock price of any company, isn’t very helpful. Daily, prices are controlled by the activity of traders – who come and go incredibly fast and mostly lose money. What’s important is whether the company is keeping itself in the Rapids of Growth. Google is doing a great job at this. Harley Davidson is Locked-in to its old image and thoroughly entrenched in trying to Defend & Extend its Lock-in – completely ignoring for the past decade the more rapid growth in sport bikes, smaller bikes and scooters. As investors, customers, employees and suppliers what we care about is the ability of management to Disrupt their Lockins and use White Space to stay in the Rapids of growth.
by Adam Hartung | Oct 15, 2008 | Defend & Extend, In the Swamp, Leadership, Lock-in
Are people risk averse? Or do they like risk? Would you believe those questions don’t matter, when trying to understand risk?
Today we’re being told that the bankers who ran some of the world’s largest investment banks were taking ridiculous risks – and the decisions to take on those risks is now undoing financial services globally. Were these bankers all gunslingers – willing to take crazy risks? Would you believe me if I said they didn’t think they were taking much, if any risk?
Risk is a relative term. What’s "risky" is really a matter of perception. Let’s say I drive to work on a local highway every day. The traffic cruises at 65 miles per hour, but since I’m always late I drive 75. On a particularly late day I drive 80. Because I usually drive 75, the relative risk seems small. But the reality is that at 80 the chances of a minor mishap becoming a disaster are far greater. Once you are comfortable driving 75, the perception of greater risk is only the marginal difference between 75 and 80 – so it seems small. Over time, if I choose to keep driving a bit faster, within short order I’ll be driving 100 miles per hour. This may seem crazy – yet there are many drivers on Germany’s high-speed autobahn highways that drive this fast – and faster!! To those of us who poke along every day at 65 miles per hour these speed demons of the autobahn seem to be taking a crazy risk – but to them, working up to those high speeds gradually over time, the relative risk now seems quite small.
And this is what happens in our business. When a bank takes a deposit, it then can loan money. But should it lend dollar for dollar – deposit compared to loans? While nonbankers might say "don’t lend more than you borrowed" that seems ridiculously conservative to bankers. Bankers say that because most loans are repaid, they only need enough deposits to cover the normal ebb-and-flow of the cash demands on the institution. So they feel comfortable loaning out 2 or 3 dollars for every dollar of deposit. Of course, the more loans the banker makes and the rarer defaults occur, the more likely the banker will start to give loans that are 4 times the amount on deposit. Where does this stop? We know with Lehman Brothers the leverage reached 30 to 1 (read about financial institution leverage and regulatory recommendations here)!!! It didn’t take many defaults for Lehman to suddenly find itself unable to meet its obligations and disappear.
The bankers at Lehman Brothers learned not to fear what they knew. Not only that, but they hired immensely smart mathematicians and physicists to try calculating the amount of risk they were taking on with their leverage and their obligations. Using mathematics far beyond the grasp of all but a fraction of the population, they asked scholars to try calculating the risk in the loan packages they sold, and the credit default swaps. They continuously studied the risk. The more they studied the easier it was to take on more risk. The longer they kept doing what they had always done, and the more knowledgable they became, the less risky they perceived their behavior. Of course, as we now know, Lehman Brothers took on far more risk than the company, its investors and its regulators could afford.
The other side of this coin is how we perceive things we don’t know. Almost none of the buggy manufacturers in the early 1900’s transitioned to making automobiles. To them automobile manufacturing involved engines, and that was too risky. By the time buggy manufacturers felt they had to change, it was too late. When we are brought new opportunities to evaluate we don’t evaluate the real merits of upside and downside. Instead, we first question if the opportunity falls into our realm of expertise. If not, we deem it too risky. Because we don’t know much about it, we choose to think it’s too risky for us. Yet, the risk might be quite low.
Take for example buying Microsoft stock in the early 1990s as PC sales skyrocketed and Microsoft already had a monopoly on operating systems – and was building its monopoly in office software. The risk was quite small, since all Microsoft needed was for PCs (PCs made by anybody – it didn’t matter) to continue selling. That was not a high-risk bet. Yet most investors shied away because they didn’t understand tech stocks – including Warren Buffet who famously bought a mere 100 shares, declaring he didn’t understand the business! (Just think, if Warren Buffet had bought a large chunk of early Microsoft, he’d be as rich as himself plus Bill Gates today – now that’s a mind-boggler.)
When markets shift, relative risk can be deadly. If we continue to perceive things we know as low risk, we will "double down" our bets on customers, market segments, technologies and products that have declining value. If we think that doing what we always did will produce old returns we will do what’s comfortable, even when the market is moving headlong toward new solutions. Look at U.S. manufacturers of televisions (remember Quasar, Magnavox and Philco?). Experts in vacuum tubes and other analog technologies, plus the manufacturing expertise for those components, they were all late seeing the shift to solid-state electronics and all ended up out of business. All that expertise in the old technology simpy wasn’t worth much when the markets shifted – even though the new technology seemed risky while the old technology seemed familiar, and reliable.
When markets shift, the greatest risk is the "do what we know" scenario. Although it’s the easiest to approve, and the most comfortable – especially at times of rapid, dynamic change – it is the one scenario guaranteed to have worsening results. There’s an old myth that the last buggy whip manufacturer will make huge profits. Guess again. As buggy whip demand declines everyone loses money until most are gone. But there isn’t just one remaining player. The few who remain constantly see prices beaten down by the excess capacity of buggy whip designers, manufacturers and parts suppliers ready to jump in and compete on a moment’s notice. Trying to be last survivor just leaves you bloody, beaten up and without resources to even feed yourself.
It’s not worth spending a lot of time trying to evaluate risk. Because rarely (maybe never) in business is there such a thing as "absolute risk" you can measure. Risk is relative. What might appear risky could well be merely a perception driven by what you don’t know. What might appear low risk could be incredibly risky due to market shifts. So the real question is, are you Disrupting yourself so you are investigating all the possibilities – good and bad? And are you keeping White Space alive so you are experimenting, testing new ideas? New products, new technologies, new markets, new distribution systems, new components, new pricing formulas, new business models —- new Success Formulas? The only way to avoid arguments of risk is to get out there and do it – so you can get a good handle on what works, and what doesn’t, in order to make decisions based on opportunity assessment rather than Lock-in.
by Adam Hartung | Oct 9, 2008 | Defend & Extend, General, In the Swamp, Leadership, Lifecycle, Lock-in
The news is really bad in the auto business. For the first time since 1993 the number of cars sold in the USA in a month has declined to below one million. Sales are down over 25% from the previous year. And sales are predicted to decline considerably more in 2009. The value of General Motors (chart here) has declined to what it was in 1950 – when the Dow Jones Industrial Average was about 269 (GM is a component of the DJIA). (Read article here.) In the 1960s, when GM was king of the industrial companies, a popular phrase was "As goes GM, so goes America." This was based on the notion that GM was a microcosm of the American industrial economy. Is this still true – does GM portend the future of America?
A lot has changed in the last 40 years. Most importantly, the globe is no longer dominated by an industrial economy. Fewer and fewer people are employed in industrial production. We see it all around us as we realize that there are more people writing computer code than making computers. We’ve shifted to an information economy. Companies that ignored this shift, like GM, without finding opportunities to get into the growth economy are now suffering. GM started down the new road once, in the 1980s, by purchasing EDS and Hughes electronics. But later GM leadership sold those businesses in order to "focus" on the auto business. So now it’s only natural to recognize that the most industrial of the industrial companies are at the greatest risk of failure. No longer is GM a microcosm of any economy – including America. As GM goes so goes GM – but that doesn’t say anything about the future of America.
Some companies have shifted. They find new opportunities for growth. Today, wind energy is getting a big lift due to higher costs for petroleum fuels and increasing restrictions on greenhouse gases from using fossil fuels. Wind farms already exist offshore European countries, producing over 1,100 megawatts of power. Now such farms are being built not only on the great prairies of Texas and the American plains, but off the eastern U.S. coastline (read article here.) While there isn’t much interest for investing in auto manufacturing, there is lots of interest for investing in these wind farms to produce electricity – especially in high-cost electricity locations along the eastern seaboard.
And in the middle of this market we find – General Electric (see chart here). GE is the only U.S. company that makes wind turbines, and is a leader in promoting the new source of power. While many people have fixated on GE Financial and its woes, they have ignored the fact that GE is an American leader in many markets seeing rapid growth globally – such as wind power, water production, health care equipment and municipal infrastructure development. These markets are benefitting from the ecomomic boom in China, India and other developing countries, as well as emerging growth in the USA.
Any country’s economy can continue growing if it develops Phoenix companies that keep their eyes on the future and create White Space projects to keep them moving toward growth. These companies don’t fall into the trap of being "focused" on a single business, and dependent upon growth within that historically defined market. They constantly look for places to grow, regardless of what the company has previously done, and develop opportunities to learn in those new markets so they can create a new Success Formula maintaining growth. As long as America has companies that keep repositioning themselves for growth – such as GE, IBM, Cisco Systems, Apple, Google, Genentech, Johnson & Johnson, Baxter, etc. – America can have a great future.
by Adam Hartung | Oct 7, 2008 | General, In the Swamp, Lifecycle, Lock-in
So the stock market is crashing. Is now the time to buy? Many CEOs are asking this question.
The problem is that too often people try to buy a company that’s "cheap", using its past history as the basis. Take Bank of America (see chart here). BofA earlier this year bought the most troubled of all the mortgage companies Countrywide Financial. And then when Lehman Brothers was falling into bankruptcy BofA purchased Merrill Lynch, a retail stock brokerage that has been realing from on-line competition since e*Trade started in the 1990s, has one of the weakest mutual fund departments, one of the weakest research departments and a weak investment bank. BofA’s view was that based upon history, these companies were very cheap. But now, shortly after the acquisitions, BofA is announcing that it must halve its dividend, and raise additional equity through a new stock sale in order to shore up its balance sheet. And on top of this, earnings are down for the quarter and the year as the CEO starts claiming that estimates are pretty meaningless (read article here). Should you buy the new stock offering?
When markets shift, the value of assets tied to old Success Formulas decline. In the new market, the old Success Formula produces weaker returns and thus it is worth less. Too many people see this lower value as being a chance to "buy on the cheap." But far too often value will continue to decline because the old business simply isn’t worth as much. In Bank of America’s case, it bought extremely large players, but those that are inexorably linked to the old markets with old Success Formulas that are fast becoming out of date. While Merrill Lynch may be a great old name, the company itself has never been able to produce its old level of returns since brokerage markets shifted over a decade ago. Increasingly, it looks like BofA simply bought out-of-date competitors that were finding themselves on the rope as this market shift happened. And the BofA leadership is even leaving the old leaders in place after the acquisition.
Just in case you think that all the strategy and finance brains in big corporations means they are better judges of company value than yourself, remember that very rarely does any acquisition become worth what it cost. All finance academicians point out that buyers overvalue acquisitions in the process. In the end, it’s the buyers that see valuations suffer due to lower than anticipated earnings. In this case, BofA has bought large – but weak – competitors in markets reeling from shifts. And BofA has shown no proclivity to take dramatic changes to alter the Success Formulas (which JPMorgan Chase did upon acquiring Bear Sterns for almost nothing). This is a recipe for weak future performance.
Those companies that will benefit from acquisitions in this turmoil will have to purchase companies that better position the acquirers for future growth. Leaders not necessarily in size, but in the ability to produce growing revenues and profits. And acquisitions which can help migrate the acquirer’s Success Formula forward toward better competitiveness and higher returns – not just adding immediate (but declining) revenue. What’s going on at BofA may look like an effort to "buy on the cheap," but it’s more likely to end up "a pig in a poke."
by Adam Hartung | Sep 11, 2008 | In the Swamp, In the Whirlpool, Leadership, Lock-in
Leaders of organizations, especially those with lots of employees and/or big revenues, have a leveraged impact when making decisions. If a manager with 8 people in a group makes an error, it’s felt by those 8, plus those all 9 work with. If the CEO of a business with over $1B of revenue, or more than 1,000 employees makes a bad decision think about the leverage that creates. Lots of people suffer. Not only the employees, but customers, investors and suppliers.
This is very apparent now at Tribune Company and especially the newspapers it controls – including the Los Angeles Times and the Chicago Tribune. These aren’t the only 2 businesses owned by Tribune Corp., but their success, or lack therof, has a serious impact on the 35-50 million people that are tightly connected to the markets where they report the news. Yes, it is true that newspapers no longer have the power they once did. But there’s no doubt that lots of our news is still dependent upon writers and editors working at these two newspapers. If we’re to root out political corruption at the state or local level, or report on energy crises, or agricultural concerns we depend significantly on reporters at big city newspapers. As reported in BusinessWeek recently (read article here), these newspapers are now at significant risk of failure due to the leadership of Sam Zell.
Back at the end of 2006 Tribune’s equity value was down 65% from its high in 1999. Revenues had been declining since 2004. Cash flow was being propped up with draconian cuts across the organization. Pink slips littered the hallways, and long-term employees were being handed early retirement plans. It was clear that management was doing everything possible to dress up the corporation for a higher valuation to some potential suitor – which was proving hard to find. Most people were very wary of the proposed pricing, recognizing that changing market dynamics in media were pushing advertising more toward the web, and coming right out of newspapers. Meanwhile, in cable targeted channels were fragmenting the market leavng variety channels running reruns or second-rate programs (like CW) with precious few eyeballs and struggling ad revenues. This was all bad news for Tribune Corporation. Something needed to be done that would help Tribune find a new way to compete and grow against the ever-more-popular internet and ad-placement behemoth Google.
Enter Sam Zell, who had a Success Formula he was ready to apply. Throughout his history he had bought beaten up real estate, borrowed a gob of money against it, done some fixing up, leased it out and then sold it for a big gain. In real estate, this had always worked. So he was ready to apply his Success Formula to newspapers. He had no plans to change the operating Success Formula at Tribune Corporation, believing the revenue problems would self-correct. He read 3 papers every day, so he figured people would be like him and return to reading newspapers soon enough. And advertisers would follow. He was going to own the Cubs and Wrigley field, but he didn’t much like baseball, so to him this was just another asset to leverage and sell. Same for those 25 second-tier television stations around the country. He didn’t intend to change the Tribune’s operating Success Formula, just tweak it a bit. And overlay his own Success Formula based on lots of debt, waiting for recovery, doing some simple sprucing, and being overbearing with employees.
Of course, as I predicted in my several blogs at the time, this was a recipe for disaster. The Tribune Corp needed a big dose of internal Disruption, and plenty of White Space to figure out where advertisers were going and how to appeal to them. Tribune needed to move hard and fast to more web understanding, and dramatically rethink how to manage its independent television stations in a world where they were the weakest of weakening broadcast stations – as well as the most generic of cable stations. Revenues were going to continue to decline – and facing a predictable economic weakening they would decline a lot and very fast. The last thing Tribune Corporation needed was more debt. It needed to conserve its assets to pay for a transformation of the company – after it could figure out what that transformation needed to be!
After adding an additional $8billion debt, growing it to $13.5billion,, and investing only $350million of his money, Sam Zell set off on a path of value destruction. And who holds the bag? The bondholders of course. Someone once told me that debt was not supposed to carry risk – that’s what equity was for. But Zell convinced investment bankers to sell his extremely risky bonds to various holders (mostly pension funds) so he could finance an overpriced deal. Now those bondholders have seen as much as a 65% reduction in the value of their investments. Were the pensioners to know they wold be so glad! Mr. Zell’s Success Formula, so tied to real estate during boom times, was the worst thing that could be applied to the struggling newspapers at Tribune. But he was able to apply it using other people’s money – so he has little to lose and much to gain while the bondholders have much to lose and almost nothing to gain.
Meanwhile, employees across Tribune are falling like flies exposed to DDT. And the news products in L.A. and Chicago are getting weaker with each passing month as journalists aren’t there to write. The people of these great cities are simply left knowing less about what’s happening in their metropolises. Everyone in both cities is getting a cold slap from this folly.
Mr. Zell keeps saying he’ll do whatever he has to do to make money with Tribune Corporation. But that’s not true. What he means is he’ll do whatever his old Success Formula recommends he do. So now, as his own newspaper boss says, they are chewing off a leg to try and get out of the falling revenue trap. This is not an approach that will make for a strong Tribune Corporation. It is a path toward a corporation with no resources, weak products and customers left without a solution. What Tribune needs is White Space to figure out how to compete as a 21st century media company. But instead all energy is being diverted toward paying off the bonds Mr. Zell sold to fund his all-too-risky bet on debt.
We all have a responsibility to understand our Success Formulas. And to understand those of the people who would lead our organization. If we see that Success Formula Locked-in, we can bet on more of the same – regardless of the outcome. Mr. Zell would rather fail as a cost-cutter than lead Tribune Corporation to its next legacy of success. But unfortunately, it is all the people dependent on Mr. Zell who will suffer most – the vendors, customers, investors and employees. They will suffer from his outdated Success Formula even more than he will – as he jets each weekend to between his home in Malibu and his home in Chicago. Leaders have the greatest responsibility to recognize their Success Formula Lock-ins, and be open to Disrupt and use White Space to find solutions which can succeed. Because when they fail, everyone around them fails as well.
by Adam Hartung | Sep 10, 2008 | General, In the Swamp, Leadership, Lock-in
CEOs and investment bankers love to talk about, and do, mergers. So do journalists. A big combination of two companies gets people all excited. There is always a lot of talk about how "synergy" will allow the two companies to be worth more combined than they were worth independently. Yet, there are no academic studies that prove this point. Quite to the contrary, academicians will tell you over and over that the synergies don’t appear, and the combined companies are worth less than they were worth independently. Usually quite quickly. So, if CEOs like to make these deals – why don’t they work? Why does Mercedez Benz buy Chrysler, only to see the value plummet and eventually sell the company off to a private equity firm?
Let’s take a look at AOL/Time Warner (see chart here). In the 1990s these two companies were leaders in their markets. AOL had pioneered internet access to the home, and was clearly #1. Time Warner had become the dominant player in cable television, also #1. Both were growing at double digit rates. To the CEOs, investment bankers, and most onlookers putting these two entities together brought together the best of both markets – creating a no-lose media company destined to be pre-eminent in the next decade. But the cost of the merger ended up far outweighing any benefits. The value of the combined company plummeted. Worth almost $100/share in 2000, today the equity trades for about $15/share (an 85% value decline.) Billions of dollars in investor equity was wiped out. And today as AOL tries to revive itself as an internet player it is derisively referred to as "AO Hell" or "Albatross OnLine" (read about AOLs newest move here.) Why didn’t the great media company that was predicted develop?
All businesses have Success Formulas. Whether profitable or not, whether growing or not, all businesses have Success Formulas. These Success Formulas are a nested, tighly integrated combination of the business’s very Identity, it’s Strategy for growth and the Tactics which support the Identity and the Strategy. All behaviors, internal sacred cows, hierarchy and organization, decision making systems, IT system, hiring procedures, asset utilization programs, metrics and costs are organized to support that Success Formula. The business isn’t an ideological being as often described by executives or journalists – it is a very tightly-knitted Success Formula operated day in and day out, every day, in pursuit of doing those things that made the business grow.
In a merger, the two business Success Formulas collide. As sensible as a combination may be, as powerfullly as they share customers, as efficiently as they may use the same infrastructure, as aligned as their strategies appear, they have two different Success Formulas. And when it comes time to merge – neither simply disappears. Suddenly, to achieve the great projected value, it is expected that some kind of new Success Formula will appear that achieves the lofty future goals. But how will that happen? These Success Formulas grew out of years of development during the businesses’ growth. This sudden combination is no substitute for the evolutionary development of a Success Formula. At the time of merger, regardless of the size or success of either business, they two suddently confront themselves as two gladiators in the colliseum. Which will reign?
And that is when things go wrong. The only way the desired value can be achieved is if a new entity is created that actually develops an entirely new, third Success Formula. But given the high stakes, who wants to take the time to develop this? Who believes they can afford to define a new Identity, to craft a new Strategy out of market success, and to build a whole new set of Tactics that support the new Strategy? Who will set up White Space to start bringing together pieces, testing the development of anything new and putting plans against the rigor of market acceptance? The CEO and investors want results – and now!!! So what happens? Inevitably, one of the Success Formulas gets picked as the winner (usually by the new CEO), and that one sets about to convert the other entity into the "designated winning" Success Formula. At this point, many of the value creators of the losing Success Formula disappear. People leave. Products are dropped. Customers, or whole markes, are dropped. Manufacturing and service systems are eliminated. Very rapidly, the exercise becomes a cost-cutting frenzy as two of everything is converted to one. And the "winner" becomes a subset of what the two starters brought to the merger.
At AOL, Time Warner bought AOL. The Time Warner guys remained in charge. Pretty quickly, they set about converting AOL into a Time Warner Success Formula. And in the fast-changing internet world, AOL quickly started losing value. Time Warner froze AOL into place as a dial-up service with specific extras. They flooded mailboxes with CDs begging people to sign up for a free 3 month service. But as bandwidth expanded, and Comcast along with the phone companies installed broadband to more and more homes and businesses, the value simply evaporated out of AOL. Time Warner remained Time Warner, but AOL soon became an out-of-date internet dinosaur.
Creating value via merger is a very tough thing. One company, ITW, does it very well (see chart here). But ITW doesn’t try to put its acquisitions onto common systems, or bring them into one operating unit. ITW is quite unique in allowing its acquisitions to create value out of their markets as they see fit. Most CEOs can’t stand this sort of independence, and they move quickly to convert the merged company into the Success Formula of the acquirer. And within months, much of the value originally sought is gone. Just like at Time Warner and AOL.
by Adam Hartung | Sep 4, 2008 | Defend & Extend, General, In the Swamp, Leadership, Lifecycle, Lock-in
WalMart (see chart here) has announced recent earnings, and they were better than Wall Street anticipated (read Marketwatch article here). Same store sales were up 3% compared to last year. As a result, the stock is worth today almost what it was worth 5 years ago (yet still more than 10% shy of all time highs from a decade ago.) Here we are in a terrible economy for retailers, with department stores, specialty stores and luxury stores all seeing double digit revenue declines. Yet WalMart comes in with a good quarterly result. Does this show WalMart is back on track to recapture past greatness?
WalMart has done nothing to make itself a better, more competitive company over the last year. It’s just done exactly what it has always done – but with a bit more price chopping than usual in some areas – and expansion of low-margin grocery sales in others. More of the same. For example, in the 30,000 person town of Minocqua, Wisconsin Wal-Mart opened a new store that was 5 times the previous store size and included a Wal-Mart grocery – offering the first competition to local grocers ever in that town. In other words, Wal-Mart kept being Wal-Mart.
Of course what happened was a recession. Certainly a recession in consumer spending. The decade of declining incomes in real terms met with the credit contraction of 2008, as well as declining home and auto values, reducing available cash for consumers. The immediate reaction was to simply buy less stuff – and become price sensitive. The first means people quit buying new diamonds and going to Aeropastale for sweatshirts, and the latter meant they started looking for where they could save dimes – not just dollars – on everything from sweatshirts to green beans. So where would you expect people to turn? Why to the retailer that has always been focused on saving dimes.
But this doesn’t mean Wal-Mart is the company you should invest in. Low-price is not the exclusive domain of Wal-Mart. I recently blogged about Aldi, a company that is even lower priced than Wal-Mart on groceries and is itself in an even bigger growth boom right now. And it’s doing new things (like its first-ever television advertising) to help itself grow. So Wal-Mart isn’t the only game in town for low-price. Competition to be the low-cost retailer will remain constant as other companies search out ways to be even lower cost than Wal-Mart – with strategies such as Aldi’s to carry a limited product line and use less labor (rather than just use cheap labor.)
More importantly, consumers don’t remain focused on price long-term. Recessions are characterized by job losses, hours worked reductions, bonus retractions and other income bashers. But things do move on. People don’t remain in a "recessionary mindset" forever. They change expenditure patterns and household budgets to get back into more comfortable lifestyles. And jobs, hours and bonuses come back. When that happens, the desire to shop WalMart will remain where it is now "only if I have to." Not a lot of high-schoolers want to show up in the sweatshirt everyone knows came from Wal-Mart, nor do many men want to purchase their work slacks at Wal-Mart. Now people feel they have to – it doesn’t mean they want to – nor that they’ll do it long term.
When short-term market shifts happen even a bad Success Formula can look good for a short while. Like the old phrase "even a stopped clock is right twice a day." Wal-Mart is extremely Locked-in to its one-horse strategy. Wal-Mart has not developed a culture which can adapt to the needs of modern consumers. It has not made its merchandizing modern, nor its store layouts, nor has it figured out how to adapt in-store selections to fit local market differences. Wal-Mart is still the company that controls the temperature in every store via thermostats in Fayetteville, Arkansas. The recent quarterly results are good news for the short-term, but do not reflect the out-of-date nature nor Lock-in of Wal-Mart’s Success Formula. By next year Wal-Mart will again be struggling to compete with more fashionable companies like Target, while fighting an even tougher batte on the price side with emerging competitors like Aldi.
If you bought Wal-Mart 5 years ago, you’ve been sitting on a paper loss (with almost no dividend return) for this whole period. Now’s the time to get out.
by Adam Hartung | Sep 3, 2008 | Defend & Extend, General, In the Swamp, Innovation, Leadership, Openness
Today Coca-Cola (see chart here) announced it was planning to acquire the largest juice company in China (read Marketwatch article here.) At a cost of $2.4 billion Coke is hoping to expand its footprint in the most populous country on earth. Are you excited? Most people aren’t – and there’s no reason to be.
What’s the innovation in this move by Coca-Cola? What are they doing that’s new? Nothing, of course. This is a simple extension of the same soft-drink business Coca-Cola has been in for decades. More of the same. Yes it’s good that they would want to do more business in the very large and growing Chinese market – but this is more Defend & Extend behavior trying to support existing Lock-ins. At first it may sound obviously good, but what’s not discussed is how much local competition Coke will face. Nor how much competition from European and other competitors. Without innovation, this kind of extend tactic will face all the traditional market competition and is unlikely to produce exciting (above-average) results. Just look at how little difference offshore acquisitions and expansion have made to Wal-Mart or GM – because as D&E plays they allow competitors to keep banging away at the company’s declining Success Formula. Just because a company announces it is entering a new market does not mean they will sell more stuff, nor make more money.
We can see that Coke is struggling to innovate when the same announcement says that the company is planning to spend $1billion in a stock buyback this year. This is an admission that without anything innovative to invest in the company is going to use its cash to prop up the stock price (which will benefit the bonus of the top execs.) Coke cannot regain its great growth glory if it’s spending all its money to do more of the same and buy its own stock. That’s the cycle of doing only what the company knows, which is why the business has been suffering from declining marginal returns for almost 20 years (Coke is down almost 50% from its highs reached in the mid-90s, see long-term chart here). Even the recently published memoirs of the ex-COO at Coke is a study in how to try avoiding failure – rather than seeking success (The Ten Commandments for Business Failure is currently paired with Create Marketplace Disruption on Amazon – a distinct contrast in approach to business management.)
This is the flip side of the discussion in yesterday’s blog about Google’s Chrome release (see video about Chrome’s launch on Marketwatch here). Chrome is significant innovation by Google trying to move beyond its traditional markets. Chrome is not about Defending & Extending Google Lock-ins to traditional markets and products. Chrome is using White Space to implement Disruptions taking Google into new markets with much higher growth, which will allow Google to remain in the Rapids. Coke’s planned acquisition is a yawner because it supports historical Lock-ins and keeps the company in the slow-growth, unexciting, non-innovative mode that has made its returns lackluster for several years. No White Space in the Coke move – just more of the same – which makes life much easier for its competitors, whether traditional or new.
by Adam Hartung | Aug 27, 2008 | Defend & Extend, General, In the Swamp, In the Whirlpool, Leadership, Lock-in
The U.S. credit crisis has a lot of people very concerned about the economy. (Read LATimes article on the high stakes of this problem here.) As well it should. It was a credit crisis in the 1930s which created a rash of loan failures lead to bank failures, deflation and the worst economy in American history. While we keep being assured there will not be another Great Depression, there is still reason for serious concern. Three major financial institutions have failed in the last year (Countrywide, Bear Sterns and IndyMac), and one of the world’s leading economists has predicted the worst is yet to come with at least one additional major financial institution collapsing. So, isn’t it worth asking "how did we get into this mess?"
It wasn’t long ago the big controversy was about how much the heads of Freddie Mac and Fannie Mae were getting paid. The argument was whether these institutions were independent banks, or government agencies. After all, they were guaranteeing FHA and similar loans, so they were using government backing as they regulated the mortgage market as well as underwrote its activities. So the question was whether the leaders should be paid like regulators – say a Federal Reserve Board member – or like executives of an independent bank. As the mortgage markets ballooned these institutions were booking more and more paper profits, and the CEO pay had gone up dramatically. Many people were questioning whether this was appropriate.
Now we can see that both institutions were allowing ever riskier loans to be made by mortgage providers. And both are near insolvency. Equity holders have been nearly wiped out as Freddie Mac’s value has dropped from $70/share to under $5 (see chart here) and Fannie Mae has dropped from $80 to $6.50 (see chart here.) Privatizing these formerly government agencies hasn’t worked out too well for investors lately.
Freddie and Fannie didn’t have bad leaders, they just kept trying to make it possible for their primary customers – the banks and mortgage companies – to keep making more and larger loans. They didn’t come out and say "we’re going to take more risk", they just slowly inched their way forward allowing loans to have less down payment, allowing the buildings to have higher valuations as collateral, allowing higher debt-to-income ratios. They didn’t start out in 1995 with the idea they would eventually be making loans for $300,000 to people who never before owned a house, had no down payment, could provide no proof of income and on an asset valuation that was 25% higher than the most recent sale. That loan would never have been approved by any bank in 1995. Or 1996. Or 2001.
But the banks and mortgage companies wanted to grow. They had a well known Success Formula. They could advertise a good rate, implement the loan application process, then sell off the loan in the secondary market with a Fannie Mae or Freddie Mac guarantee. As real estate values took off, they simply needed more leniency on some of these items so they could do more loans faster and cheaper – extend their business (the back half of Defend & Extend Management). They wanted to Defend & Extend what they knew how to do. So Freddie Mac and Fannie Mae went along. And they got the big financial houses involved as well as they packaged up what were becoming increasingly risky loans.
And that’s what happens in D&E management. In order to keep growing, it is tempting to push just a little harder by trying to extend the old Success Formula. Cut a cost corner here. Take a little more risk there. Just do a little bit more of what was previously done. Everyone can see that these actions are taking them downstream. But, so far so good! Nobody has drowned yet. We might be able to see the waterfall ahead, and hear the water crashing down below a little clearer, but so far we haven’t seen any problems. So let’s try to do just a little bit more.
Of course, inevitably, D&E managers go over the waterfall – and take their customers, investors, employees, suppliers and this time the U.S. citizenry along with them. They reach just a little farther than they should have, and then it’s a free-for-all as the business gets sucked into the Whirlpool from which there will be no return.
We saw this before, when the Savings & Loan industry melted down and went away because of the ever increasing risk its leaders took. Equity holders were wiped out, and many lenders were significantly damaged despite the unprecedented government bailout at the time. In the end, we suffered a recession and a big loss of faith in real estate as the Keating 5 were tried and the S&L industry collapsed. All by trying to maintain the Lock-in, then Extend the business just a little more into some new area. And by getting the regulators to go along, the entire country and its economy end up at risk.
D&E managers don’t like risk, and intend to take risk. But because there isn’t any White Space to develop a new Success Formula they keep extending the old one. They claim they aren’t taking risk, but in fact they are. Each risk may be small, but as we’ve seen they quickly add up. These leaders start turning a blind eye to the risk as they remain Locked-in and see no other way to grow. They have to grow, and they have to remain Locked-in, so they take risks that to outsiders might look crazy. (Think about how Enron started guaranteeing its own derivatives so it could keep growing.) But Lock-in allows them to pretend the risk isn’t as great as it is. These extensions keep the Success Formula in place, and make it appear to be producing better results. But these extensions are moving closer and closer to the waterfall, and the inevitable fall into the Whirlpool. Eventually, we all must have White Space to evolve a new Success Formula, or the trip over the waterfall is inevitable.
by Adam Hartung | Aug 26, 2008 | Defend & Extend, Ethics, General, In the Swamp, Leadership, Lock-in
Sometimes management behavior can cause outsiders to think the industry and company leaders fear growth. Take for example a new book about innovation in the movie business Inventing the Movies by Scott Kirsner (see at Amazon here or read a review in Forbes here.) As the author points out, after Edison invented the first Kinetiscope movies – which were small viewer-based single person devices – he saw no reason to move forward with a projection system. Why advance the innovation when multiple audience members appeared to risk the revenue? To Edison, he could assure each and every viewing created a payment with his single-viewer technology, but the audience viewership meant he would lose control and possibly see revenue cannibalized. Fear of cannibalization caused him to avoid new innovations which would grow total demand, and considerably grow the revenues of his fledgling movie business.
But we all know this didn’t happen. Projection systems only caused more people to want to go to the movies. Then when talking movies came about again the industry feared that investing in sound equipment would be a cost not recovered and they delayed and delayed. But talking films again increased the audience. And this cycle played out again with color movies. And lest we not forget the wars that were fought over video tapes of movies, which all industry leaders feared would kill the business. Yet, videos (and now CDs) have only increased the audience, and demand more.
All businesses develop a Success Formula early in their life cycle. That Success Formula ties the Identity of the business to its strategy and tactics. So a tactic as simple as having a single-viewer kinetiscope becomes almost impossible to change because it gets linked to the identity of the business (and often its founder – in this case Edison). Thus it takes a new entrant, often from outside the industry, to parlay the new technology into the market. This new entrant, not afraid of controlling the business through administration of an old Success Formula, is able to bring forward the new technology/solution and build the new audience/demand. And often we see the old industry leader far too late to change – stumbling, fumbling and failing.
Businesses need not follow this course, however. If they are willing to invest in White Space they can test new solutions. They can figure out new Success Formulas. They can evolve, and they can grow. Doing so isn’t really hard, it just takes a willingness to accept the requirement for White Space to take advantage of market shifts. White Space allows you to migrate forward, rather than constantly fall back into Defending & Extending what you’ve always done.
As we all know, each innovation in the movies has grown the industry, not been its doom. And that’s true in all industries. Yet, the largest players are rarely the ones who lead these shifts. Look at how it took Apple to bring about the revolution in digital music, rather than Sony. Lock-in gets in their way. If we want to avoid being pummeled by market shifts that create great growth opportunities for the new competitor we have to be vigilant about implementing and maintaining White Space that can provide our beacon for growth.
Where’s your organization’s White Space?
