by Adam Hartung | Jul 25, 2015 | Current Affairs, In the Whirlpool, Leadership
This week an important event happened on Wall Street. The value of Amazon (~$248B) exceeded the value of Walmart (~$233B.) Given that Walmart is world’s largest retailer, it is pretty amazing that a company launched as an on-line book seller by a former banker only 21 years ago could now exceed what has long been retailing’s juggernaut.
WalMart redefined retail. Prior to Sam Walton’s dynasty retailing was an industry of department stores and independent retailers. Retailing was a lot of small operators, primarily highly regional. Most retailers specialized, and shoppers would visit several stores to obtain things they needed.
But WalMart changed that. Sam Walton had a vision of consolidating products into larger stores, and opening these larger stores in every town across America. He set out to create scale advantages in purchasing everything from goods for resale to materials for store construction. And with those advantages he offered customers lower prices, to lure them away from the small retailers they formerly visited.
And customers were lured. Today there are very few independent retailers. WalMart has ~$488B in annual revenues. That is more than 4 times the size of #2 in USA CostCo, or #1 in France (#3 in world) Carrefour, or #1 in Germany (#4 in world) Schwarz, or #1 in U.K. (#5 in world) Tesco. Walmart directly employes ~.5% of the entire USA population (about 1 in every 200 people work for Walmart.) And it is a given that nobody living in America is unaware of Walmart, and very, very few have never shopped there.
But, Walmart has stopped growing. Since 2011, its revenues have grown unevenly, and on average less than 4%/year. Worse, it’s profits have grown only 1%/year. Walmart generates ~$220,000 revenue/employee, while Costco achieves ~$595,000. Thus its need to keep wages and benefits low, and chronically hammer on suppliers for lower prices as it strives to improve margins.
And worse, the market is shifting away from WalMart’s huge, plentiful stores toward on-line shopping. And this could have devastating consequences for WalMart, due to what economists call “marginal economics.”
As a retailer, Walmart spends 75 cents out of every $1 revenue on the stuff it sells (cost of goods sold.) That leaves it a gross margin of 25 cents – or 25%. But, all those stores, distribution centers and trucks create a huge fixed cost, representing 20% of revenue. Thus, the net profit margin before taxes is a mere 5% (Walmart today makes about 5 cents on every $1 revenue.)
But, as sales go from brick-and-mortar to on-line, this threatens that revenue base. At Sears, for example, revenues per store have been declining for over 4 years. Suppose that starts to happen at Walmart; a slow decline in revenues. If revenues drop by 10% then every $100 of revenue shrinks to $90. And the gross margin (25%) declines to $22.50. But those pesky store costs remain stubbornly fixed at $20. Now profits to $2.50 – a 50% decline from what they were before.
A relatively small decline in revenue (10%) has a 5x impact on the bottom line (50% decline.) The “marginal revenue”, is that last 10%. What the company achieves “on the margin.” It has enormous impact on profits. And now you know why retailers are open 7 days a week, and 18 to 24 hours per day. They all desperately want those last few “marginal revenues” because they are what makes – or breaks – their profitability.
All those scale advantages Sam Walton created go into reverse if revenues decline. Now the big centralized purchasing, the huge distribution centers, and all those big stores suddenly become a cost Walmart cannot avoid. Without growing revenues, Walmart, like has happened at Sears, could go into a terrible profit tailspin.
And that is what Amazon is trying to do. Amazon is changing the way Americans shop. From stores to on-line. And the key to understanding why this is deadly to Walmart and other big traditional retailers is understanding that all Amazon (and its brethren on line) need to do is chip away at a few percentage points of the market. They don’t have to obtain half of retail. By stealing just 5-10% they put many retailers, they ones who are weak, right out of business. Like Radio Shack and Circuit City. And they suck the profits out of others like Sears and Best Buy. And they pose a serious threat to WalMart.
And Amazon is succeeding. It has grown at almost 30%/year since 2010. That growth has not been due to market growth, it has been created by stealing sales from traditional retailers. And Amazon achieves $621,000 revenue per employee, while having a far less fixed cost footprint.
What the marketplace looks for is that point at which the shift to on-line is dramatic enough, when on-line retailers have enough share, that suddenly the fixed cost heavy traditional retail business model is no longer supportable. When brick-and-mortar retailers lose just enough share that their profits start the big slide backward toward losses. Simultaneously, the profits of on-line retailers will start to gain significant upward momentum.
And this week, the marketplace started saying that time could be quite near. Amazon had a small profit, surprising many analysts. It’s revenues are now almost as big as Costco, Tesco – and bigger than Target and Home Depot. If it’s pace of growth continues, then the value which was once captured in Walmart stock will shift, along with the marketplace, to Amazon.
In May, 2010 Apple’s value eclipsed Microsoft. Five years later, Apple is now worth double Microsoft – even though its earnings multiple (stock Price/Earnings) is only half (AAPL P/E = 14.4, MSFT = 31.) And Apple’s revenues are double Microsoft’s. And Apple’s revenues/employee are $2.4million, 3 times Microsoft’s $731k.
While Microsoft has about doubled in value since the valuation pinnacle transferred to Apple, investors would have done better holding Apple stock as it has more than tripled. And, again, if the multiple equalizes between the companies (Apple’s goes up, or Microsoft’s goes down,) Apple investors will be 6 times better off than Microsoft’s.
Market shifts are a bit like earthquakes. Lots of pressure builds up over a long time. There are small tremors, but for the most part nobody notices much change. The land may actually have risen or fallen a few feet, but it is not noticeable due to small changes over a long time. But then, things pop. And the world quickly changes.
This week investors started telling us that the time for big change could be happening very soon in retail. And if it does, Walmart’s size will be more of a disadvantage than benefit.
by Adam Hartung | Jul 17, 2015 | Current Affairs, General, In the Swamp, Leadership, Lifecycle
Most analysts, and especially “chartists,” put a lot of emphasis on earnings per share (EPS) and stock price movements when determining whether to buy a stock. Unfortunately, these are not good predictors of company performance, and investors should beware.
Most analysts are focused on short-term, meaning quarter-to-quarter, performance. Their idea of long-term is looking back 1 year, comparing this quarter to same quarter last year. As a result, they fixate on how EPS has done, and will talk about whether improvements in EPS will cause the “multiple” (meaning stock price divided by EPS) will “expand.” They forecast stock price based upon future EPS times the industry multiple. If EPS is growing, they expect the stock to trade at the industry multple, or possibly somewhat better. Grow EPS, hope to grow the multiple, and project a higher valuation.
Analysts will also discuss the “momentum” (meaning direction and volume) of a stock. They look at charts, usually less than one year, and if price is going up they will say the momentum is good for a higher price. They determine the “strength of momentum” by looking at trading volume. Movements up or down on high volume are considered more meaningful than on low volume.
But, unfortunately, these indicators are purely short-term, and are easily manipulated so that they do not reflect the actual performance of the company.
At any given time, a CEO can decide to sell assets and use that cash to buy shares. For example, McDonald’s sold Chipotle and Boston Market. Then leadership took a big chunk of that money and repurchased company shares. That meant McDonalds took its two fastest growing, and highest value, assets and sold them for short-term cash. They traded growth for cash. Then leadership spent that cash to buy shares, rather than invest in in another growth vehicle.
This is where short-term manipulation happens. Say a company is earning $1,000 and has 1,000 shares outstanding, so its EPS is $1. The industry multiple is 10, so the share price is $10. The company sells assets for $1,000 (for purposes of this exercise, let’s assume the book value on those assets is $1,000 so there is no gain, no earnings impact and no tax impact.)
Company leadership says its shares are undervalued, so to help out shareholders it will “return the money to shareholders via a share repurchase” (note, it is not giving money to shareholders, just buying shares. $1,000 buys 100 shares. The number of shares outstanding now falls to 900. Earnings are still $1,000 (flat, no gain,) but dividing $1,000 by 900 now creates an EPS of $1.11 – a greater than 10% gain! Using the same industry multiple, the analysts now say the stock is worth $1.11 x 10 = $11.10!
Even though the company is smaller, and has weaker growth prospects, somehow this “refocusing” of the company on its “core” business and cutting extraneous noise (and growth opportunities) has led to a price increase.
Worse, the company hires a very good investment banker to manage this share repurchase. The investment banker watches stock buys and sells, and any time he sees the stock starting to soften he jumps in and buys some shares, so that momentum remains strong. As time goes by, and the repurchase program is not completed, selectively he will make large purchases on light trading days, thus adding to the stock’s price momentum.
The analysts look at these momentum indicators, now driven by the share repurchase program, and deem the momentum to be strong. “Investors love the stock” the analysts say (even though the marginal investors making the momentum strong are really company management) and start recommending to investors they should anticipate this company achieving a multiple of 11 based on earnings and stock momentum. The price now goes to $1.11 x 11 = $12.21.
Yet the underlying company is no stronger. In fact one could make the case it is weaker. But, due to the higher EPS, better multiple and higher share price the CEO and her team are rewarded with outsized multi-million dollar bonuses.
But, companies the last several years did not even have to sell assets to undertake this kind of manipulation. They could just spend cash from earnings. Earnings have been at record highs, and growing, for several years. Yet most company leaders have not reinvested those earnings in plant, equipment or even people to drive further growth. Instead they have built huge cash hoards, and then spent that cash on share buybacks – creating the EPS/Multiple expansion – and higher valuations – described above.
This has been so successful that in the last quarter untethered corporations have spent $238B on buybacks, while earning only $228B. The short-term benefits are like corporate crack, and companies are spending all the money they have on buybacks rather than reinvesting in growth.
Where does the extra money originate? Many companies have borrowed money to undertake buybacks. Corporate interest rates have been at generational (if not multi-generational) lows for several years. Interest rates were kept low by the Federal Reserve hoping to spur borrowing and reinvestment in new products, plant, etc to drive economic growth, more jobs and higher wages. The goal was to encourage companies to take on more debt, and its associated risk, in order to generate higher future revenues.
Many companies have chosen to borrow money, but rather than investing in growth projects they have bought shares. They borrow money at 2-3%, then buy shares – which can have a much higher immediate impact on valuation – and drive up executive compensation.
This has been wildly prevalent. Since the Fed started its low-interest policy it has added $2.37trillion in cash to the economy. Corporate buybacks have totaled $2.41trillion.
This is why a company can actually have a crummy business, and look ill-positioned for the future, yet have growing EPS and stock price. For example, McDonald’s has gone through rounds of store closures since 2005, sold major assets, now has more stores closing than opening, and has its largest franchisees despondent over future prospects. Yet, the stock has tripled since 2005! Leadership has greatly weakened the company, put it into a growth stall (since 2012,) and yet its value has gone up!
Microsoft has seen its “core” PC market shrink, had terrible new product launches of Vista and Windows 8, wholly failed to succeed with a successful mobile device, written off billions in failed acquisitions, and consistently lost money in its gaming division. Yet, in the last 10 years it has seen EPS grow and its share price double through the power of share buybacks from its enormous cash hoard and ability to grow debt. While it is undoubtedly true that 10 years ago Microsoft was far stronger, as a PC monopolist, than it is today – its value today is now higher.
Share buybacks can go on for several years. Especially in big companies. But they add no value to a company, and if not exceeded by re-investments in growth markets they weaken the company. Long term a company’s value will relate to its ability to grow revenues, and real profits. If a company does not have a viable, competitive business model with real revenue growth prospects, it cannot survive.
Look no further than HP, which has had massive buybacks but is today worth only what it was worth 10 years ago as it prepares to split. Or Sears Holdings which is now worth 15% of its value a decade ago. Short term manipulative actions can fool any investor, and actually artificially keep stock prices high, so make sure you understand the long-term revenue trends, and prospects, of any investment. Regardless of analyst recommendations.
by Adam Hartung | Jul 8, 2015 | Current Affairs, Defend & Extend, In the Whirlpool, Leadership, Lock-in, Web/Tech
Microsoft announced today it was going to shut down the Nokia phone unit, take a $7.6B write-off (more than the $7.2B they paid for it,) and lay off another 7,800 employees. That makes the layoffs since CEO Nadella took the reigns almost 26,000. Finding any good news in this announcement is a very difficult task.
Unfortunately, since taking over as Microsoft’s #1 leader, Mr. Nadella has been remarkably predictable. Like his peer CEOs who take on the new role, he has slashed and burned employment, shut down at least one big business, taken massive write-offs, and undertaken at least one wildly overpriced acquisition (Minecraft) that is supposed to be a game changer for the company. He apparently picked up the “Turnaround CEO Playbook” after receiving the job and set out on the big tasks!
Yet he still has not put forward a strategy that should encourage investors, employees, customers or suppliers that the company will remain relevant long-term. Amidst all these big tactical actions, it is completely unclear what the strategy is to remain a viable company as customers move, quickly and in droves, to mobile devices using competitive products.
I predicted here in this blog the week Steve Ballmer announced the acquisition of Nokia in September, 2013 that it was “a $7.2B mistake.” I was off, because in addition to all the losses and restructuring costs Microsoft endured the last 7 quarters, the write off is $7.6B. Oops.
Why was I so sure it would be a mistake? Because between 2011 and 2013 Nokia had already lost half its market share. CEO Elop, who was previously a Microsoft senior executive, had committed Nokia completely to Windows phones, and the results were already catastrophic. Changing ownership was not going to change the trajectory of Nokia sales.
Microsoft had failed to build any sort of developer community for Windows 8 mobile. Developers need people holding devices to buy their software. Nokia had less than 5% share. Why would any developer build an app for a Windows phone, when almost the entire market was iOS or Android? In fact, it was clear that developing rev 2, 3, and 4 of an app for the major platforms was far more valuable than even bothering to port an app into Windows 8.
Nokia and Windows 8 had the worst kind of tortuous whirlpool – no users, so no developers, and without new (and actually unique) software there was nothing to attract new users. Microsoft mobile simply wasn’t even in the game – and had no hope of winning. It was already clear in June, 2012 that the new Windows tablet – Surface – was being launched with a distinct lack of apps to challenge incumbents Apple and Samsung.
By January, 2013 it was also clear that Microsoft was in a huge amount of trouble. Where just a few years before there were 50 Microsoft-based machines sold for every competitive machine, by 2013 that had shifted to 2 for 1. People were not buying new PCs, but they were buying mobile devices by the shipload – literally. And there was no doubt that Windows 8 had missed the mobile market. Trying too hard to be the old Windows while trying to be something new made the product something few wanted – and certainly not a game changer.
A year ago I wrote that Microsoft has to win the war for developers, or nothing else matters. When everyone used a PC it seemed that all developers were writing applications for PCs. But the world shifted. PC developers still existed, but they were not able to grow sales. The developers making all the money were the ones writing for iOS and Android. The growth was all in mobile, and Microsoft had nothing in the game. Meanwhile, Apple and IBM were joining forces to further displace laptops with iPads in commercial/enterprise uses.
Then we heard Windows 10 would change all of that. And flocks of people wrote me that a hybrid machine, both PC and tablet, was the tool everyone wanted. Only we continue to see that the market is wildly indifferent to Windows 10 and hybrids.
Imagine you write with a fountain pen – as most people did 70 years ago. Then one day you are given a ball point pen. This is far easier to use, and accomplishes most of what you want. No, it won’t make the florid lines and majestic sweeps of a fountain pen, but wow it is a whole lot easier and a darn site cheaper. So you keep the fountain pen for some uses, but mostly start using the ball point pen.
Then the fountain pen manufacturer says “hey, I have a contraption that is a ball point pen, sort of, and a fountain pen, sort of, combined. It’s the best of all worlds.” You would likely look at it, but say “why would I want that. I have a fountain pen for when I need it. And for 90% of the stuff I write the ball point pen is great.”
That’s the problem with hybrids of anything – and the hybrid tablet is no different. The entrenched sellers of old technology always think a hybrid is a good idea. But once customers try the new thing, all they want are advancements to the new thing. (Just look at the interest in Tesla cars compared to the stagnant sales of hybrid autos.)
And we’re up to Surface 3 now. When I pointed out in January, 2013 that the markets were rapidly moving away from Microsoft I predicted Surface and Surface Pro would never be important products. Reader outcry at that time from Microsoft devotees was so great that Forbes editors called me on the carpet and told me I lacked the data to make such a bold prediction. But I stuck by my guns, we changed some language so it was less blunt, and the article ran.
Two and a half years later and we’re up to rev number Surface 3. And still, almost nobody is using the product. Less than 5% market share. Right again. It wasn’t a technology prediction, it was a market prediction. Lacking app developers, and a unique use, the competition was, and remains, simply too far out front.
Windows 10 is, unfortunately, a very expensive launch. And to get people to use it Microsoft is giving it away for free. The hope is then users will hook onto the cloud-based Office 365 and Microsoft’s Azure cloud services. But this is still trying to milk the same old cow. This approach relies on people being completely unwilling to give up using Windows and/or Office. And we see every day that millions of people are finding alternatives they like just fine, thank you very much.
Gamers hated me when I recommended Microsoft should give (for free) xBox to Nintendo. Unfortunately, I learned few gamers know much about P&Ls. They all assumed Microsoft made a fortune in gaming. But anyone who’s ever looked at Microsoft’s financial filings knows that the Entertainment Division, including xBox, has been a giant money-sucking hole. If they gave it away it would save money, and possibly help leadership figure out a strategy for profitable growth.
Unfortunately, Microsoft bought Minecraft, in effect “doubling down” on the bet. But regardless of how well anyone likes the products, Microsoft is not making money. Gaming is a bloody war where Sony and Microsoft keep battling, and keep losing billions of dollars. The odds of ever earning back the $2.5B spent on Minecraft is remote.
The greater likelihood is that as write offs continue to eat away at profits, and as markets continue evolving toward mobile products offered by competitors hurting “core” Microsoft sales, CEO Nadella will eventually have to give up on gaming and undertake another Nokia-like event.
All investors risk looking at current events to drive decision-making. When Ballmer was sacked and Nadella given the CEO job the stock jumped on euphoria. But the last 18 months have shown just how bad things are for Microsoft. It is a near monopolist in a market that is shrinking. And so far Mr. Nadella has failed to define a strategy that will make Microsoft into a company that does more than try to milk its heritage.
I said the giant retailer Sears Holdings would be a big loser the day Ed Lampert took control of the company. But hope sprung eternal, and investors jumped on the Sears bandwagon, believing a new CEO would magically improve a worn out, locked-in company. The stock went up for over 2 years. But, eventually, it became clear that Sears is irrelevant and the share price increase was unjustified. And the stock tanked.
Microsoft looks much the same. The actions we see are attempts to defend & extend a gloried history. But they don’t add up to a strategy to compete for the future. HoloLens will not be a product capable of replacing Windows plus Office revenues. If developers are attracted to it enough to start writing apps. Cortana is cool, but it is not first. And competitive products have so much greater usage that developer learning curve gains are wildly faster. These products are not game changers. They don’t solve large, unmet needs.
And employees see this. As I wrote in my last column, it is valuable to listen to employees. As the bloom fell off the rose, and Nadella started laying people off while freezing pay, employee support of him declined dramatically. And employee faith in leadership is far lower than at competitors Apple and Google.
As long as Microsoft keeps playing catch up, we should expect more layoffs, cost cutting and asset sales. And attempts at more “hail Mary” acquisitions intended to change the company. All of which will do nothing to grow customers, provide better jobs for employees, create value for investors or greater revenue opportunities for suppliers.
by Adam Hartung | Jun 30, 2015 | Current Affairs, In the Swamp, In the Whirlpool, Leadership
24×7 Wall Street just released its fourth annual analysis of the worst companies to work for in America. By looking across all four reports it is possible to identify likely problems which will be valuable for investors, employees (current and prospective,) suppliers and communities to know.
Trend 1- Low minimum wages & “Wage gap” issues remain a big deal
The lists are dominated by retailers. Of the 30 unique companies identified, exactly half (15) were retailers. A handful were on the list 2 or more years. Consistently these employees complained about low wages.
By paying minimum wage, and often refusing to hire employees full time, the companies keep costs of brick and mortar store operations lower.
However, this takes a toll on employee morale as overall pay does not meet minimum living standards. Further employees feel heavily overworked and stressed, while having no job security. Often this leads to employee unhappiness with senior management, frequently offering low evaluations of the CEO – who makes 1,000 times their annual earnings.
As employees fight for higher wages, and a reduction in the “wage gap,” it will apply pressure to the sustainability of these retailers who rely on very low pay to maintain (or enhance) profits. The trend to a higher minimum wage will challenge profit growth – or maintenance – in these companies.
Trend 2 – Employees often “see change coming” and become negatively vocal
Jos. A Banks jumped onto the list as #4 in 2013. Just before a major shake-up and being acquired by Men’s Wearhouse. Family Dollar also appeared on the list in 2014 (#9,) only to be embroiled in a takeover battle with Dollar General, and finally aquired by Dollar Tree within 7 months. Office Max appeared on the list (#5) in 2012, and was acquired by Office Depot 8 months later. And, of course, Radio Shack made the list in 2012 (#3,) 2013 (#5) and 2014 (#11) only to file bankruptcy in 2015.
Employees can see when something bad is impending, likely jeopardizing their livelihoods, and start talking about it.
Similarly, growing internet threats are often picked-up by employees. hh Gregg employees started complaining loudly in 2014 (#8) as their 100% commission compensation became threatened by a growing Amazon.com. And that same year Books-A-Million was #1 on the list, as part time staffers saw the same advancing Amazon. And in 2012 Game Stop (#10) employees could see how the advancing Netflix and Hulu threatened the “core business” and started to light up the complaint section.
Trend 3 – Ignoring employee unhappiness while focusing on earnings can portend a disaster
Sears and KMart (collectively Sears Holdings) made the list in 3 of the 4 years. The stock was $66 in June, 2011, and $55 in 6/12 when it made #6. By 6/13 it had declined to $39, and made the list at #7. Starting 6/14 the stock was reasonably flat, and missed the list. But then in 6/17 the stock fell to 27 and reappeared twice – as both Sears and KMart.
Employees have consistently expressed their dismay with CEO Ed Lampert, and 80% actively dislike his leadership. After the Radio Shack experience, there is ample reason to listen more to these employees than the CEO who keeps promising a turnaround – amidst a long string of large quarterly losses and declining sales.
But this also opens the door for looking at some stocks that have defied employee unrest. Dillard’s made the list all 4 years. In 2012 the stock rose from $54 to $66, yet appeared #2 on the list. In 2013 the stock rose to $85 as it made the list #3. 2014 the stock made it to $119, and was sixth. In 2015 the stock peaked at $149, but has recently declined to $111 as it made the list #2.
Similarly Express Scripts rose from $53 in 2012 to $62 in 2013 when it appeared on the list in position #2. In 2014 it rose to $71 as it remained #2. And it 2015 the stock is at $85 as it topped the list #1.
It would be worthwhile to look at the clues employees are sending. Express Scripts employees are loudly complaining (louder than literally any other company) across multiple years of being overworked, overstressed, underpaid and without any job security. As are Dillard’s employees, who are the most outspoken in retail. How long will profit improvements be sustainable in these companies?
While the data is less clear on Dollar General, it appeared on the list as #4 in 2013. Then Family Dollar appeared on the list as #9 in 2014. Dollar General subsequently tried buying Family Dollar, and reappeared on the list as #10 in 2015. What are employees saying about the sustainability of the “dollar store” segment in a very tough retail market with growing internet competitors?
Any CEO can slash employee costs and payroll for a few years, but at some point the model simply collapses – aka, Sears Holdings and Radio Shack. Or there is a loss of identity as suffered by Office Max, Jos. A Banks and Family Dollar. It would be worthwhile for anyone to listen carefully to the feedback of these employees before investing in company equity, investing one’s livelihood as an employee, investing one’s resources to be a supplier, or investing one’s tax base as a community official.
There are a number of “one off” issues on the list. Companies appear once primarily due to bad CEO performance (Xerox, #5 this year, HP #8 in 2012 as the revolving door on the CEO office reached a high pitch.) Or due to some change in market competition.
But it is possible to look through these issues – which could become future trends but show limited insight today – to see that an aggregated employee view of leadership offers insights not always found in the P&L or management’s discussion of earnings. If you choose to put your resources into these companies, be aware of the risks warnings being sent by employees!
Please refer to the 24x7WallStreet.com site for deeper information on how the list was compiled, who is on each list, and their editor’s opinions of employee comments. 24×7 list in 2015 – 24×7 list in 2014 – 24×7 list in 2013 – 24×7 list in 2012
by Adam Hartung | Jun 14, 2015 | Current Affairs, In the Rapids, Leadership, Web/Tech
Dick Costolo was let go from his role as CEO of Twitter, to be replaced by a former CEO that was also fired. Unfortunately, it looks very strongly as if the Board made this decision for the wrong reasons.
Even though investors have been unhappy with Twitter’s share price, as CEO Mr. Costolo was doing a decent job of growing the company and improving profits. And even though analysts keep offering reasons why he was fired, it looks mostly as if this was a political decision in a company with a “soap opera” executive culture. Investors should be worried.
Let’s compare Mr. Costolo to CEO Zuckerberg’s performance at Facebook, and Mr. Bezos’ performance at Amazon. The latter two have been widely heralded for their leadership, so it sets a pretty good bar.
None of these three companies have enough earnings to matter. If you aren’t a growth investor, and you always value a company on earnings, then none of these are your cup of tea. All are evaluated on revenue and user metrics.
As you can see, Twitter’s revenue growth exceeds its comparators. Yes, its decline has been more dramatic, but we are comparing Twitter to companies that are much older and bigger. The net is to understand that revenues are growing, and at a better clip than Facebook and Amazon.
Next we should look at active monthly users. Again, these numbers are growing at all 3. And some analysts have said it is the deceleration in the rate of new user growth that doomed Mr. Costolo. But this defies logic given that during his tenure Twitter has dramatically outperformed its competition.
Lastly, let’s look at the “quality” of users. We can measure this by calculating the revenue per user. If this goes up, then the company is growing it top line by gaining more revenue per user – it is not “discounting” its way to higher volume. Instead,we can expect profits to improve based upon growth in this metric.
And here we can see that Twitter has wildly outperformed Facebook and Amazon. Twitter has grown its revenue per user by over 9-fold in the last 4 years, an excellent 75% per year compounded. Facebook, by comparison, roughly tripled its revenue/user (still very good) creating a 25%/year growth (certainly not to be sneezed at.) Amazon’s growth per user across the full 4 years was 25% – or about 4%/year.
It isn’t hard to see that Mr. Costolo has been doing a pretty good job leading Twitter.
But Twitter has had a very checkered past when it comes to leaders. Several articles have been written about the revolving door on the CEO office, with founders back-stabbing each other as money is raised and efforts are made to improve company performance technologically and financially.
The Board has shown a proclivity to spend too much time listening to rumors, and previous CEOs. Rather than focusing on exactly how many users are coming aboard, and how much revenue is generated on those users.
The returning CEO was himself previously replaced. And during his tenure there were many technical problems. Why he would be inserted, and the best performing CEO in company history shunted aside is completely unclear. But for investors, employees, users (of which I am one) and customers this change in leadership looks to be poorly conceived, and quite concerning. Mr. Costolo was doing a pretty good job.
Data on revenues came from Marketwatch for Twitter, Facebook and Amazon. Data on users (in Amazon’s case customers) came from Statista.com for Twitter, Facebook and Amazon. Charts were created by Adam Hartung (C).
by Adam Hartung | Jun 7, 2015 | Defend & Extend, In the Swamp, Innovation, Leadership, Transparency
Did you ever notice that Human Resource (HR) practices are designed to lock-in the past rather than grow? A quick tour of what HR does and you quickly see they like to lock-in processes and procedures, insuring consistency but offering no hope of doing something new. And when it comes to hiring, HR is all about finding people that are like existing employees – same school, same degrees, same industry, same background. And HR tries its very hardest to insure conformity amongst employees to historical standard – especially regarding culture.
Several years ago I was leading an innovation workshop for leaders in a company that made nail guns, screw guns, nails and screws. Once a market leader, sales were struggling and profits were nearly nonexistent due to the emergence of competitors from Asia. Some of their biggest distributors were threatening to drop this company’s line altogether unless there were more concessions – which would insure losses.
They liked to call themselves a “fastener company,” which has long been the trend with companies that like to make it sound as if they do more than they actually do.
I asked the simple question “where is the growth in fasteners?” The leaders jumped right in with sales numbers on all their major lines. They were sure that growth was in auto-loading screwguns, and they were hard at work extending this product line. To a person, these folks were sure they new where growth existed.
But I had prepared prior to the meeting. There actually was much higher growth in adhesives. Chemical attachment was more than twice the growth rate of anything in the old nail and screw business. Even loop-and-hook fasteners [popularly referred to by the tradename Velcro(c)] was seeing much greater growth than the old-line mechanical products.
They looked at me blank-faced. “What does that have to do with us?” the head of sales finally asked. The CEO and everyone else nodded in agreement.
I pointed out to them they said they were in the fastener business. Not the nail and screw business. The nail and screw business had become a bloody fight, and it was not going to get any better. Why not move into faster growing, less competitive products?
Competitors were making lots of battery powered and air powered tools beyond nail guns and screw guns, and their much deeper product lines gave them much higher favorability with retail merchandisers and professional tool distributors. Plus, competitor R&D into batteries was already showing they could produce more powerful and longer-lasting tools than my client. In a few major retailers competitors already had earned the position of “category leader” recommending the shelf space and layout for ALL competitors, giving them a distinct advantage.
This company had become myopic, and did not even realize it. The people were so much alike that they could finish each others sentences. They liked working together, and had built a tightly knit culture. The HR head was very proud of his ability to keep the company so harmonious.
Only, it was about to go bankrupt. Lacking diversity in background, they were unable to see beyond their locked-in business model. And there sure wasn’t anyone who would “rock the boat” by admitting competitors were outflanking them, or bringing up “wild ideas” for new markets or products.
According to the New York Times 80% of hiring is done based on “cultural fit.” Which means we hire people we want to hang out with. Which almost always means people that are a lot like ourselves. Regardless of what we really need in our company. Thus companies end up looking, thinking and acting very homogenously.
It is common amongst management authors and keynote speakers to talk about creating “high-performance teams.” The vaunted Jim Collins in “Good to Great” uses the metaphor of a company as a bus. Every company should have a “core” and every employee should be single-mindedly driving that “core.” He says that it is the role of good leaders to get everyone on the bus to “core.” Anyone who isn’t 100% aligned – well, throw them off the bus (literally, fire them.)
We see this phenomenon in nepotism. Where a founder, CEO or Chairperson who succeeds uses their leadership position to promote relatives into high positions.
Wal-Mart’s Board of Directors, for example, recently elected the former Chairman’s son-in-law to the position of Chairman. He appears accomplished, but today Wal-Mart’s problem is Amazon and other on-line retail. Wal-Mart desperately needs outside thinking so it can move beyond its traditional brick-and-mortar business model, not someone who’s indoctrinated in the past.
The Reputation Institute just completed its survey of the most reputable retailers in the USA. Top of the list was Amazon, for the third straight year. Wal-Mart wasn’t even in the top 10, despite being the largest U.S. retailer by a considerable margin. Wal-Mart needs someone at the top much more like Jeff Bezos than someone who comes from the family.
Despite what HR often says, it is incredibly important to have high levels of diversity. It’s the only way to avoid becoming myopic, and finding yourself with “best practices” that don’t matter as competitors overwhelm your market.
Ever wonder why so many CEOs turn to layoffs when competitors cause sales and/or profits to stall? They are trying to preserve the business model, and everyone reporting to them is doing the same thing. Instead of looking for creative ways to grow the business – often requiring a very different business model – everyone is stuck in roles, processes and culture tied to the old model. As everyone talks to each other there is no “outsider” able to point out obvious problems and the need for change.
In 2011, while he was still CEO, I wrote a column titled “Why Steve Jobs Couldn’t Find a Job Today.” The premise was pretty simple. Steve Jobs was not obsessed with “cultural fit,” nor was he a person who shied away from conflict. He obsessed about results. But no HR person would consider a young Steve Jobs as a manager in their company. He would be considered too much trouble.
Yet, Steve Jobs was able to take a nearly dead Macintosh company and turn it into a leader in mobile products. Clearly, a person very talented in market sensing and identifying new solutions that fit trends. And a person willing to move toward the trend, rather than obsess about defending and extending the past.
Does your organization’s HR insure you would seek out, recruit and hire Steve Jobs, or Jeff Bezos? Or are you looking for good “cultural fit” and someone who knows “how to operate within that role.” Do you look for those who spot and respond to trends, or those with a history related to how your industry or business has always operated? Do you seek people who ask uncomfortable questions, and propose uncomfortable solutions – or seek people who won’t make waves?
Too many organizations suffer failure simply because they lack diversity. They lack diversity in geographic sales, markets, products and services – and when competition shifts sales stall and they fall into a slow death spiral.
And this all starts with insufficient diversity amongst the people. Too much “cultural fit” and not enough focus on what’s really needed to keep the organization aligned with customers in a fast-changing world. If you don’t have the right people around you, in the discussion, then you’re highly unlikely to develop the right solution for any problem. In fact, you’re highly unlikely to even ask the right question.
by Adam Hartung | May 31, 2015 | Current Affairs, Defend & Extend, In the Whirlpool, Leadership, Web/Tech
Information technology (IT) services company Computer Sciences Corporation (CSC) recently announced it is splitting into two separate companies. One will “focus” on commercial markets, the other will “focus” on government contracts. Ostensibly, as we’ve heard before, leadership would like investors, employees and customers to believe this is the answer for a company that has incurred a number of high profile failed contracts, a turnover in leadership, vast losses and declining revenue.
Oh boy.
After years of poor performance, and an investigation by the UK parliament into a failed contract for the National Health Services, in 2012 CSC brought in a new CEO. Like most new CEOs, his first action was to announce a massive cost-cutting program. That primarily meant vast layoffs. So out the door went thousands of people in order to hopefully improve the P&L.
Only a services company doesn’t have any hard assets. The CSC business requires convincing companies, or government agencies, to let them take over their data centers, or PC deployment, or help desk, or IT development, or application implementation – in other words to outsource some part (or all) of the IT work that could be done internally. Winning this work has been an effort to demonstrate you can hire better people, that are more productive, at lower cost than the potential client.
So when CSC undertook a massive layoff, service levels declined. It was unavoidable. Where before CSC had 10 people doing something (or 1,000) now they have 7 (or 700). It’s not hard to imagine what happens next. Morale declines as layoffs ensue, and the overworked remaining employees feel (and perhaps really are) overworked. People leave for better jobs with higher pay and less stress. Yet, the contract requirements remain, so clients often start complaining about performance, leading to more pressure on the remaining employees. A vicious whirlpool of destruction starts, as things just keep getting worse.
Immediately after taking the CEO job in 2012 Mike Lawrie declared a massive $4.3B loss. This allowed him to “bring forward” anticipated costs of the anticipated layoffs, cancelled contracts, etc. Most importantly, it allowed him to “cost shift” future costs into his first year in the job – the year in which he would not be fired, regardless how much he wrote off. This is a classic financial machination applied by “turnaround CEOs” in order to blame the last guy for not being truthful about how badly things were, while guaranteeing the end of the new guy’s first year would show a profit due to the huge cost shift.
True to expectations, after one year with Lawrie as CEO, CSC declared a $1B profit for fyscal 2013 (about 20% of the previous write-off.) But then fyscal 2014 returned to the previous norm, as profits shrunk to just $674M on about $12B revenues (~5% net margin.) For 4th quarter of fyscal 2015 revenues dropped another 12.6% – not hard to imagine given the layoffs and ensuing customer dissatisfaction. Most troubling, the commercial part of CSC, which represents 75% of revenue, saw all parts of the business decline between 15-20%, while the federal contracting (much harder to cancel) remained flat. This is not the trajectory of a turnaround.
CEO Lawrie blames the deteriorating performance on execution missteps. And he has promised to keep his eyes carefully on the numbers. Although he has admitted that he doesn’t really know when, or if, CSC will return to any sort of growth.
No wonder that for more than a year prior to this split CSC was unable to sell itself. Despite a lot of hard effort, no banker was able to put together a deal for CSC to be purchased by a competitor or a private banking (hedge fund) operation.
If none of the professionals in making splits and turnarounds were willing to take on this deal, why should individual investors? In this case, watching people walk away should be a clear indicator of how bad things are, and how clueless leadership is regarding a fix for the problems.
The real problem at CSC isn’t “execution.” The real problem is that the market has shifted substantially. For decades CSC’s outsourcing business was the norm. But today companies don’t need a lot of what CSC outsources. They are closing down those costly operations and replacing them with cloud services, cloud application development and implementation, mobile deployments and significant big data analytics. Or looking for new services to solve problems like cybersecurity threats. CSC quite simply hasn’t done anything in those markets, and it is far, far behind. It is a big dinosaur rapidly being overtaken by competitors moving more quickly to new solutions.
One of CSC’s biggest competitors is IBM, which itself has had a series of woes. However, IBM has very publicly set up a partnership with Apple and is moving rapidly to develop industry-specific software as a service (SaaS) offerings that are mobile and operate in the cloud. These targeted enterprise solutions in health care, finance and other industries are designed to make the services offered by CSC obsolete.
Although it may have had a huge client base of 1,000 customers. And CSC brags that 175 of the Fortune 500 buy some services from it, exactly what does CSC bring to the table to keep these customers? Years of cost cutting means the company has not invested in the kinds of solutions being offered by IBM and competitors such as Accenture, HP and Dell domestically – and WiPro, TCS (Tata Consulting Services,) Infosys and Cognizant offshore. Not to mention dozens of up-and-coming small competiters who are right on the market for targeted solutions with the latest technology such as 6D Gobal Technologies. CSC is still stuck in its 1980s consulting model, and skill set, in a world that is vastly different today.
CSC has no idea how to “focus” on clients. That would mean investing in modern solutions to rapidly changing client needs. CSC failed to do that 15 years ago when most outsourcing involved heavy use of offshore resources. And CSC has never caught up. Leadership overly relied on selling old services, and discounting. It’s model caused it to underbid projects, until the UK government almost shut the company down for its inability to deliver, and constantly hiding actual results.
Now CSC lacks any of the capabilities, people or skills to offer clients what they want. Its diffuse customer base is more a liability than a benefit, because these customers are “end of life” for the services CSC offers. Years of declining revenues demonstrate that as value declines, contracts are either allowed to go to very cheap offshore providers, lapse completely or cancelled early in order to shift client resources to more important projects where CSC cannot compete.
This split is just an admission that leadership has no idea what to do next. Customers are leaving, and revenues are declining. Margins, at 5%, are terrible and there is no money to invest in anything new. Some of the world’s best investors have looked at CSC deeply and chosen to walk away. For employees and individual investors it is time to admit that CSC has a limited future, and it is time to find far greener pastures.
by Adam Hartung | May 22, 2015 | In the Whirlpool, Leadership, Lock-in, Web/Tech
Hewlett Packard yesterday announced second quarter results. And they were undoubtedly terrible. Revenue compared to a year ago is down 7%, net income is down 21% as the growth stall at HP continues.
Yet, CEO Meg Whitman remains upbeat. She is pleased with “the continued success of our turnaround.” Which is good, because nobody else is. Rather than making new products and offering new solutions, HP has become a company that does little more than constantly restructure!
This latest effort, led by CEO Whitman, has been a split of the company into two corporations. For “strategic” (red flag) reasons, HP is dividing into a software company and a hardware company so that each can “focus” (second red flag) on its “core market” (third red flag.) But there seems to be absolutely no benefit to this other than creating confusion.
This latest restructuring is incredibly expensive. $1.8billion in restructuring charges, $1billion in incremental taxes, $400million annually in duplicated overhead services, then another $3billion in separation charges across the two new companies. That’s over $5B – which is more than HP’s net income in 2014 and 2013. There is no way this is a win for investors.
Additionally, HP has eliminated 48,000 jobs this this latest restructuring began in 2012. And the total will reach 55,000. So this is clearly not a win for employees.
The old HP will now be a hardware company, focused on PCs and printers. Both of which are declining markets as the world goes mobile. This is like the newspaper part of a media company during a split. An old business in serious decline with no clear path to sustainable sales and profits – much less growth. And in HP’s case it will be in a dog-eat-dog competitive battle to try and keep customers against Dell, Acer and Lenovo. Prices will keep dropping, and profits eroding as the world goes mobile. But despite spending $1.2billion to buy Palm (written off,) without any R&D, hard to see how this company returns profits to shareholders, generates new jobs, or launches new products for distributors and customers.
The new HP will be a software company. But it comes to market with almost no share against monster market leader Amazon, and competitors Microsoft and Cisco who are fighting to remain relevant. Even though HP spent $10B to buy ERP company Autonomy (written off) everyone has newer products, more innovation, more customers and more resources than HP.
Together there was faint hope for HP. The company could offer complete solutions. It could work with its distributors and value added resellers to develop unique vertical market solutions. By tweaking the various parts, hardware and software, HP had the possibility of building solutions that could justify premium prices and possibly create growth. But separated, these are now 2 “focused” companies that lack any new innovations, sell commodity products and lack enough share to matter in markets where share leads to winning developers and enterprise customers.
This may be the last stop for investors, and employees, to escape HP before things get a lot worse.
HP was the company that founded silicon valley. It was the tech place to work in the 1960s, 1970s and early 1980s. It was the Google, Facebook or Apple of that earlier time. When Carly Fiorina took over the dynamic and highly new product driven company in July, 1999 it was worth $45/share. She bought Compaq and flung HP into the commodity PC business, cutting new products and R&D. By the time the Board threw her out in 2005 the company was worth $35/share.
Mark Hurd took the CEO job, and he slashed and burned everything in sight. R&D was almost eliminated, as was new product development. If it could be outsourced, it was. And he whacked thousands of jobs. By killing any hope of growing the company, he improved the bottom line and got the stock back to $45.
Which is where it was 5 years ago today. But now HP is worth $35/share, once again. For investors, it’s been 25 years of up, down and sideways. The last 5 years the DJIA went up 80%; HP down 24%.
Companies cannot add value unless they develop new products, new solutions, new markets and grow. Restructuring after restructuring adds no value – as HP has demonstrated. For long-term investors, this is a painful lesson to learn. Let’s hope folks are getting the message loud and clear now.
by Adam Hartung | May 8, 2015 | Current Affairs, Defend & Extend, Food and Drink, In the Swamp, In the Whirlpool, Leadership
McDonald’s just had another lousy quarter. All segments saw declining traffic, revenues fell 11%. Profits were off 33%. Pretty well expected, given its established growth stall.
A new CEO is in place, and he announced is turnaround plan to fix what ails the burger giant. Unfortunately, his plan has been panned by just about everyone. Unfortunately, its a “me too” plan that we’ve seen far too often – and know doesn’t work:
- Reorganize to cut costs. By reshuffling the line-up, and throwing out a bunch of bodies management formerly said were essential, but now don’t care about, they hope to save $300M/year (out of a $4.5B annual budget.)
- Sell off 3,500 stores McDonald’s owns and operate (about 10% of the total.) This will further help cut costs as the operating budgets shift to franchisees, and McDonald’s book unit sales creating short-term, one-time revenues into 2018.
- Keep mucking around with the menu. Cut some items, add some items, try a bunch of different stuff. Hope they find something that sells better.
- Try some service ideas in which nobody really shows any faith, like adding delivery and/or 24 hour breakfast in some markets and some stores.
Needless to say, none of this sounds like it will do much to address quarter after quarter of sales (and profit) declines in an enormously large company. We know people are still eating in restaurants, because competitors like 5 Guys, Meatheads, Burger King and Shake Shack are doing really, really well. But they are winning primarily because McDonald’s is losing. Even though CEO Easterbrook said “our business model is enduring,” there is ample reason to think McDonald’s slide will continue.
Possibly a slide into oblivion. Think it can’t happen? Then what happened to Howard Johnson’s? Bob’s Big Boy? Woolworth’s? Montgomery Wards? Size, and history, are absolutely no guarantee of a company remaining viable.
In fact, the odds are wildly against McDonald’s this time. Because this isn’t their first growth stall. And the way they saved the company last time was a “fire sale” of very valuable growth assets to raise cash that was all spent to spiffy up the company for one last hurrah – which is now over. And there isn’t really anything left for McDonald’s to build upon.
Go back to 2000 and McDonald’s had a lot of options. They bought Chipotle’s Mexican Grill in 1998, Donato’s Pizza in 1999 and Boston Market in 2000. These were all growing franchises. Growing a LOT faster, and more profitably, than McDonald’s stores. They were on modern trends for what people wanted to eat, and how they wanted to be served. These new concepts offered McDonald’s fantastic growth vehicles for all that cash the burger chain was throwing off, even as its outdated yellow stores full of playgrounds with seats bolted to the floors and products for 99cents were becoming increasingly not only outdated but irrelevant.
But in a change of leadership McDonald’s decided to sell off all these concepts. Donato’s in 2003, Chipotle went public in 2006 and Boston Market was sold to a private equity firm in 2007. All of that money was used to fund investments in McDonald’s store upgrades, additional supply chain restructuring and advertising. The “strategy” at that time was to return to “strategic focus.” Something that lots of analysts, investors and old-line franchisees love.
But look what McDonald’s leaders gave up via this decision to re-focus. McDonald’s received $1.5B for Chipotle. Today Chipotle is worth $20B and is one of the most exciting fast food chains in the marketplace (based on store growth, revenue growth and profitability – as well as customer satisfaction scores.) The value of all of the growth gains that occurred in these 3 chains has gone to other people. Not the investors, employees, suppliers or franchisees of McDonald’s.
We have to recognize that in the mid-2000s McDonald’s had the option of doing 180degrees opposite what it did. It could have put its resources into the newer, more exciting concepts and continued to fidget with McDonald’s to defend and extend its life even as trends went the other direction. This would have allowed investors to reap the gains of new store growth, and McDonald’s franchisees would have had the option to slowly convert McDonald’s stores into Donato’s, Chipotle’s or Boston Market. Employees would have been able to work on growing the new brands, creating more revenue, more jobs, more promotions and higher pay. And suppliers would have been able to continue growing their McDonald’s corporate business via new chains. Customers would have the benefit of both McDonald’s and a well run transition to new concepts in their markets. This would have been a win/win/win/win/win solution for everyone.
But it was the lure of “focus” and “core” markets that led McDonald’s leadership to make what will likely be seen historically as the decision which sent it on the track of self-destruction. When leaders focus on their core markets, and pull out all the stops to try defending and extending a business in a growth stall, they take their eyes off market trends. Rather than accepting what people want, and changing in all ways to meet customer needs, leaders keep fiddling with this and that, and hoping that cost cutting and a raft of operational activities will save the business as they keep focusing ever more intently on that old core business. But, problems keep mounting because customers, quite simply, are going elsewhere. To competitors who are implementing on trends.
The current CEO likes to describe himself as an “internal activist” who will challenge the status quo. But he then proves this is untrue when he describes the future of McDonald’s as a “modern, progressive burger company.” Sorry dude, that ship sailed years ago when competitors built the market for higher-end burgers, served fast in trendier locations. Just like McDonald’s 5-years too late effort to catch Starbucks with McCafe which was too little and poorly done – you can’t catch those better quality burger guys now. They are well on their way, and you’re still in port asking for directions.
McDonald’s is big, but when a big ship starts taking on water it’s no less likely to sink than a small ship (i.e. Titanic.) And when a big ship is badly steered by its captain it flounders, and sinks (i.e. Costa Concordia.) Those who would like to think that McDonald’s size is a benefit should recognize that it is this very size which now keeps McDonald’s from doing anything effective to really change the company. Its efforts (detailed above) are hemmed in by all those stores, franchisees, commitment to old processes, ingrained products hard to change due to installed equipment base, and billions spent on brand advertising that has remained a constant even as McDonald’s lost relevancy. It is now sooooooooo hard to make even small changes that the idea of doing more radical things that analysts are requesting simply becomes impossible for existing management.
And these leaders, frankly, aren’t even going to try. They are deeply wedded, committed, to trying to succeed by making McDonald’s more McDonald’s. They are of the company and its history. Not the CEO, or anyone on his team, reached their position by introducing a revolutionary new product, much less a new concept – or for that matter anything new. They are people who “execute” and work to slowly improve what already exists. That’s why they are giving even more decision-making control to franchisees via selling company stores in order to raise cash and cut costs – rather than using those stores to introduce radical change.
These are not “outside thinkers” that will consider the kinds of radical changes Louis V. Gerstner, a total outsider, implemented at IBM – changing the company from a failing mainframe supplier into an IT services and software company. Yet that is the only thing that will turn around McDonald’s. The Board blew it once before when it sold Chipotle, et.al. and put in place a core-focused CEO. Now McDonald’s has fewer resources, a lot fewer options, and the gap between what it offers and what the marketplace wants is a lot larger.
by Adam Hartung | Apr 30, 2015 | Current Affairs, Defend & Extend, In the Rapids, Innovation, Leadership, Web/Tech
Last week saw another slew of quarterly earnings releases. For long term investors, who hold stocks for years rather than months, these provide the opportunity to look at trends, then compare and contrast companies to determine what should be in their portfolio. It is worthwhile to compare the trends supporting the valuations of market leaders Google and Facebook.
Google once again reported higher sales and profits. And that is a good thing. But, once again, the price of Google’s primary product declined. Revenues increased because volume gains exceeded the price decline, which indicates that the market for internet ads keeps growing. But this makes 15 straight quarters of price declines for Google. Due to this long series of small declines, the average price of Google’s ads (cost per click) has declined 70%* since Q3 2011!
While this is a miraculous example of what economists call demand elasticity, one has to wonder how long growth will continue to outpace price degradation. At some point the marginal growth in demand may not equal the marginal decline in pricing. Should that happen, revenues will start going down rather than up.
Part of what drives this price/growth effect has been the creation of programmatic ad buying, which allows Google to place more ads in more specific locations for advertisers via such automated products as AdMob, AdExchange and DoubleClick Bid Manager. But such computerized ad buying relies on ever more content going onto the web, as well as ever more consumption by internet users.
Further, Google’s revenues are almost entirely search-based advertising, and Google dominates this category. But this is largely a PC-related sale. Today 67.5% of Google ad revenue is from PC searches, while only 32.5% is from mobile searches. Due to this revenue skew, and the fact that people do more mobile interaction via apps, messaging apps and social media than browser, search ad growth has fallen considerably. What was a 24% year over year growth rate in Q1 2012 has dropped to more like 15% for the last 8 quarters.
So while the market today is growing, and Google is making more money, it is possible to see that the growth is slowing. And Google’s efforts to create mobile ad sales outside of search has largely failed, as witnessed by the recent death of Google+ as competition for Twitter or Facebook. It is the market shift, to mobile, which creates the greatest threat to Google’s ability to grow; certainly at historical rates.
Simultaneously, Facebook’s announcements showed just how strongly it is continuing to dominate both social media and mobile, and thus generate higher revenues and profits with outstanding growth. The #1 site for social media and messenger apps is Facebook, by quite a large margin. But, Facebook’s 2014 acquisition of What’sApp is now #2. WhatsApp has doubled its monthly active users (MAUs) just since the acquisition, and now reaches 800million. Growth is clearly accelerating, as this is from a standing start in 2011.
Facebook Messenger at #3, just behind WhatsApp. And #5 is Instagram, another Facebook acquisition. Altogether 4 of the top 5 sites, and the ones with greatest growth on mobile, are Facebook. And they total over 3billion MAUs, growing at over 300million new MAUs/month. Thus Facebook has already emerged as the dominant force, with the most users, in the fast-growing, accelerating, mobile and app sectors. (Just as Google did in internet search a decade ago, beating out companies like Yahoo, Ask Jeeves, etc.)
Google is moving rapidly to monetize this user base. From nothing in early 2012, Facebook’s mobile revenue is now $2.5B/quarter and represents 67% of global revenue (the inverse of Google’s revenues.) Further, Facebook is now taking its own programmatic ad buying tool, Atlas, to advertisers in direct competition with Google. Only Atlas places ads on both social media and internet browser pages – a one-two marketing punch Google has not yet cracked.
Google’s $17.3B Q1 2015 revenue is 30 times the revenue of Facebook. There is no doubt Google is growing, and generating enormous profits. But, for long-term investors, growth is slowing and there is reason to be concerned about the long term growth prospects of Google as the market shifts toward more social and more mobile. Google has failed to build any substantial revenues outside of search, and has had some notable failures recently outside its core markets (Google + and Google Glass.) Just how long Google will continue growing, and just how fast the market will shift is unclear. Technology markets have shown the ability to shift a lot faster than many people expected, leaving some painful losers in their wake (Dell, HP, Sun Microsystems, Yahoo, etc.)
Meanwhile, Facebook is squarely positioned as the leader, without much competition, in the next wave of market growth. Facebook is monetizing all things social and mobile at a rapid clip, and wisely using acquisitions to increase its strength. As these markets continue on their well established trends it is hard to be anything other than significantly optimistic for Facebook long-term.
* 1x .93 x .88 x .84 x .85 x .94 x .96 x .94 x .93 x .89 x .91 x .94 x .98 x .97 x .95 x .93 = .295
