by Adam Hartung | Oct 26, 2008 | Defend & Extend, General, Quotes
(Read the following quote in Forbes, October 5, 1998, written by Peter Drucker) “As we advance deeper into the knowledge economy, the basic assumptions underlying much of what is taught and practiced in the name of management are hopelessly out of date… most of our assumptions about business, technology and organization are at least 50 years old. They have outlived their time… Get the assumptions wrong and everything that follows from them is wrong.”
Last week, former Reserve Board Chairman Alan Greenspan admitted to Congress that his assumptions about financial services and the products being offered, including credit default swaps (CDS), were wrong (read article here). As a result, what he thought would happen in the financial markets – from interest rates to equity prices to currency values – turned out to be wrong. Unfortunately, this helped create the opportunity for runaway leverage and the banking meltdown which has affected world trade since early September. When leaders operate with wrong assumptions, the price paid by everyone can be pretty hefty.
The reality is that pretty much all leaders work with assumptions about business that are very country specific. The impact of global knowledge transfer – of worldwide information at a moment’s notice – of labor arbitrate happening in hours – and the immediacy of financing and financial reactions – is still not well understood by leaders trained in an earlier era. Thus leaders under-recognized the speed with which manufacturing jobs could move around the world – as well as the speed with which IT services could move to lower cost markets. Even though the current Federal Reserve Chairman (Dr. Bernanke) is a student of America’s Great Depression, what he doesn’t understand is that Depression happened in an isolated way to the USA. Today, globalization means that problems with U.S. banks becomes a problem globally. For all his studies of history – things in financial services have fundamentally shifted. His assumptions are, well, often wrong.
In November there will be an economic summit. Some are referring to it as the next “Bretton Woods” – a reference to the meeting in upstate New York which determined how foreign currency exchange rates would be set and how banks would interact between countries (read about the summit here). Yet, there are others who say no changes are needed. But let’s get real. Of course we need to rethink how our country-based banking system works in a world where insurance companies and hedge funds often move faster and have more ability to affect markets than traditional banks. In the 1800s banks in the USA issued their own currency – and then states issued their own currency. Eventually this disappeared to federal currency. So, do we now need a global currency? With the change to the Euro in Eurpope the need for individual country currencies took a step toward unnecessary. Should that trend continue? You see, it’s easy to think about the world using old assumptions – like a U.S. dollar as independent of other countries – but does it make sense in a world where products and services are supplied globally and governments (such as India and China notably) now manipulate their currencies to maintain price advantages?
On Friday evening a “guru” on ABC’s Nightline was talking about the wild swings on the New York Stock Exchange and the NASDAQ. He commented “the only way to get hurt on a roller coaster is to get off. So hold onto your equities and keep buying.” Give me a break. A roller coaster is a closed system. Even though it goes up and down, you know where it will end and the result. WE DON’T KNOW THAT ABOUT EQUITIES TODAY. Many, many companies we’ve known for decades could disappear (GM, Ford, Chrysler are prime examples). Just like Lehman Brothers disappeared, and AIG practically so. If you were an investor in common or preferred equities of Freddie Mac or Fannie Mae, your “roller coaster ride” did not have a happy ending – and you would obviously have been a whole lot smarter to have jumped off. You may get bruised, but that would have been better than the disaster that loomed.
It is critically important to check assumptions. This is not easy. We don’t think about assumptions, they just are part of how we operate. That’s why now, more than ever, it is incredibly important to do scenario planning which will challenge assumptions by opening our eyes to what really might happen. Because you can never assume tomorrow will be like yesterday – not in business. To survive you have to constantly be planning for a future that can be very, very different. Doing more of what you always did will not produce the same results in a shifting world. Planning for future shifts is one of the most important things managers can do.
by Adam Hartung | Oct 21, 2008 | Disruptions, In the Rapids, Leadership, Openness
Yesterday I talked about how Lock-in to an old Success Formula kept Sun Microsystems from undertaking Disruptions in the 1990s that would have helped the company keep from floundering. One could get the point that with this weak economy, the die has been cast and there’s little we can do. "Oh Contrare little one".
Let’s look at Apple (see chart here) – the company Sun passed up to focus on its core server business in the 1990s. Today Apple announced profits are up 26% this year – despite the soft economy (read article here). We all know about the iPod, iTunes, iTouch and now iPhone. Apple has demonstrated that it is willing to bring out new products in new markets without regard for "market conditions", and as a result drive new revenues and profits. It would be easy to delay new investments and new launches in this economy to drive up profits, but the company CEO maintains commitment to internal Disruptions and ongoing White Space to drive growth – especially while competitors are retrenching.
Another recent example is Coach (see chart here) the maker of high-end luggage, leather goods and fashion accesories. Most high-end goods are seeing sales plummet. But Coach used its scenarios about the future to invest in its 103 factory outlets and many discount outlets. Instead of running to the high end and doing more of the same, while cutting costs, Coach has put new products into the market and offered new discount programs – in addition to its growth of outlets beyond the traditional Coach stores (read article about Coach here.)
Any company can take action at any time to grow. All it takes are plans based on future scenarios, rather than based on just doing "more of the same." Being obsessive about competitors allows for launching new products before anyone else, and gaining share. And using Disruptions to create White Space for successful new business development. This can happen at any time – not just when times are good. In fact, when times are bad (like now) it can be the very best time to focus on growth. When competitors are trying to retrench it creates the opportunity to change how customers view you, and grow. This might well be the best time ever to not only Disrupt your own thinking – but Disrupt competitors by changing your Success Formula and doing what’s not expected!
by Adam Hartung | Oct 20, 2008 | In the Swamp, In the Whirlpool, Leadership, Lock-in
With the economy soft, and sales harder to come by, more companies are thinking about what changes they can make to be more competitive. But what we’re seeing now is the emergence of competitors that Disrupted when times were good, and the decline of those who chose to Defend & Extend old Success Formulas in order to maximize profits back then.
Let’s take a look at Sun Microsystems (see chart here.) Trading today at $5.25/share, Sun was a darling of the internet boom – peaking at about $250/share in 2000. But $5.25/share (adjusted for splits) is about what Sun was worth in the mid-1990s. At that time Sun was a big winner as internet usage exploded and the telecom companies – as well as industry participants from tech to manufacturers – could not get enough Unix servers. Everyone was predicting that the need for servers was never going to decline, and Sun was "#1 with a rocket", to use an old radio term for a big hit song.
In 1995 Sun held a management retreat for all its managers and higher in Monterey, CA. Scott McNealy, the chairman and CEO, asked the audience "if you could buy Apple, would you do it?" The audience reacted with a positive roar! These managers all saw the benefit of having a low-price workstation line to augment their expensive servers. Further, Unix was notoriously difficult to use and the hope of bringing a better GUI interface was very appealing. They saw that if they could help the sales of Macs it would be a great way to slow the Wintel (Microsoft Windows plus Intel microprocessor) PC platform – which was the biggest competitor to Unix. And Apple had lots of applications in media and the office that eluded the very techie Sun products. These managers, directors and V.P.s had all thought about an Apple + Sun merger, and they saw the opportunities.
Mr. McNealy looked at the raucous, hopeful crowd and said, "you think you could fix that mess? With all we have to do to keep up with market growth, you don’t see buying Apple as a major diversion?" The air was sucked out of the room. Obviously, Apple was troubled. But there was real hope for growth in new and unpredictable ways from combining the two companies, their positive brands, their great technologies and their creative roots. But Mr. McNealy went on to tell the audience that the executive team had thought about the acquisition, and just couldn’t see doing it. It would be too disruptive.
That management retreat had as its keynote speaker Gary Hamel, author of Competing for the Future. Mr. Hamel gave a great presentation about how his research showed great companies figured out their core – their core strength – and then reinforced that strength. The rest of the retreat was spent with the management personnel in various break-out sessions defining the "core" at Sun Microsystems and then identifying how Sun could reinforce that core.
Of course, it only took 5 years for the internet bubble to burst. The telecoms were some of the first victims, with their value plummeting. Demand for servers fell off a proverbial cliff. Meanwhile, Unix servers from IBM and others had increased in performance and capability – giving the once high-flying Sun a competitive kick in the pants. Worse, the power of Wintel servers had continued to increase, making the price difference between a Unix server and a Wintel server much less acceptable. IT Department customers were beginning to shift to PC servers in order to lower cost. And Sun, with its focus on servers, had no desktop product to sell – no competitor to the PC – nor any software products to sell. The internet market was rapidly shifting toward Cisco and those who sold robust network gear. Sun was watching its market disappear right out from under it – and happening in weeks.
Now it’s unclear what the future holds for Sun Microsystems (read article here). Sales have not recovered. Losses have been mounting. Sun’s dealing with hundreds of millions of dollars in restructuring costs (again), and some of its businesses are now worth so little that the company is probably going to be forced to write off millions (maybe billions) in goodwill on the books. If it has to write off too much good will, Sun could end up declaring bankruptcy.
The time for Disruption at Sun was when business was good – in 1995 and 1996. Had they bought Apple, who knows what combination might have happened. At the time, Cisco (see chart here) was growing quite handily. But Cisco built into its ethos the notion that the company would obsolete its own products. This desire, to never ride too far out the product curve and instead cannibalize their own sales before competitors did, has allowed Cisco to keep growing revenues and profits. Instead of "focusing on its core" Cisco keeps looking for the competitors (companies and products) that could make Cisco obsolete – and using those competitors to help Cisco drive growth.
Even with Disruptions, many competitors will not survive this recession. Not because the managers are lazy or sloppy. But because they will become victims of better competitors who built Success Formulas more aligned with future market needs. Those who Disrupted in 2005 and 2006, who positioned themselves for globalization and rapid market shifts, will do relatively better in 2009 than those who chose to Defend & Extend what they used to do. The best time to Disrupt and create White Space is when things are good – because that prepares you to win big when markets shift and times get tough.
by Adam Hartung | Oct 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 10, 2008 | Defend & Extend, General, Leadership, Lifecycle, Openness
We talk a lot about evolving markets. When we use that phrase, evolving, we think of gradual change. In reality, evolutionary change is anything but gradual.
People think of change as happening along the blue line to the left. A little change every year. But what really happens is like the red line. Things go along with not much change for a very long time, then there’s a dramatic change, and then an entirely new "normal" takes hold. This big change is what’s called a "punctuated equilibrium."
What we’ve recently seen in the financial services industry is a punctuated equilibrium. For years the banks went along with only minor change. They kept slowly enhancing the products and services, a little bit each year. Regulations changed, but only slightly, year to year. Then suddenly there’s a big change. Something barely understood by the vast majority of people, credit default swaps tied to subprime mortgage backed securities, became the item that sent the industry careening off its old rails. That’s because the underlying competitive factors have been changing for years, but the industry did not react to those underlying factors. Large players continued as if the industry would behave as it had since 1940. Now, suddently, the fact that everything from asset accumulation to liability management and regulation will change – and change rapidly.
When punctuated equilibrium happens, the old rules no longer apply. The assumptions which underpinned the old economics, and norms for competition, become irrelevant. Competition changes how returns will be created and divvied up. Eventually a new normal comes about – and it is always tied to the environment which spawned the big change. The winners are those who compete best in the new environment – irrespective of their competitive position in the old environment. The one thing which is certain is that following the old assumptions is certain to get you into trouble.
I’ve been surprised to listen to "financial experts" on ABC and CNBC advising investors since this financial services punctuated equilibrium hit. Consistently, the advice has been "don’t sell. Wait. Markets always come back. You only have a paper loss now, if you sell it becomes a real loss. Just wait. In fact, keep buying." And I’m struck as to how tied this advice is to the old equilibrium. Since the 1940s, it’s been a good thing to simply ride out a downturn. But folks, we ain’t ever seen anything like this before!! This isn’t even the Great Depression all over again. This is an entirely different set of environmental changes.
In reality, the best thing to have done upon recognizing this change would be to sell your equities. The marketplace is saying that global competition is changing competition. How money will be obtained, and how it will be doled out, is changing. Old winners are very likely to not be new winners. Competitive challenges to countries, as well as industries and companies, means that fortunes are shifting dramatically. No longer can you consider GM a bellweather for auto stocks – you must consider everyone from Toyota to Tata Motors (today the total equity value of Ford plus GM is 1/10th the value of Toyota). No longer can you assume that real estate values in North America will go up. No longer can you assume that China will buy all the U.S. revolving debt. No longer can you assume that America will be the importer of world goods. How this economic change will shake out – who will be the winners – is unclear. And as a result the Dow Jones Industrial Average has dropped 40% in the last year.
To all those television experts, I would say they missed the obvious. How can it be smart to have held onto equities if the value has dropped 40%? Call it a paper loss versus a real loss – but the reality is that the value is down 40%! To get back to the original value – to get your money back with no gain at all – will take a return of 5% per year (higher than you could have received on a guaranteed investment for the last 8 years) for over 10 years! That’s right, at 5% to get your money back will take 10 years!! Obviously, you would have been smarter to SELL. And every night this week, as the market fell further, these gurus kept saying "hold onto your investments. It’s too late to sell. Just wait." Give me a break, if the market is dropping day after day, how is it smart to watch your value just go down day after day! You should quote Will Rogers and say to these investment gurus "it’s not the return on my money I’m worried about, it’s the return of my money"!!
Or read what my favorite economist, Mr. Rosenberg of Merrill Lynch wrote today "There is no indication…that the deterioration in the fundamentals is abating…all the invormation at hand suggests that the risk of being underinvested at the bottom is lower than the risk of being overexposed to equities….in other words, the risk of geing out of the market right now is still substantially less than the risk of continuing to overweight stocks…what matters now is to protect your investments and preserve your capital." (read article here)
The world is full of conventional wisdom. Conventional wisdom is based on the future being like the past. But when punctuated equilibrium happens, the future isn’t like the past. And conventional wisdom is, well, worthless. What is valuable is searching out the new future, and learning how to compete anew. Right now it’s worth taking the time to focus on future competitors and figure out how you can take advantage of serious change to better your position. You can come out on top if you head for the future – but not if you plan for a return to the past.
by Adam Hartung | Oct 9, 2008 | Defend & Extend, General, In the Swamp, Leadership, Lifecycle, Lock-in
The news is really bad in the auto business. For the first time since 1993 the number of cars sold in the USA in a month has declined to below one million. Sales are down over 25% from the previous year. And sales are predicted to decline considerably more in 2009. The value of General Motors (chart here) has declined to what it was in 1950 – when the Dow Jones Industrial Average was about 269 (GM is a component of the DJIA). (Read article here.) In the 1960s, when GM was king of the industrial companies, a popular phrase was "As goes GM, so goes America." This was based on the notion that GM was a microcosm of the American industrial economy. Is this still true – does GM portend the future of America?
A lot has changed in the last 40 years. Most importantly, the globe is no longer dominated by an industrial economy. Fewer and fewer people are employed in industrial production. We see it all around us as we realize that there are more people writing computer code than making computers. We’ve shifted to an information economy. Companies that ignored this shift, like GM, without finding opportunities to get into the growth economy are now suffering. GM started down the new road once, in the 1980s, by purchasing EDS and Hughes electronics. But later GM leadership sold those businesses in order to "focus" on the auto business. So now it’s only natural to recognize that the most industrial of the industrial companies are at the greatest risk of failure. No longer is GM a microcosm of any economy – including America. As GM goes so goes GM – but that doesn’t say anything about the future of America.
Some companies have shifted. They find new opportunities for growth. Today, wind energy is getting a big lift due to higher costs for petroleum fuels and increasing restrictions on greenhouse gases from using fossil fuels. Wind farms already exist offshore European countries, producing over 1,100 megawatts of power. Now such farms are being built not only on the great prairies of Texas and the American plains, but off the eastern U.S. coastline (read article here.) While there isn’t much interest for investing in auto manufacturing, there is lots of interest for investing in these wind farms to produce electricity – especially in high-cost electricity locations along the eastern seaboard.
And in the middle of this market we find – General Electric (see chart here). GE is the only U.S. company that makes wind turbines, and is a leader in promoting the new source of power. While many people have fixated on GE Financial and its woes, they have ignored the fact that GE is an American leader in many markets seeing rapid growth globally – such as wind power, water production, health care equipment and municipal infrastructure development. These markets are benefitting from the ecomomic boom in China, India and other developing countries, as well as emerging growth in the USA.
Any country’s economy can continue growing if it develops Phoenix companies that keep their eyes on the future and create White Space projects to keep them moving toward growth. These companies don’t fall into the trap of being "focused" on a single business, and dependent upon growth within that historically defined market. They constantly look for places to grow, regardless of what the company has previously done, and develop opportunities to learn in those new markets so they can create a new Success Formula maintaining growth. As long as America has companies that keep repositioning themselves for growth – such as GE, IBM, Cisco Systems, Apple, Google, Genentech, Johnson & Johnson, Baxter, etc. – America can have a great future.
by Adam Hartung | Oct 8, 2008 | Defend & Extend, General, Leadership, Lifecycle
Today Walgreen’s (see chart here) announced it was dropping its plan to purchase Long’s Drugs (see chart here). (Read article here.) This means a lower offer to buy Long’s from CVS (see chart here) now comes to the forefront. Yet, some of Long’s big shareholders are balking that the CVS bid is too low. And all this amid the most dynamic set of economic circumstances since the 1930s. So, who’s right?
As you might expect, it all depends on your scenario about the future. Walgreen’s has seen it’s equity value fall 50% in the last 2 years. Pretty amazing given that the "core" business is considered highly resistant sales of necessary drug items – after all regardless the economy people get sick and they need medicine. But the reality is that Walgreen’s built its reputation on its Success Formula the last decade of being able to open a new store every 20 hours or so. That’s an easy to understand Success Formula, but it has the obvious downside of identifying the weakness of saturation. To maintain growth, Walgreen’s requires opening more and more stores. But there are markets (like the hometown Chicago area) where stores are getting almost every block! People started wondering if Walgreen’s could keep growing once it had to drive more revenue out of existing stores – rather than just opening new ones.
But now real estate is falling in value. And we all know debt is getting harder and more expensive to obtain. It’s going to be harder and harder to borrow money to buy land and put up buildings. We’re also hearing that pension payments are going to be cut, due to lower stock valuations, and money for health care could be harder to come by. Looking forward, Walgreen’s decided it was smarter to focus on its existing stores than taking on a slug of new debt and a bunch of new stores. Especially given that many of these new stores (at Long’s) would be redundant to existing Walgreen’s in California — and who’s going to buy the land and buildings or leases for those stores if the economy going forward is as bad as being predicted? Sears (see chart here) buyer Ed Lampert was supposed to make a fortune selling all those Sears buildings – and that hasn’t exactly worked out (to put it mildly).
You have to hand it to a leadership team willing to change course. The good news is that for the last several years Walgreen’s hasn’t just opened new stores. The company has experimented with all kinds of new sales initiatives – from printing photos to refilling ink cartridges to selling groceries and even clothing. Unfortunately, many of those efforts took a back seat to new store openings. Walgreen’s didn’t see them as Disruptive growth opportunities, and they weren’t given White Space with permission to do whatever was necessary to succeed, nor the dedicated resources to really develop an alternative Success Formula. So they were just experiments with minimal impact. But now, for Walgreen’s to keep growing, it will have to do some Disrupting and put those projects front and center. The company will have to put some serious energy into learning if it can bring out its own high-end cosmetics line (aborted), or it’s own designer clothing (aborted) or capture decent share in selected office supplies versus Staples (aborted).
It’s hard for a Locked-in organization to change course. The momentum to keep doing what was always done is enormous. For Walgreen’s it must have appeared oh-so-tempting to buy Long’s. "Damn the Torpedos, full speed ahead" is such an easy cry for the company skipper to make. But here it really appears that some good scenario planning has kept the company from running headlong into a deal that could bankrupt the business if things do go southward economically (as it appears).
But to regain its previous success, Walgreen’s now has to change its Success Formula. And that requires more than walking away from a deal. It requires implementing a Disruption and getting serious about White Space to figure out what will make Walgreen’s the super-retailer of 2020. The company made a good move today, and now we’ll have to see if they can follow through.
Meanwhile, if you own Long’s Drug you should sell as fast as possible. The company value has increased 4x in the last 4 years – with a huge pop based on the acquisition discussions. And the company has no plan for how to grow enough to maintain the recent value. If CVS is willing to purchase Long’s, sell to them. What we can be sure of is that the saturation of drug stores has already begun, and any business that has too many assets, and too much debt, is not a good place to be invested. Better to have the cash.
by Adam Hartung | Oct 7, 2008 | General, In the Swamp, Lifecycle, Lock-in
So the stock market is crashing. Is now the time to buy? Many CEOs are asking this question.
The problem is that too often people try to buy a company that’s "cheap", using its past history as the basis. Take Bank of America (see chart here). BofA earlier this year bought the most troubled of all the mortgage companies Countrywide Financial. And then when Lehman Brothers was falling into bankruptcy BofA purchased Merrill Lynch, a retail stock brokerage that has been realing from on-line competition since e*Trade started in the 1990s, has one of the weakest mutual fund departments, one of the weakest research departments and a weak investment bank. BofA’s view was that based upon history, these companies were very cheap. But now, shortly after the acquisitions, BofA is announcing that it must halve its dividend, and raise additional equity through a new stock sale in order to shore up its balance sheet. And on top of this, earnings are down for the quarter and the year as the CEO starts claiming that estimates are pretty meaningless (read article here). Should you buy the new stock offering?
When markets shift, the value of assets tied to old Success Formulas decline. In the new market, the old Success Formula produces weaker returns and thus it is worth less. Too many people see this lower value as being a chance to "buy on the cheap." But far too often value will continue to decline because the old business simply isn’t worth as much. In Bank of America’s case, it bought extremely large players, but those that are inexorably linked to the old markets with old Success Formulas that are fast becoming out of date. While Merrill Lynch may be a great old name, the company itself has never been able to produce its old level of returns since brokerage markets shifted over a decade ago. Increasingly, it looks like BofA simply bought out-of-date competitors that were finding themselves on the rope as this market shift happened. And the BofA leadership is even leaving the old leaders in place after the acquisition.
Just in case you think that all the strategy and finance brains in big corporations means they are better judges of company value than yourself, remember that very rarely does any acquisition become worth what it cost. All finance academicians point out that buyers overvalue acquisitions in the process. In the end, it’s the buyers that see valuations suffer due to lower than anticipated earnings. In this case, BofA has bought large – but weak – competitors in markets reeling from shifts. And BofA has shown no proclivity to take dramatic changes to alter the Success Formulas (which JPMorgan Chase did upon acquiring Bear Sterns for almost nothing). This is a recipe for weak future performance.
Those companies that will benefit from acquisitions in this turmoil will have to purchase companies that better position the acquirers for future growth. Leaders not necessarily in size, but in the ability to produce growing revenues and profits. And acquisitions which can help migrate the acquirer’s Success Formula forward toward better competitiveness and higher returns – not just adding immediate (but declining) revenue. What’s going on at BofA may look like an effort to "buy on the cheap," but it’s more likely to end up "a pig in a poke."
by Adam Hartung | Oct 5, 2008 | General, Leadership, Lifecycle, Lock-in, Openness
This blog primarily focuses on businesses. But in Create Marketplace Disruption I point out that Success Formulas exist at multiple levels – not just companies. At a higher level, Success Formulas exist for functional groups, work teams and individuals. At a lower level than companies, Success Formulas exist for industries and even entire economies. When a shift happens at any level, all levels above that have to adjust for that shift. Over the last few weeks, we’ve been witnessing the impact of shifts in economies that are having a tumultuous impact on the financial services industry – and the companies participating in that industry.
With last week’s announcement of higher expected first time unemployment claims (see article here), The U.S. is confirmed to be headed into a recession (if not already there [article here].) But beyond the U.S., the economies of the developed economies in 2009 is expected to grow .6% -the weakest since 1982. The emerging markets are expected to grow at 6.1% (weakest since 2003) – 5.5 percentage points higher – 10x developed markets – 4x the average difference in growth rates during the 1990s. This is a pretty massive change. (Read article here)
The U.S. banking crisis has been the result of lots of bad loans on everything from mortgages to autos and credit cards. As asset values (principally homes) and incomes declined, the number of unpaid loans went up. It turned out that many of these loans had been packaged and sold off, and derivative instruments were created on those assets to help increase returns, causing not only the lenders to get into trouble by defaults, but investors (like insurance companies). Sort of a "domino effect" – or some say the falling of a "house of cards." While this explains why U.S. banks and insurance companies stumbled, why are we also seeing a rash of problems across Europe and some in Asia (read article here). The governments are "bailing out" banks and other financial companies from Ireland to Iceland – while putting in place lots of additional regulations (like banning short sales [article here] – a tactic also being used in the USA.)
In the USA, banks and investment banks allowed ever-increasing risk to creep into the debt market via higher lending limits on asset values and incomes. They were seeking ways to maintain results by manufacturing ever riskier transactions dependent on fast rising asset values and incomes – even if there was no reason to believe they would happen. They were looking for ways to Defend & Extend their Success Formula. We now can see that was happening all around the developed markets. Emerging market governments were buying secure U.S. Treasuries. But everywhere else institutions were trying to find higher yields in order to Defend & Extend their Success Formulas. As a result they bought mortgaged-backed securities and other even riskier instruments. Now that those securities are defaulting, all the developed markets are seeing big financial industry problems. The unwinding of risk is causing big problems all across the developed markets where actually making things – manufacturing, IT code, services – has been declining.
At the base of the pyramid, the economy, we can now see that the markets which make things are doing a lot better than those which have been outsourcing. This had already made a big difference in many manufacturing industries. And now we can see it in financial services. What underlies these industry problems is that the relative competitiveness of the economies is shifting. Every industry, company, functional manager, work team and individual will have to alter their Success Formulas to deal with this change – or face declining returns. Some started making these changes years ago (such as GE and IBM), and others have not (such as GM and Ford).
If there is not going to be a wholesale realignment of global economic leadership, it will require the government, industry and company leaders in the developed countries to make substantial changes in their Success Formulas. The recent U.S. financial services industry bail-out bill only addressed the current debt and cash flow crisis. It did not address the fundamental changes in the economic competitiveness. We can soon expect similar requests for government bail-outs from the auto industry, homebuilding industry, appliance industry, etc. Until government leaders develop a different economic model, the developed countries will struggle. And the industries that formerly led in these countries will continue to see market dominance shift as it has done in IT services, customer service, furniture manufacturing and several others. Success Formulas must be changed from the bottom to the top – including those of the individuals who are seeing the changes in competition affect them.
What’s needed now more than ever is White Space to address these market Challenges. Just as the New Deal in the 1930s and the dramatic tax reductions of the 1980s allowed for experimentation and creation of entirely new Success Formulas to changed market conditions – similar White Space is needed in government today. And those who lead their industries and companies must begin using more White Space to find new ways to compete – rather than trying to Defend & Extend despite declining returns. Equally, functional group heads and work team leaders will find themselves having to use more White Space to address competitive needs – rather than falling back on old assumptions about what works.
Those who implement White Space and develop new Success Formulas they can migrate toward will be able to improve their competitiveness and survive – possibly thrive! Those that don’t will find the future very tough sledding. There is no doubt about the global shifts that started a decade ago and are continuing today. Trying to wind the clock backward will never happen. Old competitive models are now obsolete. The winners will be those who follow the Phoenix Principle and use White Space to migrate their Success Formulas.
