Hostess Brands filed for liquidation this week. Management blamed its workforce for the failure. That is straightforward scapegoating.
In 1978 Dan White killed San Francisco's mayor George Moscone and city supervisor Harvey Milk. The press labeled his defense the "Twinkie Defense" because he claimed eating sugary junk food – like Twinkies – caused diminished capacity. Amazingly the jury bought it, and convicted him of manslaughter instead of murder saying he really wasn't responsible for his own actions. An outraged city rioted.
Nobody is rioting, but management's claim that unions caused Hostess failure is just as outrageous.
Founded in 1930 as Interstate Bakeries Co. (IBC) the company did fine for years. But changing consumer tastes, including nutrition desires, changed how much Wonder Bread, Twinkies, HoHos and Honey Buns people would buy — and most especially affected the price – which was wholly unable to keep up with inflation. This trend was clear in the early 1980s, as prices were stagnant and margins kept declining due to higher costs for grain and petroleum to fuel the country's largest truck fleet delivering daily baked goods to grocers.
IBC kept focusing on operating improvements and better fleet optimization to control rising costs, but the company was unwilling to do anything about the product line. To keep funding lower margins the company added debt, piling on $450M by 2004 when forced to file bankruptcy due to its inability to pay bills. For 5 years financial engineers from consultancies and investment banks worked to find a way out of bankruptcy, and settled on adding even MORE debt, so that – perversely – in 2009 the renamed Hostess had $670M of debt – at least 2/3 the total asset value!
Since then, still trying to sell the same products, margins continued declining. Hostess lost a combined $250M over the last 3 years.
The obvious problem is leadership kept trying to sell the same products, using roughly the same business model, long, long, long after the products had become irrelevant. "Demand was never an issue" a company spokesman said. Yes, people bought Twinkies but NOT at a price which would cover costs (including debt service) and return a profit.
In a last, desperate effort to keep the outdated model alive management decided the answer was another bankruptcy filing, and to take draconian cuts to wages and benefits. This is tanatamount to management saying to those who sell wheat they expect to buy flour at 2/3 the market price – or to petroleum companies they expect to buy gasoline for $2.25/gallon. Labor, like other suppliers, has a "market rate." That management was unable to run a company which could pay the market rate for its labor is not the fault of the union.
By constantly trying to defend and extend its old business, leadership at Hostess killed the company. But not realizing changing trends in foods made their products irrelevant – if not obsolete – and not changing Hostess leaders allowed margins to disintegrate. Rather than developing new products which would be more marketable, priced for higher margin and provide growth that covered all costs Hostess leadership kept trying to financial engineer a solution to make their horse and buggy competitive with automobiles.
And when they failed, management decided to scapegoat someone else. Maybe eating too many Twinkies made the do it. It's a Wonder the Ding Dongs running the company kept this Honey Bun alive by convincing HoHos to loan it money! Blaming the unions is simply an inability of management to take responsibility for a complete failure to understand the marketplace, trends and the absolute requirement for new products.
We see this Twinkie Defense of businesses everywhere. Sears has 23 consecutive quarters of declining same-store sales – but leadership blames everyone but themselves for not recognizing the shifting retail market and adjusting effectively. McDonald's returns to declining sales – a situation they were in 9 years ago – as the long-term trend to healthier eating in more stylish locations progresses; but the blame is not on management for missing the trend while constantly working to defend and extend the old business with actions like taking a slice of cheese off the 99cent burger. Tribune completey misses the shift to on-line news as it tries to defend & extend its print business, but leadership, before and afater Mr. Zell invested, refuses to say they simply missed the trend and let competitors make Tribune obsolete and unable to cover costs.
Businesses can adapt to trends. It is possible to stop the never-ending chase for lower costs and better efficiency and instead invest in new products that meet emerging needs at higher margins. Like the famous turnarounds at IBM and Apple, it is possible for leadership to change the company.
But for too many leadership teams, it's a lot easier to blame it on the Twinkies. Unfortunately, when that happens everyone loses.
Apple is launching the iPhone 5, and the market cap is hitting record highs. No wonder, what with pre-orders on the Apple site selling out in an hour, and over 2 million units being presold in the first 24 hours after announcement.
We care a lot about Apple, largely because the company has made us all so productive. Instead of chained to PCs with their weight and processor-centric architecture (not to mention problems crashing and corrupting files) while simultaneously carrying limited function cell phones, we all now feel easily interconnected 24×7 from lightweight, always-on smart devices. We feel more productive as we access our work colleagues, work tools, social media or favorite internet sites with ease. We are entertained by music, videos and games at our leisure. And we enjoy the benefits of rapid problem solving – everything from navigation to time management and enterprise demands – with easy to use apps utilizing cloud-based data.
In short, what was a tired, nearly bankrupt Macintosh company has become the leading marketer of innovation that makes our lives remarkably better. So we care – a lot – about the products Apple offers, how it sells them and how much they cost. We want to know how we can apply them to solve even more problems for ourselves, colleagues, customers and suppliers.
Amidst all this hoopla, as you figure out how fast you can buy an iPhone 5 and what to do with your older phone, you very likely forgot that Kraft will be splitting itself into 2 parts in about 2 weeks (October 1). And, most likely, you don't really care.
And you can't imagine why I would even compare Kraft with Apple.
Kraft was once an innovation leader. Velveeta, a much maligned product today, gave Americans a fast, easy solution to cheese sauces that were difficult to make. Instant Mac & Cheese was a meal-in-a-box for people on the run, and at a low budget. Cheeze Whiz offered a ready-to-eat spread for canape's. Individually wrapped American cheese slices solved the problem of sticky product for homemakers putting together lunch sandwiches for school children. Miracle Whip added spice to boring sandwiches. Philadelphia brand cream cheese was a tasty, less fattening alternative to butter while also a great product for sauces.
But, the world changed and these innovations have grown a lot less interesting. Frozen food replaced homemade sauces and boxed solutions. Simultaneously, cooking skills improved. Better options for appetizers emerged than stuffed celery or something on a cracker. School lunches changed, and sandwich alternatives flourished. Across Kraft's product lines, demand changed as new technologies were developed that better fit customers' needs leading to revenue stagnation, margin erosion and an increasing irrelevancy of Kraft in the marketplace – despite its enormous size.
Apple turned itself around by focusing on innovation, becoming the most valuable American publicly traded company. Kraft eschewed innovation for cost cutting, doing more of the same trying to defend its "core," leaving investors with virtually no returns. Meanwhile thousands of Kraft employees have lost their jobs, even though revenues per employee at Kraft are 1/6th those at Apple. And supplier margins are a never-ending cycle of forced reductions as Kraft tries to capture their margin for itself.
Chart Source: Yahoo Finance 18 September, 2012
Apple's value went up because it's revenues went up. In 2007 Apple had #24B in revenues, while Kraft was 150% bigger at $37B. Ending 2011 Apple's revenues, all from organic growth, were up 4x (400%) at $108B. But Kraft's 2011 revenues were only $54B, including roughly $10B of purchased revenues from its Cadbury acquisition, meaning comparative Kraft revenues were $44B; a growth of (ho-hum) 3.5%/year.
Lacking innovation Kraft could not grow the topline, and simply could not grow its value. And paying a premium price for someone else's revenues has led to…. splitting the company in 2 in only 2 years, mystifying everyone as to what sort of strategy the company ever had to grow!
But Kraft's new CEO is not deterred. In an Ad Age interview he promised to ramp up advertising while slashing more jobs to cut costs. As if somehow advertising Velveeta, Miracle Whip, Philadelphia and Mac & Cheese will reverse 30 years of market trends toward different products which better serve customer needs!
Apple spends nearly nothing on advertising. But it does spend on innovation. Innovation adds value. Advertising aging products that solve no new needs does not.
Unfortunately for employees, suppliers and shareholders we can expect Kraft to end up just like Hostess Brands, owner of Wonder Bread and Twinkies, which recently filed bankruptcy due to 40 years of sticking to its core business as the market shifted. Industry leaders know this, as they announced this week they are using Kraft's split to remove the company from the Dow Jones Industrial Average.
Companies that innovate change markets and reap the rewards. By delivering on trends they excite customers who flock to their solutions. Companies that focus on defending and extending their past, especially in times of market shifts, end up failing. Failure may not happen overnight, but it is inevitable.
"If you can't dazzle 'em with brilliance – Baffle 'em with Bulls**t" – W. C. Fields
Just 18 months ago Kraft CEO Irene Rosenfeld was working very hard to convince investors she needed to grow Kraft with a $19B acquisition of Cadbury. This was after her expensive acquisition of Lu Biscuits from Danone. Part of her justification for the massive expenditure was an out-of-date industrial manufacturing adage, "Scale is a source of great competitive advantage. " How these acquisitions provided scale advantage was never explained.
Now she wants to convince investors Kraft needs to be split into two companies, saying the acquisition trail has left her with "different portfolios." (Quotes from the Wall Street Journal, "Activists Pressed for Kraft Spinoff") For some reason, scale is now less important than portfolio focus. And the scale advantages that justified the acquisition premiums are now – unimportant?
If Ms. Rosenfeld was a politician, she might be accused of being a "flip-flopper." Remember John Kerry?
Ms. Rosenfeld would like to break Kraft into 2 parts. Some brands would be in a new "grocery," or "domestic" business (Oscar Mayer, Cool Whip, Maxwell House, Jell-O, Philadelphia Cream Cheese, Kool Aid, Miracle Whip is a partial list.) The rest of the company would be a "snack" or "international" business. Although the latter would still include the North American snacks and confectionary brands. (More detail in the Wall Street Journal "Kraft: Breaking Down the Breakup.")
We will ignore the obvious questions about why the acquisitions if your strategy was to split up the company. Instead, looking forward, the critical questions to have answered would be "How will this break-up help Kraft grow? And what is the benefit for investors, employees and shareholders of this massive, and costly, change?"
Kraft was split off from Altria at the end of 2006, with Ms. Rosenfeld at the helm. At its rebirth, Kraft became a Dow Jones Industrial member. Rich in revenues and resources, at the time, Kraft was valued at about $35/share. Now, 5 years and all the M&A machinations later, Kraft is valued (with optimism about the breakup value) at about $35/share! Between the two dates the company's value was almost always lower. So investors have gained nothing for their 5 years of waiting for Ms. Rosenfeld to "transform" Kraft.
The big winners at Kraft have been their investment bankers. They received enormous multi-million dollar fees for helping Ms. Rosenfeld buy and sell businesses. And they will receive massive additional fees if the company is split in two. In fact, given her focus on M&A as opposed to actually growing Kraft, one could well assess Ms. Rosenfeld's tenure as more investment banker than Chief Executive Officer. She didn't really do anything to improve Kraft. She just moved around the pieces, and swapped some.
Kraft has had no growth, other than from the expensive purchased acquisition revenues. Despite its massive $50B revenue stream, what new innovation – what exciting new product – can you recall Kraft introducing? Go ahead, take your time. We can wait.
What's that – you can't think of any. Nor can anybody else.
In Kraft's historical businesses, volume declined 1.5% over the last couple of years. The company has been shrinking. According to Crain's Chicago Business in "Kraft's Rosenfeld's About Face Spurred by Dwindling Options," the only reason revenues grew in the base business was due to rising commodity prices, which were passed along, with a premium added, in retail price increases to consumers! A business doesn't have a sparkling future when it keeps selling less, and raising prices, on products that consumers largely could care less about.
When was the last time you asked for a Velveeta sandwich? Interestly, Tang now seems to have outlived even NASA and the American space program. Have you enjoyed that sugar-laden breakfast delight lately? Or when did you last look for that special opportunity to use artificial ice-cream (Cool Whip) in your desert?
BusinessInsider.com tried valiantly to make the case "The Kraft Foods Split is the Grand Finale of an Epic Transformation." But as the author takes readers through the myriad re-organizations, in the end we realize that all these changes did nothing to actually improve the business – and managed to tick off Kraft's largest investor, Warren Buffet of Berkshire Hathaway, who has been selling shares!
The argument that Kraft has 2 portfolios as a justification for splitting the company makes no sense. Every investor is taught to have a wide portfolio in order to maximize returns at lowest risk. That Kraft has multiple product lines is a benefit to investors, not a negative!
Unless the leaders have no idea how to use the resources from these businesses to innovate, and bring out new products building on market trends and creating growth! And that's the one thing most lacking at Kraft. It's not a portfolio issue – it's a complete lack of innovation issue! As Burt Flickingerof Strategic Resources Group pointed out, Kraft has been losing .5% to 1% market share every year for the last decade in its "core" business, and he understatedly commente that Kraft has "very little innovation."
Markets have shifted dramatically the last 5 years, and food is no exception. People want fewer carbs, and fewer fats. They want easily prepared foods, but without additives like sugar (or high fructose corn syrup,) salt and oil that have negative long-term health implications for blood pressure, heart disease and diabetes. Also, they don't want hidden calories that make ease of preparation a trade-off with their wastelines! Further, most families have changed from the traditional 3 times per day standard meals to more grazing habits, and from large portions to smaller portions with greater variety.
But Kraft addressed none of these shifts with new products. Instead, it kept pouring advertising dollars into the traditional foodstuffs, even as these were finding less and less fit with 2011 dietary needs – or consumer interest! When the most exciting thing anyone can say about a Kraft launch the last 5 years was the re-orientation of the Triscuit line (did you catch that, or did you somehow miss it?) then it's pretty clear innovation has been on the back burner. Or maybe stuck in the shelf with the Cheez Whiz.
It is clear that Ms. Rosenfeld offered no brilliance as Kraft's leader. Uninspiring to consumers, investors and employees. She made very expensive acquisitions to create the illusion of revenue growth; financial machinations that hid declines in the traditional business which suffered from no innovation investment. After all that money was thrown around, and facing very little prospect of any growth, it was time for the biggest baffling bulls**t of all – split the company up so nobody can trace the value destruction!
Andrew Lazar at Barclay's Capital Plc gave a pretty good insight in another Crain's Chicago Business article ("Kraft Jettisons U. S. Brands so Global Snack Biz Can Fly Higher.") He said Kraft (aka Ms. Rosenfeld) is "Taking action before it ever has to potentially disappoint investors in a struggle to reach overly optimistic sales growth targets."
Yes, I think Mr. Fields had it pretty right when it comes to describing the leadership of Ms. Rosenfeld and her team at Kraft. They have been unable to dazzle us with any brilliance. The question is whether we'll be foolish enough to let them baffle us with their ongoing bulls**t. What Kraft needs is not a break-up. What Kraft needs is new leadership that understands how to move beyond the past, tie investments to market needs, and start Kraft growing again!!
This week most people don't really care about Kraft. After the U.S. debt ceiling "crisis," followed by the Friday night announcement of the U.S. debt downgrade, the news has been dominated by mostly economic, rather than company, items. The collapse of the DJIA has been a lot more important than a non-value-adding split-up of a single component. And that is unfortunate, because the leadership of Kraft have been playing chess games with company pieces, rather than actually doing what it takes to help a company grow. With the right leadership, Kraft could be creating the jobs everyone so desperately wants.
- McDonald's relies on operational improvements to raise profits, these are short-lived and give no growth
- McDonald's growth cycles, and investors forget long-term it isn't growing much at all
- You can't depend on recurring recessions to make your business look good
- Apple has shown how to create long-term revenue growth, and greater investor wealth, by developing new markets and solutions
- Investors in McDonald's are likely to be less pleased than investors in Apple
Subway is now #1 in size, as "McDonald's Loses World's Biggest Title to Subway" according to Crain's Chicago Business. The transition wasn't hard to predict, since Subway has been much larger in the USA for several years. Now Subway has gained on McDonald's internationally. What's striking about this is that McDonald's could see it coming, and really did nothing about it. While Subway keeps focused on growth, McDonald's has focused on preserving its historical business. And that bodes poorly for long-term investor performance.
For more than a decade McDonald's size has swung back and forth as it opened stores, then closed hundreds in an "operational improvement program," before opening another round of stores – to then repeat the cycle. McDonald's has not shown any US store growth for a long time, and has relied on expanding its traditional business offshore.
Even the menu remains almost unchanged, dominated by burgers, fries and soft drinks. "New" product rollouts have largely been repeats of decades old products, like McRib, which cycle on and off the menu. And the most "strategic" decision we hear about was executives spending countless hours, along with thousands of franchisees, trying to figure out whether or not to reduce the amount of cheese on a cheeseburger (which they did, saving billions of dollars.) Even though it spent almost a decade figuring out how to launch McCafe, the whole idea gets little atttention or promotion. There just isn't much energy put into innovation, or growth at McDonald's. Or even trying to be a leader in new marketing tools like social media, where chains like Papa John's have done much better.
Most people have forgotten that McDonald's acquired and funded the growth of Chipotle's, one of the fastest growing quick food chains. But in 2006 McDonald's leadership sold Chipotle's to raise cash to fund another one of those operational improvement rounds. The business that showed the most promise, that has much more growth opportunity than the tiring McDonald's brand, was sold off in order to Defend and Extend the known, but not so great, McDonald's.
Sort of like selling your patents in order to pay for maintenance and upgrades on the worn out plant tooling.
Soon after Chipotle's sale the "Great Recession" started. And people quit dining out – or went downmarket. Thousands of restaurants closed, and chains like Bennigan's declared bankruptcy. As people started eating a bit more frequently in McDonald's investors cheered. But, this was really more akin to the old phrase "even a stopped clock is right twice a day." McDonald's was the benefactor of an unanticipated economic event. And as the economy has improved McDonald's has cheered its improved oprations and higher profits. But, where is future growth? What will create long-term growth into 2015 and 2020? (To be honest, I'm not sure where this will be for Subway, either.)
This cycle of bust and repair – which will lead to another bust when a competitor or other external event challenges McDonald's unaltered success formula – is very different from what's happened at Apple. Rather than raising money to defend its historical business (the Macintosh business) Apple actually cut back its Mac products to fund development of new businesses – the big winner being iPod and iTunes. Then Apple focused on additional new markets, transforming smart phone growth with the iPhone and altering the direction of computing with the iPad. Rather than trying to Defend its past and Extend into new markets (like McDonald's international efforts) Apple has created, and led, new markets.
Performance at Apple has been much better than McDonald's. As we can see, only during the clock-stopped period at the height of the recession did investors lose faith in Apple's growth, while defaulting to defensiveness at McDonald's.
Chart source: Yahoo Finance
Steve Toback at bNet.com gives us insight into how Apple has driven its growth in "10 Ways to Think Different – Inside Apple's Cult-like Culture." These 10 points look nothing like the McDonald culture – or hardly any company that has growth problems. A quick scan gives insight to how any company can identify, develop and grow with new solutions in new markets:
- Empower employees to make a difference.
- Value what's important, not minutiae
- Love and cherish the innovators
- Do everything important internally
- Get marketing
- Control the message
- Little things make a big difference
- Don't make people do things, make them better at doing things
- When you find something that works, keep doing it
- Think different
What's most worrisome is that the protectionist culture we see at McDonald's, and frankly most U.S. companies, is the kind that led General Motors to years of faultering results and eventual bankruptcy. Recall that GM once bought Hughes Aircraft and EDS as growth devices (around 1980,) and opened the greenfield Saturn division to learn how to compete with offshore auto makers head-on. But the first two were sold, just like McDonald's sold Chipotle, to raise funds for propping up the poorly performing auto business. Saturn was gutted of its uniqueness in cost-saving programs to "align" it with the other auto divisions, and closed in the recent bankruptcy. (Read more detail on The Fall of GM in this short eBook.)
While McDonald's isn't at risk of immediate bankruptcy, investors need to understand that it's value is unlikely to rise much. Operational improvements are not the source of growth. They are short-term tactics to support historical behaviors which trade off short-term profit improvement for long-term new market development. In McDonald's case, this latest round of performance focus matched up with an economic downturn, unexpectedly benefitting McDonald's very quickly. But long-term value comes from creating new business opportunities that meet changing needs. And for that you need to not sell your innovations — instead, invest in them to drive growth.
- It sounds good to refocus a business on its core
- It sounds good to centralize for cost reductions and belt tightening as part of refocusing
- It sounds good to sell “non-essential” businesses to raise cash
- It sounds good to have a company buy back shares
- But these efforts serve to destroy the company, killing it softly as it sounds good, but guts the business of revenues and innovation
- Sara Lee’s CEO destroyed the company softly by following such a strategy
The vultures are swirling around Sara Lee. “Sara Lee Said to Get Bid from Bain, Apollo Group Exceeding $18.70 a Share” was the Bloomberg headline. JBS and Blackstone Group are reportedly considering making an offer, according to the Wall Street Journal. This has, of course, driven up the share price from its steady decline of 67% between 2006 and 2009.. But unless you’re a short-term trader, even this acquisition offer is barely going to get you back to break even for your 5 year old investment.
Five years ago Brenda Barnes took leadership at Sara Lee to much fanfare, as she broke the long-problematic glass ceiling for women executives. But her plan for Sara Lee hasn’t worked out so well. Although her compensation has been in the millions, for investors, employees and suppliers this has been a very rough 5 years.
Ms. Barnes took over Sara Lee saying it was a “hodgepodge” of inefficient brands and businesses. Her goal was to streamline Sara Lee, refocus the company and regenerate its core. That certainly sounded good.
Her first steps were to consolidate operations into a central headquarters, including all R&D for the far-flung businesses. She started cutting costs, and heads, as she reduced the number of marketers and centralized purchasing. Going after “synergies,” consolidations were forced on all functions, and the re-launched R&D was staffed at a fraction of earlier product development efforts. The intent, accomplished, was to launch fewer products, and focus on cost reductions. To many listeners, this sounded so soothing. After all, who wouldn’t think there was “fat” to be cut? Who ever believes cost-cutting reaches an end? Why not try to “milk” more out of the old products rather than undertake costly new product launches?
Simultaneously, Ms. Barnes began selling businesses. Gone was the European meats and apparel units, soon followed by the direct sales business sale to Tupperware, and the Body Care business sale to Unilever. Branded apparel was spun out as a seperate company, and the bakery business was sold to Group Bimbo [transaction not yet closed.] Revenues declined from $13.2B in June, 2008 to $10.8B in June 2010 – and after the bakery sale would fall to $8.7B – a revenue drop of 1/3 in just a few years. But this was to refocus, and generate billions of cash for share buybacks. To many that sounded good as well.
All of this streamlining, cost cutting, consolidating and refocusing did raise cash. But, for investors, quarterly dividends were cut from 19.75 cents/share in April, 2006 to 10 cents/share in August, 2006. Only recently have dividends been raised to 11.5 cents/share, but this is still a reduction of over 40% from where dividends were prior to implementing the new refocusing strategy.
After years of implementation, Sara Lee investors in 2010 were holding stock worth less, and had lower dividends, than before this new plan was put into effect.
It all sounded so good, like the lyrics of a lullaby. Refocus. Go back to the business core. Get out of non-essential businesses. Consolidate operations with belt-tightening. Centralize functions to get more done with fewer resources. Sell businesses to raise cash. And invest that cash in share buybacks that would raise the company value. (The alchemy of this last statement still mystifies me. At the end, you’ve sold all the businesses to raise money to buy the last shares – and nobody is left with anything. It’s like selling parts of the house to pay the maintenance – eventually there’s nowhere left to live. How anybody thinks this is good for any constituency of the company is hard to fathom.)
What has been accomplished under the Barnes leadership?
- The equity value cratered, only to be uplifted by a private equity takeover effort that may allow investors to regain their original investment
- Cash dividends have been gutted
- Sara Lee is now a much smaller company, with no new products and no growth plan
- Operating cash flow has declined
- Cash has been dispersed in meaningless stock buybacks that have accomplished nothing
- Tens of thousands of jobs have been lost
- Suppliers have been squeezed out, or if still selling to Sara Lee had their margins squeezed
- Downers Grove, IL ,where the headquarters is located, can link declines in commercial and residential real estate to the downfall of Sara Lee
While it may sound like a comforting song, business leadership that turns to cutting the business throws it into a growth stall from which there is almost no hope of recovery. Even though short-term there may be bragging about the effort to refocus, cut costs and raise cash, these actions simply kill the business – softly and slowly perhaps, but kill it nonetheless.
Sales and profit problems are the result of remaining stuck in old market approaches long after the market has shifted to superior solutions. The only way to “fix” the business is to get closer to the market and launch new products, technologies, processes or solutions that are aligned with emerging market trends. You can’t cost-cut, refocus or re-align a business to success. You have to grow it.
- We too often think of competition as “head to head”
- Smart competitors avoid direct competition, instead using alternative methods in order to lower cost while appealing directly to market needs
- Proctor & Gamble has long dominated advertising for many consumer goods, but the impact, value and payoff of traditional advertising has declined markedly as people have switched to the web
- New competitors can utilize internet and social media tools to achieve better brand positioning and targeted marketing at far lower cost than old mass media products
- Colgate is in a great position to blow past P&G by investing quickly and taking the lead in internet marketing for its products
- Eschew calls for investing in old methods of competition, and instead find new ways to compete that allow you to end-run traditional leaders
According to a recent Advertising Age article (“To Catch Up Colgate May Ratchet Up Its Ad Spending“) Colgate has done a surprisingly good job of holding onto market share, despite underspending almost all its competitors in advertising. This is no mean feat in consumer products, where advertising dominates the cost structure. But the AdAge folks are predicting that to avoid further declines, and grow, Colgate will have to dramatically up its ad spending. That would be old-fashioned, backward-thinking, short-sighted and a lousy use of resources!
Colgate competes with lots of companies, but across categories its primary competitor is Proctor & Gamble. In toothpaste, P&G’s Crest outspends Colgate by over $25M – or about 35%. In dishsoap Colgate spent nothing on Palmolive in 2010, compared to P&G’s spend of $30M on Dawn. In deodorant/body soap Colgate spent about $9M on Softsoap, Irish Spring and Speedstick while P&G spent 9 times more (over $82M) on Old Spice and Secret. (Side note, Unilever spent $148M on Dove and a whopping $267M when adding in Axe and Degree!) In pet food, Unilever spends $35M dollars more (almost 4x) on Iams than Colgate spent on Hills Science Diet. Altogether, in these categories, P&G spent almost $158M more than Colgate (2.5x more)! As a big believer in traditional advertising, AdAge therefore predicts that Colgate should dramatically increase its annual ad budget – and maintain these higher levels for 5 years in order to overcome its historical “underspending.”
But that would be like deciding to trade punches with Goliath!
Why would Colgate want to do more of what P&G does the most? While advisors try to pit competitors directly against each other, head-to-head “gladiator style” combat leaves the combatants bloody – some dead. That’s a dumb way to compete. Colgate has long spent in other areas, such as supporting dog rescue operations and with product specialists gaining endorsements while eschewing more general advertising. Now, if Colgate wants to take action to grow share, it should pick up a sling (to continue the (Biblical metaphor) in its ongoing battle. And the good news is that Colgate has an entire selection of new, alternative weapons to use today.
Across all its product categories, Colgate can utilize a plethora of new social media marketing tools. At costs far lower than traditional mass advertising, Colgate can build promotional web programs that appeal directly to targeted consumers. Twitter, Facebook, Foursquare, Groupon, YouTube, Google and many other tool providers allow Colgate to spend far, far less than traditional advertising to provide specific brand promotions, product information, purchase incentives (such as coupons) and product variations targeted at various niches.
With these tools Colgate can not only reach directly into buyer laptops and mobile devices, but offer specific information and incentives. Traditional advertising, whether print (newspaper and magazine), radio, television or coupons is a low percentage tool. Seeking response rates (or even recall rates) of just 1 to 5 percent is normal – meaning 90% percent of your spending is, quite literally, just “overhead” cost. But with modern on-line tools it is very common to have response rates of 50% – or even higher! (Depending upon how targeted and accurate, of course!)
Colgate is in a great position!
It has spent much less than competitors, and maintained good brand position. It’s biggest competitors are locked-in to spending vast sums on traditional tools that have low impact and are in declining media. Colgate could now decide to commit itself to using the new, modern tools which are lower cost, and have decidedly more targeted results. In this way, Colgate can get out of the “colliseum” where the gladiators are warring, and throw rocks at them from the stands. Play its own game – to win – while letting those in the pit whack away at each other becoming weaker and weaker trying to use the old, heavy and unsophisticated tools.
Now is a wonderful time to be the “underdog” competitor. “Media” and advertising are in transition. How people obtain information on products and services is moving from traditional advertsing and PR (public relations) focused through mass media to networks with common interests in social media. Instead of delays in obtaining information, based upon publisher programming dates, customers are seeking immediate, and current information, exactly when they need it – on their mobile devices. Those competitors who rapidly adopt these new tools are well positioned to be the new Davids in the battle with old Goliaths. And that includes YOU.
- Business leaders like consistency
- Consistency leads to repetition, sameness, and lower rates of return
- Kraft's product lines are consistent, but without growth
- Kraft's value has been stagnant for 10 years
- Disruptive competitors make higher rates of return, and grow
- Disruptive competitors have higher valuations – just look at Groupon
"Needless consistency is the hobgoblin of small minds" – Ralph Waldo Emerson
That was my first thought when I read the MediaPost.com Marketing Daily article "Kraft Mac & Cheese Gets New, Unified Look." Whether this 80-something year old brand has a "unified" look is wholly uninteresting. I don't care if all varieties have the same picture – and if they do it doesn't make me want to eat more powdered cheese and curved noodles.
In fact, I'm not at all interested in anything about this product line. It is kind of amusing, in an historical way, to note that people (largely children) still eat the stuff which fueled my no-cash college years (much like ramen noodles does for today's college kids.) While there's nothing I particularly dislike about the product, as an investor or marketer there's nothing really to like about it either. Pasta products always do better in a recession, as people look for cheaper belly-fillers (especially for the kid,) so that more is being sold the last couple of years doesn't tell me anything I would not have guessed on my own. That the entire category has grown to only $800M revenue across this 8 decade period only shows that it's a relatively small business with no excitement! Once people feel their finances are on firm footing sales will soon taper off.
Kraft's Mac & Cheese is emblematic of management teams that lock-in on defending and extending old businesses – even though the lack of growth leaves them struggling to grow cash flow and create a decent valuation. Introducing multiple varieties of this product has not produced growth that even matched inflation across the years. Primarily, marketing programs have been designed to try keeping existing customers from buying something else. This most recent Kraft program is designed to encourage adults to try a product they gave up eating many years ago. This is, at best, "foxhole" marketing. Spending money largely just to keep the brand from going away, rather than really expecting any growth. Truly, does anyone think this kind of spending will generate a billion dollar product line in 2011 – or even 2012?
What's wrong with defensive marketing, creating consistency across the product line – across the brand – and across history? It doesn't produce high rates of return. There are lots of pasta products, even lots of brands of mac & cheese. While Kraft's product surely produces a positive margin, multiple competitors and lack of growth means increased spending over time merely leaves the brand producing a marginal rate of return. Incremental ad spending doesn't generate real growth, just a hope of not losing ground. We know people aren't flocking to the store to buy more of the product. New customers aren't being identified, and short-term growth in revenues does not yield the kinds of returns that would enhance valuation and make the world a better place for investors – or employees.
While Kraft is trying to create headlines with more spending in a very tired product, across town in Chicago Groupon has created a $500M revenue business in just 2 years! And new reports from the failed acquisition attempt by Google indicate revenues are likely to reach $2B in 2011 (CNNMoney.com, Fortune, "Google's Groupon Groping Reveals the Shifting Power of the Web World.") Where's Kraft in this kind of growth market? After all, coupons for Kraft products have been in mailers and Sunday inserts for 50 years. Why isn't Kraft putting money into a real growth business, which is producing enormous value while cash flow grows in multiples? While Groupon has created somewhere around $6B of value in 2 years, Kraft's value has only gone sideways for the last decade (chart at Marketwatch.com.)
Kraft has not introduced a new product since — well — DiGiorno. And that's been more than a decade. While the company has big revenues – so did General Motors. The longer a company plays defense, regardless of size, trying to extend its outdated products (and business model) the riskier that business becomes. While big revenues appear to offer some kind of security, we all know that's not true. Not only does competition drive down margins in these older businesses, but newer products make it harder and harder for the old products to compete at all. Eventually, the effort to maintain historical consistency simply allows competitors to completely steal the business away with new products, creating a big revenue drop, or producing such low returns that failure is inevitable.
Lots of business people like consistency. They like consistency in how the brand is executed, or how products are aligned. They like consistency in the technology base, or production capabilities. They like consistency in customers, and markets. They like being consistent with company history – doing what "made the company famous." They like the similarity of doing something again, and again, hoping that consistency will produce good returns.
But consistency is the hobgoblin of small minds. And those who are more clever find ways to change the game. Xerox figured out how to let everyone be a one-button printer, and killed the small printing press manufacturers. HP's desktop printers knocked the growth out of Xerox. Google figured out a better way to find information, and place ads, just about killing newspapers (and magazines.) Apple found a better way to use mobile minutes, taking a big bite out of cell phone manufacturers. Amazon found a better way to sell things, killing off bookstores and putting a world of hurt on many retailers. Netflix found a better way of distributing DVDs and digital movies, sending Blockbuster to bankruptcy. Infosys and Tata found a better way of doing IT services, wiping out PWC and nearly EDS. Hulu (and soon Netflix, Google and Apple) has found a better way of delivering television programming, killing the growth in cable TV. Groupon is finding a better way of delivering coupons, creating huge concerns for direct mail companies. Now tablet makers (like Apple) are demonstrating a better way of working remotely, sending shivers of worry down the valuation of Microsoft. These companies, failed or in jeapardy, were very consistent.
Those who create disruptions show again and again that they can generate growth and above average returns, even in a recession. While those who keep trying to defend and extend their old business are letting consistency drive their behavior – leading to intense competition, genericization, and lower rates of return. Maybe Kraft should spend more money looking for the next food we would all like, rather than consistently trying to convince us we want more Mac & Cheese (or Velveeta).
- Businesses usually try defending an old solution in the face of an emerging new solution
- Status Quo Police use “cannibalization” concerns to stop the organization from moving to new solutions and new markets
- If you don’t move early, you end up with a dying business – like newspapers – as new competitors take over the customer relationship – like Apple is doing with news subscriptions
- You can adapt to shifting markets, profitably growing
- You must disrupt your lock-ins to the old success formula, including stopping the Status Quo Police from using the cannibalization threat
- You should set up White Space teams early to embrace the new solutions and figure out how to profitably grow in the new market space
When Sony saw MP3 technology emerging it worked hard to defend sales of CDs and CD Players. It didn’t want to see a decline in the pricing, or revenue, for its existing business. As a result, it was really late to MP3 technology, and Apple took the lead. This is the classic “Innovator’s Dilemma” as described by Professor Clayton Christenson of Harvard. Existing market leaders get so hung up on defending and extending the current business, they fear new solutions, until they become obsolete.
In the 1980s Pizza Hut could see the emergence of Domino’s Pizza. But Pizza Hut felt that delivered pizza would cannibalize the eat-in pizza market management sought to dominate. As a result Pizza Hut barely participated in what became a multi-biliion dollar market for Domino’s and other delivery chains.
The Status Quo Police drag out their favorite word to fight any move into new markets. Cannibalization. They say over and over that if the company moves to the new market solution it will cannibalize existing sales – usually at a lower margin. Sure, there may someday be a future time to compete, but today (and this goes on forever) management should keep close to the existing business model, and protect it.
That’s what the newspapers did. All of them could see the internet emerging as a route to disseminate news. They could see Monster.com, Vehix.com, eBay, CraigsList.com and other sites stealing away their classified ad customers. They could see Google not only moving their content to other sites, but placing ads with that content. Yet, all energy was expended trying to maintain very expensive print advertising, for fear that lower priced internet advertising would cannibalize existing revenues.
Now, bankrupt or nearly so, the newspapers are petrified. The San Jose Mercury News headlines “Apple to Announce Subscription Plan for Newspapers.” As months have passed the newspapers have watched subscriptions fall, and not built a viable internet distribution system. So Apple is taking over the subscription role – and will take a cool third of the subscription revenue to link readers to the iPad on-line newspaper. Absolute fear of cannibalization, and strong internal Status Quo Police, kept the newspapers from embracing the emerging solution. Now they will find themselves beholden to the device providers – Apple’s iPad, Amazon’s Kindle, or a Google Android device.
But it doesn’t have to be that way. Netflix built a profitable growth business delivering DVDs to subscribers. Streaming video clearly would cannibalize revenues, because the price is lower than DVDs. But Netflix chose to embrace streaming – to its great betterment! The Wrap headlines “Why Hollywood should be Afraid of Netfilx – Very Afraid.” As reported, Netflix is now growing even FASTER with its streaming video – and at a good margin. The price per item may be lower – but the volume is sooooo much higher!
Had Netflix defended its old model it was at risk of obsolescence by Hulu.com, Google, YouTube or any of several other video providers. It could have tried to slow switching to streaming by working to defend its DVD “core.” But by embracing the market shift Netflix is now in a leading position as a distributor of streaming content. This makes Netfilx a very powerful company when negotiating distribution rights with producers of movie or television content (thus the Hollywood fear.) By embracing the market shift, and the future solution, Netflix is expanding its business opportunity AND growing revenue profitably.
Don’t let fear of cannibalization, pushed by the Status Quo Police, stop your business from moving with market shifts. Such fear will make you like the proverbial deer, stuck on the road, staring at the headlights of an oncoming auto — and eventually dead. Embrace the market shift, Disrupt your Locked-in thoughts (like “we distribute DVDs”) and set up White Space teams to figure out how you can profitably grow in the new market!
- Success Formulas age, losing their value
- To regain growth, you have to identify with market trends – not reinforce old Lock-ins
- KFC is losing sales due to a market shift, but its response is not linked to market trends
- KFC’s plan to invest heavily in its old icon is Defend & Extend management
- Market to what it takes to regain new customers, and lost customers, not what your current customers (core customers) value
- The Status Quo Police have driven a very bad decision at KFC – more poor results will follow
- You have to market toward future needs, not what worked years ago.
Who’s Colonel Sanders? According to USAToday, in “KFC Tries to Revive Founder Colonel Sanders Prestige” 60% of American’s age 18 to 25 don’t know. For us older Americans, this may seem amazing, because we were raised on advertising that promoted the legend of a cooking Kentucky Colonel who “did chicken right” creating the recipe for what became today’s enormous Kentucky Fried Chicken (KFC) franchise. But it’s been a very, very long time since “the Colonel” left KFC in the 1980s, declaring that the chain, then owned by Heublein, didn’t make chicken so “finger lickin’ good” any longer. Were he alive today, the famed Colonel – who became a caricature of himself before death, would be an astounding 120 years old! Now most people don’t have a clue who’s picture that is in the red logo – if they notice there’s even a picture of someone there.
KFC is the largest chicken franchise, with 15,000 stores. But size has not been any help as the chain has lost its growth. Last quarter’s same-store sales fell 7%. A clear sign a deadly growth stall has started that bodes badly for the future! People have stopped going to KFC outletd. So management needs to do something to bring new customers into the stores – in American and globally. In a remarkable display of defending the Status Quo, leadership’s recommended solution for this problem is to put a heavy marketing blitz into “educating” consumers about the Colonel, and the oompany’s history!
Are we to believe that knowing about some long dead company founder will drive customers’ decisions where to eat lunch or dinner next week? Or next year?
I don’t know why people are eating less KFC, but it’s a sure bet it’s NOT because the Colonel has faded from the limelight. Times have changed dramatically. Everything from the acceptance of fried food, to concerns about chicken raising, to menu variety, to store appearance, and alternative competitive opportunities have had an impact on sales at KFC. What KFC needs is to understand these market trends, recognize where consumers are headed with their prepared food purchases, and position the company to deliver what consumers WANT this year and in the future. If KFC finds the trend – even if it’s not chicken – it can regain its growth. KFC needs to give the market what it wants – and is that a heavy education about a dead icon?
KFC is trying to turn back the clock. It is looking internally, historically, and hoping that by promoting the Colonel it can regain the glorious growth of previous decades. KFC leadership is remaining firmly committed to its old and clearly tiring Success Formula (the one that is producing declining sales and profits.) So it is holding fast to its menu, its preparation methods, its store appearance, its “brand” image and now even its iconic founder that is irrelevant to this current generation and any international consumer!
Does anyone really think reviving the Colonel – a white haired senior
citizen in his heyday -will create double digit growth? Or bring in
those young people between ages 18 and 25? There’s not one shred of
market input which says this is the way to grow KFC. Only a belief that
somehow future success will come from an attempt to replay what worked
when the Success Formula was created over 40 years ago.
In a telling quote from the article “KFC’s trying to paint a new picture — actually asking its core consumers to paint it for them.” The marketers are actually hoping a contest to re-sketch the lost icon will drive people to “reconnect” with the franchise. What’s worse, clearly they are hoping to appeal to the “core” customers – current customers – rather than find out why lost customers left, and what new customers might want to encourage a switch to KFC. They are “focusing on their core” rather than figuring out what the market wants.
Add on top of this that management has admitted it expectsmost (possibly all) future growth to come from international expansion, and you really have to question how focusing marketing on the Colonel makes any sense. Why would people in Europe, South America, India, China or elsewhere have any connection to a character more attuned to America’s civil war than today’s global economy and international high-energy brand images?
This is the kind of decision that is driven by a strong Status Quo Police. Of all the options, from changing the menu and name, to developing a new icon, to creating a new image for the alphabet soup that is KFC (most young people don’t even relate KFC to the original name – and international customers have no connection at all) – all the things that could be based on market trends – leadership went down the road of doing more of the same.
It’s a sure bet we’ll be reading about further declines in KFC over the next year. There will be a big store closing program. Then a quality program to improve customer service and cleanliness. Layoffs will happen. Some kind of lean program to tighten up the supply chain and cut costs. Revenues will probably decline another 15-25%. Exactly what McDonald’s did about 6 years ago when it sold Chipotle’s to “refocus on its core.” Management will talk about how its “core” customers relate well to the Colonel, and they are sure if given time the marketing will return KFC to its old glory.
And the only people who will enjoy this are the Status Quo Police. For the rest of us, it’s watching another great company fall victim to its past, rather than migrate toward a better, high growth future.
Read my Forbes.com column “Fire the Status Quo Police” for more insight to how consumer branded companies hurt long-term viability by maintaining brand status quo rather than migrating with market trends.
“Playboy’s Circulation drops 34%” is the Chicago Tribune headline. Is anyone surprised? If ever there was a brand, and business, that was out of step with current markets it has to be Playboy. That the business still exists is a wonder. But let’s spend a few minutes to see why Playboy has fallen on hard times, and what the alternative might have been – and could still be.
The Playboy Success Formula is really clear. Since founded by Hugh Hefner, the company has focused on titillating the male libido with a magazine that focused on pictures of naked women, videos of same (physical videos, on-line videos and television), radio talk shows about sex, and alternative lifestyle issues such as recreational drug use. At one time this was unique, and in a male dominated 1960s it was even tolerated. Although never mainstream, the business was very profitable early in its lifecycle. Thus the founder kept doing more of the same, building a small empire and eventually taking the company public.
But the market shifted. Larry Flint and others ushered in a new era of pornography altering the market for prurient, sexually oriented material. Women in the workforce – and I’d like to think a heavy dose of decency – made public toleration of such material unacceptable. You couldn’t read a Playboy at work, or on the airplane, and you wouldn’t have a business lunch at their clubs. Other magazines sprung up to deal with men’s interests in automobiles, clothing, music, sports, etc. in a more acceptable – and for most people more significant and intelligent – manner. Other lifestyle publications were developed that discussed illicit drug use and non-traditional ways of life more directly, explicitly and with greater advocacy. The advent of cable TV and then the internet increasingly made access to the key features of Playboy’s product readily available, very inexpensive (often free) and targeted at niche audiences.
Yet, despite these many market changes, Playboy’s founder and his daughter, the company CEOs for 40+ years, steadfastly stuck to their old Success Formula. They kept thinking that people wanted those “bunny eared” products. They talked a lot about the heritage of Playboy, how it broke ground in so many markets, and opened the door for lots of new competitors. But they kept doing what the company always did – including foisting upon us the ever aging founder as a “role model” for male menopause and the anti-family aged entrepreneur. Playboy today is what it always was – and there simply aren’t a whole lot of people with much interest in those products any more. Nobody mismanaged the brand, the market just walked away from it. Sort of like the demand for Geritol.
Playboy focused on its core. And now its on the edge of bankruptcy. The company keeps outsourcing more and more of the work, as the staff has dropped to nearly nothing, cutting costs everywhere possible. Sales continue to decline, and the brand looks like it will soon join Polaroid and Woolworths on the heap of once famous but floundered companies. Playboy’s fatal mistake wasn’t that it was started as a prurient men’s magazine – but rather that for 40 years its leadership kept Defending & Extending that original Success Formula despite rather dramatic market shifts. Now, today, Playboy is a sour lemon that not many a marketer would want to be stuck promoting.
But – it didn’t have to be that way. Just imagine if you’d been given control of Playboy 30 years ago. What could you have done?
As soon as Hustler hit the newsstands, and the first women’s right protests developed – including the early push for the Equal Rights Amendment – it was clear that the future of the magazine was in jeopardy. Instead of doing “more of the same” could you have considered something else?
The growth of women in the workforce meant a lot of new opportunities. Why not jump onto that bandwagon? If you’re really at the forefront of “lifestyle” issues, as the leadership claimed, then you would have identified that women in the workforce meant something new was brewing – a group of consumers that would have more cash, and more influence. And not only would that be an appealing market, but so would the men who would be adjusting to new lifestyle issues as homes became dominated by 2-worker leadership.
Playboy was well positioned to be Victoria’s Secret. At a time before anybody else was really thinking about a significant market for attractive and comfortable lingerie Playboy certainly had the leading edge. Or, even more likely, the water carrying publication for Dr. Ruth-style discussions about sexuality. There was an emerging market for information targeted at increasingly affluent women about automobiles, stereos, apartments, resume writing, job hunting and even at-work etiquette — all topics that had been the dominant discussion areas for Playboy’s historically male readership. Had the leadership at Playboy opened its eyes, and scanned the horizon for growth markets being developed as a result of the trends which were negatively impacting it, these leaders would have been able to create a bevy of scenarios that were filled with opportunities for growth.
It’s hard to imagine today Playboy being anything else. But all that stopped stopped Playboy’s evolution was a commitment to its “core” – to its old Success Formula. That the CEO for over 20 years was a well educated woman is testament to the power of “core” philosophy versus a willingness to look at market opportunities. By keeping Playboy’s Success Formula tightly aligned with her father’s founding ideas she quite literally led the company into smaller and smaller sales with less and less profit. The big loser was, of course, investors. Playboy is worth very little today as Mr. Hefner hints at making a bid to take the company private once again.
Singer was once a sewing machine company. But when Japanese products surpassed Singer’s product capabilities and achieved a cost advantage in the 1970s, Singer leadership converted Singer into a defense contractor. And Singer went on to multiply its value before being acquired by General Dynamics.
IBM was an office machine company famous for mechanical typewriters and adding machines. The founder said he would never enter computers. Fortunately for employees and shareholders the founder’s son took the company into computers and the company flourished as competitive typewriter companies such as Smith Corona – stuck on the core business – disappeared.
There’s a time for lemons – in your tea or on a salad. But when markets shift, lemons just turn sour. If you want to succeed long-term you have to shift with markets. And that might well mean making significant change. Adding water and sugar to the lemons is a good start – as lemonade is less about lemons than what you’ve added to it. After you open that lemonade stand, see where the market leads you.
No matter where you start, every day offers the opportunity to head toward new, emerging markets. No matter what your historical “core” you can literally become any business you want to become. Coke was founded by a pharmacist who wanted to boost counter sales in his store – and it was worth a lot more than the pills he was constructing. Those who develop scenarios about the future prepare for market shifts, understand the competitive changes and use them to identify the opportunities for a new future. Then they use White Space teams to move the business into a new Success Formula. Anybody can do it. You could even have remade Playboy. So what’s the plan for the future of your business? More of the same …. or …..