The S&P 500 ended 2011 almost exactly where it started. If ever there was a year when being invested in the right companies, and selling the dogs, mattered for higher portfolio returns it was 2011. The good news is that many of the 2011 dogs were easy to spot, and easy to sell before ruining your portfolio.
There were many bad performers. However, there was a common theme. Most simply did not adjust to market shifts. Environmental changes, from technology to regulations, made them less competitive thus producing declining returns as newer competitors benefitted. Additionally, these companies chose – often over the course of several years – to eschew innovation and new product launches. They chose to keep investing in efforts to defend and extend historical, but troubled, businesses rather than innovate toward a more successful future.
Looking at the trends that put these companies into trouble we can recognize the need to continue avoiding these companies, even though many analysts are starting to say they may be "value stocks." Instead we can invest in the trends by buying companies likely to grow and increase portfolio returns in 2012.
Avoid Kodak – Buy Apple or Google
Few companies are as iconic as Eastman Kodak, inventor of amateur photography and creator of the star product in the hit 1973 Paul Simon song "Kodachrome." However, it was clear in the late 1980s that digital cameras were going to change photography. Kodak itself was one of the primary inventors of the core technology, but licensed it to others in order to generate cash it invested trying to defend and extend photographic film and paper sales. In my 2008 book "Create Marketplace Disruption" I highlighted Kodak as a company so locked-in to film sales that it was unwilling to even consider moving into new markets.
In 2011 EK lost almost all its value, falling from $3.85 share to about 60 cents. The whole company is now worth only $175M as it rapidly moves toward NYSE delisting and bankruptcy, and complete failure. The trend that doomed EK has been 2 decades in the making, yet like an ocean freighter collision management simply let momentum kill the company. The long slide has gone on for years, and will not reverse. If you want to invest in photography your best plays are smart phone suppliers Apple, and Google for not only the Android software but the Chrome apps that are being used to photoshop images right inside browser windows.
Avoid Sears – Buy Amazon
When hedge fund manager Ed Lampert took over KMart by buying their bonds in bankruptcy, then used that platform to buy Sears back in 2006 the Wall Street folks hailed him as a genius. "Mad Money" Jim Cramer said "Fast Eddie" Lampert was his former college roommate, and that was all he needed to recommend buying the stock. On the strength of such spurrious recommendations, Sears Holdings initially did quite well.
However, I was quoted in The Chicago Tribune the day of the Sears acquisition announcement saying the merged company was doomed – because the trends were clear. Wal-Mart was in pitched battle with Target to "own" the discount market which had crushed KMart. Sears was pinched by them on the low end, and by better operators of vertically focused companies such as Kohl's for clothing, Best Buy for appliances and Home Depot for repair and landscape tools. Sears was swimming against the trends, and Ed Lampert had no plans to re-invent the company. What lay ahead was cost-cutting and store closings which would kill both brands in a market already overly saturated with traditional brick-and-mortar retailers as long-term more sales moved on-line.
The retail future belongs to Amazon.com – which is where you should invest if you want to grow portfolio value in 2012. Look to Kindle Fire and other tablets to accelerate the retail movement on-line, while out-of-date Sears becomes even less relevant and of lower value.
Stay out of Nokia and Research in Motion – Buy Apple
Both companies simply missed the market shift in smart phones. Nokia did its best Motorola imitation, which missed the shift from analog to digital cell phones – and then completely missed the shift to smart phones – driving the company to near bankruptcy and acquisition by Google for its patent library. With no game at all, the Nokia Board hired a former Microsoft executive to arrange a shotgun wedding for launching a new platform – 3 years too late. Now Apple and Android have over 400,000 apps each, growing weekly, while Microsoft is struggling with 50k apps, no compelling reason to switch and struggles to build a developer network. Nokia's road to oblivion appears clear.
RIM was first to the smartphone market, and had it locked up for years. Unfortunately, top management and many investors felt that the huge installed base of corporate accounts, using Blackberry secure servers, would protect the company from competition. Now the New York Times has reported RIM leadership as one of the worst in 2011, because an installed base is no longer the competitive entry barrier Michael Porter waxed about in the early 1980s. Corporations are following their users to better productivty by moving fast as possible to the iOS and Android worlds.
RIM's doomed effort to launch an ill-devised, weakly performing tablet against the Apple iPod juggernaut only served to embarrass the company, at great expense. At this point, there's little reason to think RIM will do any better than Palm did when the technology shifted, and anyone holding RIMM will likely end up with nothing (as did holders of PALM.) If you want to be in mobile your best pick is market leading and profitably growing Apple, with a second position in Google as it builds up ancillary products like Chrome to leverage its growing Android base.
Avoid HP and Sony – Buy Apple
Speaking of Palm, to paraphrase Senator Dirkson "that billion here, a billion there" that added up to some real money lost for HP. Mark Hurd consolidated HP into a company focused on building volume largely in other people's technology – otherwise known as PCs. As printing declines, and people shift to tablets and cloud apps, HP has less and less ability to build its profit base. The trends were all going in the wrong direction as market shifts make HP less and less relevant to consumer and corporate customers.
Selecting Mr. Apotheker was a disastrous choice, and I called for investors to dump the stock when he was hired in January. An ERP executive, he was firmly planted in the technology of the 1990s. With a diminished R&D, and an atrophied new product development organization HP is nothing like the organization of its founders, and the newest CEO has offered no clear path for finding the trends and re-igniting growth at HP. If you want to grow in what we used to call the PC business you need to be in tablets now – and that gets you back, once again, to Apple first, and Google second.
Which opens the door for discussing what in the 1960s through 1980s was the most innovative of all consumer electronics companies, Sony. But when Mr. Morita was replaced by an MBA CEO that began focusing the company on the bottom line, instead of new gadgets, the pipeline rapidly dried. Acquisitions, such as a music label, replaced R&D and new product development. Allegiance to protecting the CD and DVD business, and the players Sony made – along with traditional TVs and PCs – meant Sony missed the wave to MP3, to mobile digital entertainment devices, to DVRs and the emerging market for interactive TV. What was once a leader is now a follower.
As a result Sony has lost $4.5B in investor value the last 3 year, and in 2011 lost half its value falling from $37 to $18/share. As Apple emerges as the top consumer electronics technology leader and profit creator, closely chased by Google, it is unlikely Sony will ever recover that lost value.
Buying Apple, Amazon, Google and Netflix
This column has already made the case for Apple. It is almost incomprehensible how far a lead Apple has over its competition, causing investors to fear for its revenue growth prospects. As a result, the companies P/E multiple is a remarkably low single-digit number, even though its growth is well into the double digits! But its existing position in growth markets, technology leadership and well oiled new product development capability nearly assures continued profitbale growth for at least 5 years. Even though the stock, which I recommended as my number 1 buy in January, 2011, has risen some 30% maintaining a big position is remains an investors best portfolio enhancer.
Amazon was a wild ride in 2011, and today is worth almost the same as it was one year ago. Given that the company is now larger, has a more dominant position in publishing and is the world leader on the trend to on-line retail it is a very good stock to own. The choice to think long-term and build its user links through sales of Kindle Fire at cost has limited short-term profits, but every action Amazon has taken to grow has paid off handsomely because they accelerate the natural trends and position Amazon as the leader. Remaining with the trends, and the growth, offers the potential for big payoff this year and for years to come.
Google remains #2 in most markets, but remains aligned with the trends. It was disappointing that the company cancelled so many great products in 2011 – such as Gear and Wave. And it faces stiff competition in its historical ad markets from the shift toward social media and Facebook's emergence. However, Google is the best positioned company to displace Microsoft on all those tablets out there with its Chrome apps, and it still is a competitor with the potential for long-term value creation. It's just hard to be as excited about Google as Apple and Amazon.
Netflix started 2011 great, but then stumbled. Starting the year at $190, Netflix rose to $305 before falling to $75. Investors have seen an 80% decline from the peak, and a 60% decline from beginning of the year. But this was notably not because company revenues or profits fell, because they didn't. Rather concerns about price changes and long-term competition caused the stock to drop. And that's why I remain bullish for owning Netflix in 2012.
Those who worry about Amazon, Google or Apple taking the Netflix position forget that those companies are making huge bets to compete in other markets and have shown less interest in making the big investments to compete on the content that is critical in the download market. AOL and Yahoo are also bound up trying to define new strategies, and look unlikely to ever be the content companies they once were.
For those who are banking on competitive war with Comcast and other cable companies to kill off Netflix look no further than how they define themselves (cable operators,) and their horrific customer relationship scores to realize that they are more interested in trying to preserve their old business than rapidly enter a new one. Perhaps one will try to buy Netflix, but they don't have the management teams or organization to compete effectively.
The fact is that Netflix still has the best strategy for its market, which is still growing exponentially, has the best pricing and is rapidly growing its content to remain in the top position. That makes it a likely pick for "turnaround of the year" by end of 2012 (at least in the tech/media industry) – even as investments rise over the next 12 months.
“You’ve got to be kidding me” was the line tennis great John McEnroe made famous. He would yell it at officials when he thought they made a bad decision. I can’t think of a better line to yell at Leo Apotheker after last week’s announcements to shut down the tablet/WebOS business, spin-off (or sell) the PC business and buy Autonomy for $10.2B. Really. You’ve got to be kidding me.
HP has suffered mightily from a string of 3 really lousy CEOs. And, in a real way, they all have the same failing. They were wedded to their history and old-fashioned business notions, drove the company looking in the rear view mirror and were unable to direct HP along major trends toward future markets where the company could profitably grow!
Being fair, Mr. Apotheker inherited a bad situation at HP. His predecessors did a pretty good job of screwing up the company before he arrived. He’s just managing to follow the new HP tradition, and make the company worse.
HP was once an excellent market sensing company that invested in R&D and new product development, creating highly profitable market leading products. HP was one of the first “Silicon Valley” companies, creating enormous shareholder value by making and selling equipment (oscilliscopes for example) for the soon-to-explode computer industry. It was a leader in patent applications, new product launches and being first with products that engineers needed, and wanted.
Then Carly Fiorina decided the smart move in 2001 was to buy Compaq for $25B. Compaq was getting creamed by Dell, so Carly hoped to merge it with HP’s retail PC business and let “scale” create profits. Only, the PC business had long been a commodity industry with competitors competing on cost, and the profits largely going to Intel and Microsoft! The “synergistic” profits didn’t happen, and Carly got fired.
But she paved the way for HPs downfall. She was the first to cut R&D and new product development in favor of seeking market share in largely undifferentiated products. Why file 3,500 patents a year – especially when you were largely becoming a piece-assembly company of other people’s technology? To get the cash for acquisitions, supply chain investments and retail discounts Carly started a whole new tradition of doing less innovation, and spending a lot being a copy-cat.
But in an information economy, where almost all competitors have market access and can achieve highly efficient supply chains at low cost, there was no profit to the volume Carly sought. HP became HPQ – but the price paid was an internal shift away from investing in new markets and innovation, and heading straight toward commoditization and volume! The most valuable liquid in all creation – HP ink – was able to fund a lot of the company’s efforts, but it was rapidly becoming the “golden goose” receiving a paltry amount of feed. And itself entirely off the trend as people kept moving away from printed documents!
Mark Hurd replaced Carly, And he was willing to go her one better. If she was willing to reduce R&D and product development – well he was ready to outright slash it! And all the better, so he could buy other worn out companies with limited profits, declining share and management mis-aligned with market trends – like his 2008 $13.9B acquisition of EDS! Once a great services company, offshore outsourcing and rabid price competition had driven EDS nearly to the point of bankruptcy. It had gone through its own cost slashing, and was a break-even company with almost no growth prospects – leading many analysts to pan the acquisition idea. But Mr. Hurd believed in the old success formula of selling services (gee, it worked 20 years before for IBM, could it work again?) and volume. He simply believed that if he kept adding revenue and cutting cost, surely somewhere in there he’d find a pony!
And patent applications just kept falling. By the end of his cost-cutting reign, the once great R&D department at HP was a ghost of its former self. From 9%+ of revenues on new products, expenditures were down to under 2%! And patent applications had fallen by 2/3rds
The patent decline continued under Mr. Apotheker. The latest CEO intent on implementing an outdated, industrial success formula. But wait, he has committed to going even further! Now, HP will completely evacuate the PC business. Seems the easy answer is to say that consumer businesses simply aren’t profitable (MediaPost.com “Low Margin Consumers Do It Again, This Time to HP“) so HP has to shift its business entirely into the B-2-B realm. Wow, that worked so well for Sun Microsystems.
I guess somebody forgot to tell consumer produccts lacked profits to Apple, Amazon and NetFlix.
There’s no doubt Palm was a dumb acquisition by Mr. Hurd (pay attention Google.) Palm was a leader in PDAs (personal digital assistants,) at one time having over 80% market share! Palm was once as prevalent as RIM Blackberries (ahem.) But Palm did not invest sufficiently in the market shifts to smartphones, and even though it had technology and patents the market shifted away from its “core” and left Palm with outdated technology, products and limited market growth. By the time HP bought Palm it had lost its user base, its techology lead and its relevancy. Mr. Hurd’s ideas that somehow the technology had value without market relevance was another out-of-date industrial thought.
The only mistake Mr. Apotheker made regarding Palm was allowing the Touchpad to go to market at all – he wasted a lot of money and the HP brand by not killing it immediately!
It is pretty clear that the PC business is a waning giant. The remaining question is whether HP can find a buyer! As an investor, who would want a huge business that has marginal profits, declining sales, an extraordinarily dim future, expensive and lethargic suppliers and robust competitors rapidly obsoleting the entire technology? Getting out of PCs isn’t escaping the “consumer” business, because the consumer business is shifting to smartphones and tablets. Those who maintain hope for PCs all think it is the B-2-B market that will keep it alive. Getting out is simply because HP finally realized there just isn’t any profit there.
But, is the answer is to beef up the low-profit “services” business, and move into ERP software sales with a third-tier competitor?
I called Apotheker’s selection as CEO bad in this blog on 5 October, 2010 (HP and Nokia’s Bad CEO Selections). Because it was clear his history as CEO of SAP was not the right background to turn around HP. Today ERP (enterprise resource planning) applications like SAP are being seen for the locked-in, monolithic, buraucracy creating, innovation killing systems they really are. Their intent has always been, and remains, to force companies, functions and employees to replicate previous decisions. Not to learn and do anything new. They are designed to create rigidity, and assist cost cutting – and are antithetical to flexibility, market responsiveness and growth.
But following in the new HP tradition, Mr. Apotheker is reshuffling assets – closing the WebOS business, getting rid of all “consumer” businesses, and buying an ERP company! Imagine that! The former head of SAP is buying an SAP application! Regardless of what creates value in highly dynamic, global markets Mr. Apotheker is implementing what he knows how to do – operate an ERP company that sells “business solutions” while leaving everything else. He just can’t wait to get into the gladiator battle of pitting HP against SAP, Oracle, J.D. Edwards and the slew of other ERP competitors! Even if that market is over-supplied by extremely well funded competitors that have massive investments and enormously large installed client bases!
What HP desperately needs is to connect to the evolving marketplace. Quit looking at the past, and give customers solutions that fit where the market is headed. Customers aren’t moving toward where Apotheker is taking the company.
All 3 of HP’s CEOs have been a testament to just how bad things can go when the CEO is more convinced it is important to do what worked in the past, rather than doing what the market needs. When the CEO is locked-in to old thinking, old market dynamics and old solutions – rather than fixated on understanding trends, future scenarios and the solutions people want and need bad things happen.
There are a raft of unmet needs in the marketplace. For a decade HP has ignored them. Its CEOs have spent their time trying to figure out how to make old solutions work better, faster and cheaper. And in the process they have built large, but not very profitable businesses that are now uninteresting at best and largely at the precipice of failure. They have ignored market shifts in favor of doing more of the same. And the value of HP keeps declining – down 50% this year. For HP to change direction, to increase value, it needs a CEO and leadership team that can understand important trends, fulfill unmet needs and migrate customers to new solutions. HP needs to rediscover innovation.
We like to think we can compete effectively by waiting on others to show us the market direction
You cannot make high rates of return with a “fast follower” strategy
Companies that constantly take innovations to market grow longer, and make higher rates of return
White Space allows you to learn, grow and be smart about when to get out while costs are low
“I want to be a fast follower. Let somebody else carry the cost of learning what the market wants and what solutions work. I plan to come in fast behind the leader and make more money by avoiding the investment.” Have you ever heard someone talk this way? It sounds so appealing. Only problem is – it very rarely works! Fast followers might gain share sometimes, but universally they have terrible margins. Their sales come at an enormous investment cost.
Those who enter new markets early actually gain a lot, for little cost. Take for example Amazon.com’s early entry into electronic publishing with Kindle. Entering early gave Amazon a huge advantage. Amazon may have appeared to be floundering, potentially “wasting” resources, but it was learning how the technology of e-Ink worked, how costs could be driven down and what users demanded in a solution. Every quarter Amazon was learning how to find new uses for the Kindle, making it more viable, finding new customers, encouraging repeat purchases and growing. Now Mediapost.com headlines “Review: New Kindle Kicks (Even Apple’s) B*tt.”
Now there are a raft of “fast followers” trying to catch the Kindle in the eReader market. But the Kindle is far lighter, easier to use, with greater functionality and available at one of the market’s lowest prices. While the cost of entry was low, Amazon learned immensely. That knowledge is not repeatable by companies trying to now play “catch up” without spending multiples of what Amazon spent. Amazon is so far in front of other eReaders that it’s competition is the vastly more sophisticated (and expensive) mobile devices from Apple (iPhone and iPad). By entering early, Amazon has lower cost, and considerably more/better market knowledge, than later entrants.
We see this very clearly in Microsoft’s smart phone approach. Microsoft got far behind in smart phones, losing over 2/3 its market share, as it focused on Windows 7 and Office 2010 the last 3 years while Resarch in Motion (RIM) Apple and Google pioneered the market. Now the 3 leaders have millions of units in the market, low price point establishment, and between them somewhere between 400,000 and 500,000 mobile apps available.
As reported in Mediapost.com “Microsoft Gets Serious with Windows 7 Phone” entering now is VERY expensive for Microsoft. Microsoft spent almost $1billion on Kin, which it dropped after only a few months because the product was seriously unable to compete. So now Microsoft is expecting to spend $500million on launch costs for a Windows 7 mobile operating system. But it faces a daunting challenge, what with 350,000 or so iPhone apps in existence, and Google giving Android away for free (as well as sporting some 100,000 apps itself).
The cost of entry, ignoring Microsoft’s technology development cost, to get the mindshare of developers for app development (so Windows 7 mobile doesn’t slip into the Palm or Blackberry problem of too few apps to be interesting) as well as minds of potential buyers will more likely cost well over $1B – just for communications!! Microsoft now has to take share away from the market leaders – a very expensive proposition! Like XBox marketing, these exorbitant marketing costs could well go on for several years. XBox has had only 1 quarter near break-even, all others showing massive losses. The same is almost guaranteed for the Windows 7 phone. And it’s entering so late that it may never, even with all that money being spent, catch the two leaders! Who are the new users that will come along, and what is Microsoft uniquely offering? It’s expensive to buy mind and market share.
Clearly Apple and Android entered the smart phone market at vastly lower cost, and have developed what are already profitable businesses. Microsoft will lose money, possibly for years, and may still fail – largely because it focused on its core products and chose to undertake a “fast follower” strategy in the high growth smart phone business.
We like to believe things that reinforce our behaviors. We like to think that tortoises can outrun hares. But that only happens when hares make foolish decisions. Rarely in business are the early entrants foolish. Most learn – a lot – at low cost. They figure out where the early customers are with unmet needs, and how to fulfill those needs. They learn how to identify ways to grow the business, manage costs and earn a profit. And they learn at a much lower cost than late followers. They capture mind and market share, and work hard to grow the business with new customers keeping them profitable and maintaining share.
We want to think that innovators bear a high risk. But it’s simply not true. Innovators take advantage of market learning to create revenues and profits at lower cost. Companies that keep White Space projects flourishing, entering new markets generating growth, earn higher rates of return longer than any other strategy. Just look at Cisco, Nike, Virgin, J&J and GE (until very recently). The smart money gets into the game early, developing a winning approach — or getting out before the costs get too high!
Recently SeekingAlpha.com ran the article "Time for Tivo to say Ta Ta." The author (a professor) took the point of view that Tivo had filled a need, but now there were ample new options – such as on-line downloads – making Tivo obsolete. As a result, the company should fold up its tent and let the employees move on.
I was struck, because the good professor did not seem to think it might be possible for Tivo to change its business model and move into the other growing opportunities while simultaneously maintaining the traditional Tivo set-top business until the market figures out what customers really want. That sort of predicting future markets is dangerous for 2 reasons:
the inherent assumption that Tivo can be in only one market is flawed. There is nothing stopping Tivo from participating in the marketplace robustly with mutliple solution offerings. It can even cannibalize its own "base" revenues if the market shifts into other solutions. Tivo could remain top of the market – regardless of what solution dominates
predicting future markets is a fools game. The good professor may guess some of these futurist positions right, but he's sure to get many wrong. Any business that bets its product development or investments on future predictions is destined to eventually get it wrong – and possibly destroy itself. Good leaders use scenarios to realize there are multiple possibilities, and then participate in several of them in order to be assured of growth.
Fast Company points out in "Avoiding Corporate Death Spirals in a Sea of Change" that all companies hoping to remain long-lived MUST learn to transition with shifting markets. The article parallels this blog in discussing failures at Blockbuster Video, Silicon Graphics, Digital Equipment – and more recently dramatic share declines in Palm. All are attributed to management Lock-in on early wins, then trying to Defend & Extend the early Success Formula too long. Market transitions killed them. The article goes on to point out that Cisco Systems, a company held up as an example of Phoenix Principle Management here, has succeeded and grown principally because it has learned how to adjust to market shifts.
No company needs to give up. But all companies that want to survive HAVE to learn to manage market transitions. There is no other choice. Shift happens.
Did you ever notice how often a large company will introduce a new solution (often a new technology), but then retrench from promoting it? Frequently, the market is developed by an alternate company that captures most of the value. We can see that behavior looking at smartphones.
In 2008, three early leaders were Microsoft, RIM and Palm. But Microsoft chose to invest in Defending & Extending its PC software business – with updates to the operating system in Vista and OS 7. As the market has shifted toward mobile computing, Microsoft has been clobbered. But largely because it remained stuck trying to protect its "core" while the market shifted away. Palm also tried to Defend & Extend its early position with updates, but because it did not follow the pathway to greater usage with new applications it also has seen dramatic share decline.
Meanwhile, RIM has promoted new uses within the corporate world for mobility, and thus grown its market share. And Apple has made a huge impact by bringing forward dozens of new mobile applications, closely followed by Google. What we see is a classic example of the early entrant fading largely because they decided to Defend the old market, rather than investing in the new one. Really too bad for shareholders in Microsoft (losing 20 share points) and Palm (losing 10 share points), while good for shareholders of RIM, Apple and Google.
And in Apple's case we can see that the company continues using White Space to grow revenues by expanding the new marketplace. The iPad is off to a very strong start, with tens of thousands of units ordered last week. But of greater importance is how Apple is promoting the shift to mobile devices from traditional PC devices. At SeekingAlpha.com, in "How the iPad, Slates Will Evolve the Next Two Years," the reporter projects how demand for all laptop products will decline as more capability and functionality is added to mobile devices like smartphones and these new slate products.
Microsoft can keep trying to Defend & Extend PC technology, but it won't be long before their efforts largely won't matter. Don't forget that once Cray computers was a rapidly growing super-computer company. But increasing performance from much alternative products eventually made Cray irrelevant. Same for Silicon Graphics and Sun Microsystems.
Today the market capitalization of Microsoft is about $250B, about 4x sales. Apple's market cap is just over $200B, about 6x sales. Google's market cap is about $180B, about 8x sales. All reflect investor expectations about future growth. The D&E company is simply not expected to grow – and in fact is much more likely to disappoint than the companies growing share in growing markets toward which customers are shifting.
And any company can choose to participate in growth, versus Defend & Extend. While Tribune Corporation is trying to find a way out of bankruptcy, and struggling to figure out how to deal with market shifts away from newspapers, Hearst is taking positive action. The Wall Street Journal reports in "Hearst Jumps Into the Apps Business" how the old-line newspaper company has set up a White Space project, complete with dedicated people and its own funding, to begin developing mobile applications for news!
Even when business leaders see a market shift, far too many choose to Defend & Extend the "core." Unfortunately, that leads to disappointments. Keep in mind Microsoft and its rapid loss of Smartphone share as users move increasingly to mobile devices from PCs. To succeed leaders need to drive their organizations in the direction of market shifts, and growth. Like Apple, Google and even Hearst.
