Google's earnings announcement, which came after the close of the market on Wednesday, signaled that it continues to experience extremely high revenue and earnings growth.
However, in keeping with my proprietary research results, the company's performance is beginning to be better-anticipated by observers, resulting in the attenuation of its total returns in response to such stellar revenue growth.
Further, as happens with long-experienced, high revenue growth levels, and their attendant infrastructure growth, in people and expenses, profit margins are suspected, by analysts, of beginning to come under pressure.
I wouldn't say Google won't have great total returns anymore. I would suggest that its size and growth rate are beginning to affect its continued performance in ways that they have not prior to this. When I hear about expenses for large, new initiatives, such as their online payment system, creating significant expenses, I can't help but think that Google is becoming a 'normal 'company, at last.
Friday morning, Scott McNealy, of SunMicrosystems, was a guest host on CNBC. He opined on Google, and YouTube, marveling at how, since the days of Microsoft, Sun, Apple, Dell, Yahoo, AOL, et. al., it seems that the timeframe in which companies experience such spectacular growth, and the sizes to which they grow, keep getting, respectively, shorter, and larger.
What puzzled me is how McNealy failed to notice the significant differences between these various firms. The earlier examples tended to produce hardware, and software. The latter tended to be for a couple of specific applications- operating systems, Office, etc. AOL was more of a networking application itself, using hardware, but offering fairly rigid software for online activities. Yahoo was the first generation of 'informational' software, wherein the consumer could and can just use the service for free. It's a mile wide and an inch deep, as has been discussed in prior posts on this blog (search on "Yahoo" to read them).
Google is, in my opinion, quite different from all of these. It's primary application was a superior search engine, around which it clustered advertising, using another superior methodology. By offering something totally consumer-configurable, for free, it skyrocketed. Google requires hardware to support its users, but it offers an essentially unchanging service, search, then mapping, auctions, etc., for which users provide all the tailoring.
No wonder why it's grown faster and larger than its predecessors. It's the latest "perfect" combination of pure software usage, for free, requiring no hardware building, little software building of an individual-specific or application-specific nature, and the revenues come straight from user behavior, rather than explicit "selling" by Google. Probably more than most companies, Google has succeeded in making large parts of its business completely "virtual," yet generic, to its customers.
Friday, February 02, 2007
Liquidity, Risk and Greed: Will The Private Equity Business Self-Destruct?
Monday's Wall Street Journal featured an article, positioned as "Financial Insight," on what is viewed as excessive private equity borrowing . Excessive risk is taken, passed off to banks, and greed rules. Liquidity everywhere, fueling ever more risky, leveraged deals.
Haven't we seen this before? According to Hugo Dixon, the author of the piece, heads of two leading private equity partnerships boasted recently, at the Davos Economic Forum, that they are cutting their risk exposure while increasing volumes, by requiring that the banks who wish to play must hold debt, or offer bridge financing. This begins to sound very much like Mike Milken's original LBO machine of the 1980s at Drexel Burnham. And recalls the ill-fated Ohio Mattress deal which drove First Boston into the arms of Credit Suisse after the 1989 imbroglio.
To be sure, it's likely that some private equity group will do one too many marginal deals, which will catch a large- or medium-sized bank off-guard, holding a sizable debt position, and it will either fold under the weight of the bad paper, or be driven to merge with another institution.
On one level, it's the same old, same old...every decade, it's a new financial product/market that melts down. Because, as my mentor, Gerry Weiss, taught me at Chase Manhattan Bank nearly twenty years ago, financial services firms tend to find growth most easily, in enlarging markets, by taking more risk. Especially when upfront fees are the revenue and profit source, but back-end loaded losses are the risk. The people deal, get paid fabulously, and walk, with the public or private institution owners hold the bag....er....risk......and take the losses.
When I first read Dixon's piece, I thought it pretty much does describe how the private equity craze will end. Then I read Alan Murray's piece in the Journal later in the week, and wrote this post. I now feel that several premium brand names in the private equity space- Texas Pacific, KKR, Silverlake Partners- may succeed in continuing to buy and improve the long-term value and returns of formerly-publicly-held companies without undue risk. I suspect that what Mr. Dixon envisions will occur among a second-tier group of private equity partnerships and banks dealing in more marginal "opportunities."
It might dent some of the frothier fringe deals but, like the mortgage banking market of the past year, won't adversely affect the better-positioned players doing higher-quality business.
Haven't we seen this before? According to Hugo Dixon, the author of the piece, heads of two leading private equity partnerships boasted recently, at the Davos Economic Forum, that they are cutting their risk exposure while increasing volumes, by requiring that the banks who wish to play must hold debt, or offer bridge financing. This begins to sound very much like Mike Milken's original LBO machine of the 1980s at Drexel Burnham. And recalls the ill-fated Ohio Mattress deal which drove First Boston into the arms of Credit Suisse after the 1989 imbroglio.
To be sure, it's likely that some private equity group will do one too many marginal deals, which will catch a large- or medium-sized bank off-guard, holding a sizable debt position, and it will either fold under the weight of the bad paper, or be driven to merge with another institution.
On one level, it's the same old, same old...every decade, it's a new financial product/market that melts down. Because, as my mentor, Gerry Weiss, taught me at Chase Manhattan Bank nearly twenty years ago, financial services firms tend to find growth most easily, in enlarging markets, by taking more risk. Especially when upfront fees are the revenue and profit source, but back-end loaded losses are the risk. The people deal, get paid fabulously, and walk, with the public or private institution owners hold the bag....er....risk......and take the losses.
When I first read Dixon's piece, I thought it pretty much does describe how the private equity craze will end. Then I read Alan Murray's piece in the Journal later in the week, and wrote this post. I now feel that several premium brand names in the private equity space- Texas Pacific, KKR, Silverlake Partners- may succeed in continuing to buy and improve the long-term value and returns of formerly-publicly-held companies without undue risk. I suspect that what Mr. Dixon envisions will occur among a second-tier group of private equity partnerships and banks dealing in more marginal "opportunities."
It might dent some of the frothier fringe deals but, like the mortgage banking market of the past year, won't adversely affect the better-positioned players doing higher-quality business.
Thursday, February 01, 2007
Private Equity As The Solution To Bad Corporate Governance
As a result of Alan Murray's Wall Street Journal column and appearance on CNBC yesterday morning, I have a developed, literally overnight, a different view of the private equity phenomenon. Alan is a managing editor of the paper, and a very shrewd, insightful writer with typically free market-leaning opinions, usually supported by evidence.
I've thought, for some time now, that the concept of shareholder 'democracy,' as currently bandied about, is wrong. For instance, I am listening to Congressman, Barney Frank, the new House Finance chairman with dubious credentials, on CNBC right now, as I write this. His verbiage is a good example of what I mean. Contrary to Frank, and others, I don't think the publicly-held company model was ever intended to raise the marginal shareholder to the level of voting on the CEO's compensation package, or similar "rights."
Previously, I've written in my blog that corporate structures of the 1890s were probably more effective than today's corporate model. Blogger is misbehaving this morning, so I cannot search for the post and link to it. In those days, however, a few men who actually knew how to create value and run a business, and make money. The public was allowed in because, ultimately, the barons needed more capital. With regulation of the capital markets over time, it worked. Boards were largely composed of wealthy, successful capitalists. The marginal public shareholder received the same financial benefit of ownership as the barons, without needing the skill or knowledge of the latter. A sort of asymmetric, one-way shareholder 'democracy.'
After some reflection, I realized that Murray's comments on private equity demonstrate that it is the new version of that old model. Successful businessmen use other's money, but now, in a smart twist, not for equity, but debt. So they don't give an unwanted vote/voice to the masses of small capitalists, or even concentration vehicles for funds, such as pension funds. Very astute, really. Take the public's money, but in a non-voting manner, without any reporting requirements.
Is this not new-style 1890s capitalism? I now think private equity is the, if not merely a, response to bad corporate governance.
In his excellent piece yesterday, Alan Murray wrote, in part,
"Increasingly, shareholders and directors are asking a fundamental question: If managers can create so much wealth for private owners, why can't they do the same for public shareholders?
Christobal Conde, chief executive officer of software company SunGard Data Systems, thinks he has an answer to that question. He was also in Davos last week and happy to tell his story to anyone who asked. As a public-company CEO, he was skeptical when Silver Lake's Mr. Hutchins first approached him two years ago about leading a buyout of his company. He thought private-equity firms made their money mostly through financial engineering, loading the target company with debt. But since then, he has learned otherwise. The buyout, he says, made SunGard a better company.
First, "it allowed us to push an enormous amount of change through the organization," Mr. Conde says. "It made everyone more receptive." That is particularly true of top managers, who were given twice the ownership stake in the company that they had when it was public. By boosting the company's debt, the buyout also ensured the value of those ownership stakes would skyrocket if the managers met their goals.
Second, he says his new private-equity partners -- which include Silver Lake, Blackstone, Bain Capital, Goldman Sachs Group, Kohlberg Kravis Roberts, Providence Equity and Texas Pacific Group -- have taught the company a great deal about improving the business in areas like purchasing.
"Like any company, we were very inbred," Mr. Conde says. But the private-equity partners operate across companies and industries, and were able to bring new knowledge to the firm "that has helped us enormously."
Finally, he says, his private-equity partners aren't obsessed with quarterly earnings. They understand a company's earnings may be volatile, and instead they focus on longer-term goals.
"I spend more time with my new private-equity shareholders than I did with the old ones," he says. "But I get so much more of it."
Mr. Conde says SunGard is still owned by many of the same pension funds that owned it before. That is the ultimate irony behind the new financial alchemy. Pension funds are paying hefty fees to private-equity firms -- which generally charge 2% of funds under management, plus 20% of the profit -- to make investments that the pension funds used to make by themselves.
Shareholders are right to be concerned about this trend. But the fault lies less with a private-equity market that is generating superior returns than with a public-company market that is generating lousy ones. Investors would be better off if public companies could clean up their own houses, and get rid of the high-priced middleman."
Look at what Mr. Conde is describing! Old-style, 'robber baron' capitalism. Isn't this what a board is supposed to do? In effect, these private equtiy titans buy choice, undervalued assets, and then reap equity rewards for overseeing their operations. They add as much value as the CEOs do, because they create the proper environment, goals, and long-term perspective for the eventual realization of the firm's value.
Is it not ironic that Conde points out how many pension funds invest in him via what Murray calls "middleman?" In fact, this is the answer to the claim that business doesn't care about the poor blue-collar worker, or compensation inequities. If the blue-collar worker's pension is invested with a fund that invests in private equity, then the lower-paid masses are, in fact, capable of reaping equity returns via the very deals which some feel disenfranchise or underpay them. Wages down, portfolio value up!
Here's another insight. If, as I wrote last summer as a solution to America's corporate governance problems, board members were required to "run" for the post, and invest significant assets of their own in the company, thus clearly aligning their financial interests with those of shareholders, it might improve corporate board oversight and involvement in the operation of companies.
Suppose private equity firm partners offered their services to a publicly-held company. Would they not, in effect, take board positions, in exchange for options to own much of the firm, or be paid a percentage of the value they created over, say, a function of the firm's prior total returns, relative to the S&P500? In effect, like my idea, they'd commit their financial fortunes to, and align them with those of the firm's. But what mechanism exists for shareholders to do this? None.
It would, in fact, be a sort of return to the days of the original form of shareholder capitalism. A few wealthy, skilled owners running the boards of large companies. Since, instead, many boards are infested with lesser lights, faded failures of other boards (look at Microsoft for a great example of this tendency), or "politically correct" members with absolutely no business skills, corporate performances are often appallingly bad, while CEOs and board members are still handsomely compensated.
Faced with this situation, private equity partners have followed Gresham's Law. They have, a la Ayn Rand, withheld their services from the poorly-paying public market for their services and, instead, gone private. In their private world, they are the new Morgans, Goulds and Schiffs. They invite investors to participate in a limited manner, with no vote. Just a financial reward.
Is this not the best solution smart, competent businessmen can effect in today's market? Since the publicly-held companies can't organize themselves to hire private equity partners as new, more-effective board members, these skilled operators simply created their own 'private' equity market, in which they can do the same job, for appropriate, risk-adjusted rewards.
Publicly-held company shareholders miss this source of premium returns because they are forced to invest via a broken, ineffective model which espouses "shareholder democracy," as if the marginal $10,000 investor in, say, Boeing, knows anything about how much the CEO should earn, or which board members, from a pre-selected slate, can properly and profitably oversee the firm's CEO and senior executive team.
Now, for a prediction as to a form of solution which may develop. What is to stop private equity firms from issuing securities of participation in their ventures, in small denominations, as limited equity partners? Would not brands such as Texas Pacific, KKR, and Silverlake command a premium in the market? By attracting investor capital to their privately-held efforts, these partnerships could effectively begin to drain capital from poorly-run public firms, and then slowly, inexorably, pull them into the private equity world, where the value they add would accrue to the small, limited partner.
Truth is, the worst part of the structure of today's publicly-traded firms is that the board-CEO governance mechanism mitigates against the effective management of the firm for consistently superior total returns. Read Murray's passage quoting Mr. Conde of Sungard. Conde essentially says that he could not run the company 'right' in the public markets. So the small investor has no chance, currently, to enjoy the fruits of really top-notch corporate management or governance.
Maybe they'll get a break, when some of the better private equity firms begin to add investment vehicles for the smaller investor.
I've thought, for some time now, that the concept of shareholder 'democracy,' as currently bandied about, is wrong. For instance, I am listening to Congressman, Barney Frank, the new House Finance chairman with dubious credentials, on CNBC right now, as I write this. His verbiage is a good example of what I mean. Contrary to Frank, and others, I don't think the publicly-held company model was ever intended to raise the marginal shareholder to the level of voting on the CEO's compensation package, or similar "rights."
Previously, I've written in my blog that corporate structures of the 1890s were probably more effective than today's corporate model. Blogger is misbehaving this morning, so I cannot search for the post and link to it. In those days, however, a few men who actually knew how to create value and run a business, and make money. The public was allowed in because, ultimately, the barons needed more capital. With regulation of the capital markets over time, it worked. Boards were largely composed of wealthy, successful capitalists. The marginal public shareholder received the same financial benefit of ownership as the barons, without needing the skill or knowledge of the latter. A sort of asymmetric, one-way shareholder 'democracy.'
After some reflection, I realized that Murray's comments on private equity demonstrate that it is the new version of that old model. Successful businessmen use other's money, but now, in a smart twist, not for equity, but debt. So they don't give an unwanted vote/voice to the masses of small capitalists, or even concentration vehicles for funds, such as pension funds. Very astute, really. Take the public's money, but in a non-voting manner, without any reporting requirements.
Is this not new-style 1890s capitalism? I now think private equity is the, if not merely a, response to bad corporate governance.
In his excellent piece yesterday, Alan Murray wrote, in part,
"Increasingly, shareholders and directors are asking a fundamental question: If managers can create so much wealth for private owners, why can't they do the same for public shareholders?
Christobal Conde, chief executive officer of software company SunGard Data Systems, thinks he has an answer to that question. He was also in Davos last week and happy to tell his story to anyone who asked. As a public-company CEO, he was skeptical when Silver Lake's Mr. Hutchins first approached him two years ago about leading a buyout of his company. He thought private-equity firms made their money mostly through financial engineering, loading the target company with debt. But since then, he has learned otherwise. The buyout, he says, made SunGard a better company.
First, "it allowed us to push an enormous amount of change through the organization," Mr. Conde says. "It made everyone more receptive." That is particularly true of top managers, who were given twice the ownership stake in the company that they had when it was public. By boosting the company's debt, the buyout also ensured the value of those ownership stakes would skyrocket if the managers met their goals.
Second, he says his new private-equity partners -- which include Silver Lake, Blackstone, Bain Capital, Goldman Sachs Group, Kohlberg Kravis Roberts, Providence Equity and Texas Pacific Group -- have taught the company a great deal about improving the business in areas like purchasing.
"Like any company, we were very inbred," Mr. Conde says. But the private-equity partners operate across companies and industries, and were able to bring new knowledge to the firm "that has helped us enormously."
Finally, he says, his private-equity partners aren't obsessed with quarterly earnings. They understand a company's earnings may be volatile, and instead they focus on longer-term goals.
"I spend more time with my new private-equity shareholders than I did with the old ones," he says. "But I get so much more of it."
Mr. Conde says SunGard is still owned by many of the same pension funds that owned it before. That is the ultimate irony behind the new financial alchemy. Pension funds are paying hefty fees to private-equity firms -- which generally charge 2% of funds under management, plus 20% of the profit -- to make investments that the pension funds used to make by themselves.
Shareholders are right to be concerned about this trend. But the fault lies less with a private-equity market that is generating superior returns than with a public-company market that is generating lousy ones. Investors would be better off if public companies could clean up their own houses, and get rid of the high-priced middleman."
Look at what Mr. Conde is describing! Old-style, 'robber baron' capitalism. Isn't this what a board is supposed to do? In effect, these private equtiy titans buy choice, undervalued assets, and then reap equity rewards for overseeing their operations. They add as much value as the CEOs do, because they create the proper environment, goals, and long-term perspective for the eventual realization of the firm's value.
Is it not ironic that Conde points out how many pension funds invest in him via what Murray calls "middleman?" In fact, this is the answer to the claim that business doesn't care about the poor blue-collar worker, or compensation inequities. If the blue-collar worker's pension is invested with a fund that invests in private equity, then the lower-paid masses are, in fact, capable of reaping equity returns via the very deals which some feel disenfranchise or underpay them. Wages down, portfolio value up!
Here's another insight. If, as I wrote last summer as a solution to America's corporate governance problems, board members were required to "run" for the post, and invest significant assets of their own in the company, thus clearly aligning their financial interests with those of shareholders, it might improve corporate board oversight and involvement in the operation of companies.
Suppose private equity firm partners offered their services to a publicly-held company. Would they not, in effect, take board positions, in exchange for options to own much of the firm, or be paid a percentage of the value they created over, say, a function of the firm's prior total returns, relative to the S&P500? In effect, like my idea, they'd commit their financial fortunes to, and align them with those of the firm's. But what mechanism exists for shareholders to do this? None.
It would, in fact, be a sort of return to the days of the original form of shareholder capitalism. A few wealthy, skilled owners running the boards of large companies. Since, instead, many boards are infested with lesser lights, faded failures of other boards (look at Microsoft for a great example of this tendency), or "politically correct" members with absolutely no business skills, corporate performances are often appallingly bad, while CEOs and board members are still handsomely compensated.
Faced with this situation, private equity partners have followed Gresham's Law. They have, a la Ayn Rand, withheld their services from the poorly-paying public market for their services and, instead, gone private. In their private world, they are the new Morgans, Goulds and Schiffs. They invite investors to participate in a limited manner, with no vote. Just a financial reward.
Is this not the best solution smart, competent businessmen can effect in today's market? Since the publicly-held companies can't organize themselves to hire private equity partners as new, more-effective board members, these skilled operators simply created their own 'private' equity market, in which they can do the same job, for appropriate, risk-adjusted rewards.
Publicly-held company shareholders miss this source of premium returns because they are forced to invest via a broken, ineffective model which espouses "shareholder democracy," as if the marginal $10,000 investor in, say, Boeing, knows anything about how much the CEO should earn, or which board members, from a pre-selected slate, can properly and profitably oversee the firm's CEO and senior executive team.
Now, for a prediction as to a form of solution which may develop. What is to stop private equity firms from issuing securities of participation in their ventures, in small denominations, as limited equity partners? Would not brands such as Texas Pacific, KKR, and Silverlake command a premium in the market? By attracting investor capital to their privately-held efforts, these partnerships could effectively begin to drain capital from poorly-run public firms, and then slowly, inexorably, pull them into the private equity world, where the value they add would accrue to the small, limited partner.
Truth is, the worst part of the structure of today's publicly-traded firms is that the board-CEO governance mechanism mitigates against the effective management of the firm for consistently superior total returns. Read Murray's passage quoting Mr. Conde of Sungard. Conde essentially says that he could not run the company 'right' in the public markets. So the small investor has no chance, currently, to enjoy the fruits of really top-notch corporate management or governance.
Maybe they'll get a break, when some of the better private equity firms begin to add investment vehicles for the smaller investor.
Wednesday, January 31, 2007
Unintended Consequences: Ethanol, Corn, Global Warming and Inflation
There have been several mentions in the media recently of the unintended consequences of rashly and reflexively moving from petroleum-based energy sources to those involving plants, specifically corn.
On Monday, the Wall Street Journal's Justin LaHart wrote a piece describing how the ethanol push is already driving up corn prices. Since the initial oil shock for the mid-1970s, US farm policy has induced the farm sector and the food processing industry to make heavy use of corn. According to LaHart's article, the price of corn, at the end of 2005, was "nearly 25% lower than it was 30 years earlier, even as food prices more than tripled." Corn is now a much larger component of our country's food production chain than it was in the 1970s.
This quote in the article, from Howard Simons of Bianco Research really says it all,
"If you look at cattle and hogs and chickens, what they really are, are devices for turning low-value corn into high-value meat."
So, ironically, to temper inflation from oil prices, and foreign control, we are foolishly choosing to substitute corn-based ethanol. The result is that we are now injecting a massive dose of input-sourced price inflation throughout the economy.
Could it be that, in our frantic, knee-jerk rush to wean ourselves from oil by substituting biomass-based energy sources, in the belief that it is the penultimate energy evil, we could cause ourselves significant costs far outweighing those attributable to oil, in terms of inflation, cropland usage, added greenhouse gas emissions, and distortion of resource allocations in our country in the long term?
Then there was this little item on CNBC's SquawkBox this morning, delivered by Joe Kernen. He read of the case of Indonesia switching heavily into palm oil for energy production. This resulted in the devastation of massive amounts of rain forest, to plant more palm, as well as the destruction of some environmentally-sensitive peat land. The burning of the rain forest resulted in carbon emissions that far outweighed those avoided by burning oil or coal in the first place. Finally, as a result of this, Indonesia catapulted from nowhere, to become the number three country on the list of global contributors to greenhouse gas emissions, just behind China and the US.
If that doesn't demonstrate the law of unintended consequences, what does?
Kernen went on to implore that the Congress and America, in general, seriously examine all plans for alternative energy, to more fully understand the likely (unintended) consequences of implementing such plans. Even one of the other on-air hosts of the program chimed in that he had seen reports showing that the average lifecycle energy consumption for a hybrid automobile is, in fact, greater than that for a conventional, gasoline-only vehicle.
The reason I raise this topic is to point out again, as in a recent prior post, here, that the rush of some large US companies to capitulate to unsoundly-based demands for 'green' energy 'solutions' may indeed saddle all of us, as consumers and investors, with some very nasty surprises in the coming years.
On Monday, the Wall Street Journal's Justin LaHart wrote a piece describing how the ethanol push is already driving up corn prices. Since the initial oil shock for the mid-1970s, US farm policy has induced the farm sector and the food processing industry to make heavy use of corn. According to LaHart's article, the price of corn, at the end of 2005, was "nearly 25% lower than it was 30 years earlier, even as food prices more than tripled." Corn is now a much larger component of our country's food production chain than it was in the 1970s.
This quote in the article, from Howard Simons of Bianco Research really says it all,
"If you look at cattle and hogs and chickens, what they really are, are devices for turning low-value corn into high-value meat."
So, ironically, to temper inflation from oil prices, and foreign control, we are foolishly choosing to substitute corn-based ethanol. The result is that we are now injecting a massive dose of input-sourced price inflation throughout the economy.
Could it be that, in our frantic, knee-jerk rush to wean ourselves from oil by substituting biomass-based energy sources, in the belief that it is the penultimate energy evil, we could cause ourselves significant costs far outweighing those attributable to oil, in terms of inflation, cropland usage, added greenhouse gas emissions, and distortion of resource allocations in our country in the long term?
Then there was this little item on CNBC's SquawkBox this morning, delivered by Joe Kernen. He read of the case of Indonesia switching heavily into palm oil for energy production. This resulted in the devastation of massive amounts of rain forest, to plant more palm, as well as the destruction of some environmentally-sensitive peat land. The burning of the rain forest resulted in carbon emissions that far outweighed those avoided by burning oil or coal in the first place. Finally, as a result of this, Indonesia catapulted from nowhere, to become the number three country on the list of global contributors to greenhouse gas emissions, just behind China and the US.
If that doesn't demonstrate the law of unintended consequences, what does?
Kernen went on to implore that the Congress and America, in general, seriously examine all plans for alternative energy, to more fully understand the likely (unintended) consequences of implementing such plans. Even one of the other on-air hosts of the program chimed in that he had seen reports showing that the average lifecycle energy consumption for a hybrid automobile is, in fact, greater than that for a conventional, gasoline-only vehicle.
The reason I raise this topic is to point out again, as in a recent prior post, here, that the rush of some large US companies to capitulate to unsoundly-based demands for 'green' energy 'solutions' may indeed saddle all of us, as consumers and investors, with some very nasty surprises in the coming years.
Tuesday, January 30, 2007
More on Fundamental Marketing: Still a Rare Skill
Yesterday morning's Wall Street Journal piece in the "Theory & Practice" column of its Marketplace Section was entitled, "Seeing Through Buyers' Eyes."
As do so many of this column's pieces, it rehashes an introductory marketing concept- understanding customer needs and potential uses of your product or service.
Will we never learn? This is such fundamental marketing, and, yet, it still gets coverage in a recurring column in the nation's most widely-disseminated business daily.
The article in question recounts various large companies' efforts to focus product development on how consumers would actually use their products, and what the needs of those consumers actually are, as they pertain to the companies' offerings. GM and P&G are mentioned.
As I have written before, perhaps it is a measure of overall management mediocrity that this sort of topic commands such attention. As someone who holds two marketing degrees, I can attest to the fact that the subject of this article is neither news, nor a recent finding. This sort of thing is literally the most fundamental marketing principle in existence.
Which leads me to once again, as in my prior post, be reassured by the mediocrity and lack of attention to fundamentals of most executives. This article probably is news to a lot of WSJ readers.
That just makes it easier to select the superior companies, which have superior-performing executives, in which to invest, for consistently superior total returns.
As do so many of this column's pieces, it rehashes an introductory marketing concept- understanding customer needs and potential uses of your product or service.
Will we never learn? This is such fundamental marketing, and, yet, it still gets coverage in a recurring column in the nation's most widely-disseminated business daily.
The article in question recounts various large companies' efforts to focus product development on how consumers would actually use their products, and what the needs of those consumers actually are, as they pertain to the companies' offerings. GM and P&G are mentioned.
As I have written before, perhaps it is a measure of overall management mediocrity that this sort of topic commands such attention. As someone who holds two marketing degrees, I can attest to the fact that the subject of this article is neither news, nor a recent finding. This sort of thing is literally the most fundamental marketing principle in existence.
Which leads me to once again, as in my prior post, be reassured by the mediocrity and lack of attention to fundamentals of most executives. This article probably is news to a lot of WSJ readers.
That just makes it easier to select the superior companies, which have superior-performing executives, in which to invest, for consistently superior total returns.
Socially Responsible Business and Investing
Friday's Wall Street Journal featured an editorial by Jon Entine, an adjunct fellow at the American Enterprise Institute who was recently asked by the Gates Foundation for research on "socially responsible" investing.
Mr. Entine's piece is relevant to me, and this blog, for several reasons. First, it so clearly demonstrates the degree to which commonly-held perceptions about businesses can be totally in error. Second, it focuses on the question of whether 'socially responsible investing,' whatever that might be, does, in fact, provide better returns than investing that does not strive to be 'socially responsible.' Third, it also provides perspective, via one brief sentence, on how out of touch so many pundits, observers and analysts are with reality.
Because I feel it is such an important, relevant, and interesting article, I have quoted from it below at length.
"It's January 2000. You manage a philanthropy that's decided to "do well by doing good." It bowed to advocacy groups and agreed to invest its endowment in only "good" companies.....
What companies do they recommend? Well, Enron has independent directors. Krispy Kreme gives tons of money to charity. Cendant is renowned for its diversity. HealthSouth is actively involved in communities. Check, check, check, check. The list goes on: Tyco, Adelphia, WorldCom, Rite Aid, Arthur Andersen, Qwest, Global Crossing, Martha Stewart, Bristol-Myers-Squibb, Lucent, Kmart.
Of course we know what happened. Every one of those "socially responsible" supernovas flamed out or are worth a fraction of what they once sold for, victims of self-inflicted ethical wounds. The big losers have been credulous pension funds, religious groups and liberal investors who put their hearts where their heads should have been.
Bill Gates might keep this history in mind today, when he meets with the media at the World Economic Summit in Davos and responds to a screed, masquerading as an investigation, directed at the $35 billion Bill and Melinda Gates Foundation portfolio. Three weeks ago the Los Angeles Times ran a series accusing the foundation of reaping "vast financial gains" from corporations with "environmental lapses, employment discrimination, disregard for worker rights, or unethical practices" that "contravene its good works."
U.S. stocks have an aggregate capitalization of $16 trillion. With all due respect to even the Gates Foundation's billions, its funds, spread over many hundreds of stocks, have no effect on the market value of any single stock. Selling a "bad" company would have no more impact than scooping a thimble full of water out of the deep end of the pool; it goes back in the shallow end when the person on the other side of that transaction buys it.
The social investing community also suffers from the hubris that it can separate the good guys from the bad guys. The Times report mentioned that half of the children attending a high school in South Africa suffer from asthma and other respiratory disorders that the Gates Foundation is committed to eradicating. It noted that a nearby refinery that spews out pollutants is owned in part by a foundation-held company, BP. Outrages like this would not happen, the Times suggested, if only the foundation would use socially responsible rating services of firms like the Calvert Group in Bethesda, Md. So much for investigative reporting. Calvert not only invests in BP, it praises the company as an environmental leader. For the record, Calvert added Enron to its approved list in March 2001, just as its ethical house of cards was collapsing, and also owned HealthSouth, ImClone and other ethically-challenged firms.
The dark secret of "social investing" is that it is neither art nor science: It's image and impulse. It reflects perceptions, not performance. Years ago I did a report on the Body Shop, the U.K.-based cosmetic company whose founder, Anita Roddick, was hailed as the Mother Teresa of Capitalism. In the early 1990s, the Body Shop was the world's most popular "socially responsible" investment. It was touted for its natural products, charity, fair trading and integrity. I discovered that Ms. Roddick had stolen the name, concept, product line and even its brochures from the San Francisco-based Body Shop that started seven years before she opened her copycat version. Ms. Roddick fabricated her history; she gave almost no money to charity over the company's first 11 years, and has given meagerly since. The Body Shop's products were made mostly from water and cheap petrochemicals; it had a record of exploiting poor Third World producers; and its franchise system was riddled with mismanagement, which eventually resulted in the company paying more than $500 million to buy out dissidents and diffuse fraud suits. My report sent the company's stock down by more than $600 million -- causing great anguish to social investors -- and contributed to a 10-year tailspin that resulted in its being sold.
The market has proved remarkably efficient in determining what marks a corporation as "good." Customers and investors vote on that every day. It should come as no surprise that a recent Wharton study calculated that funds that layer on ideological screens often perform worse than the general market by about 31 basis points a year, a huge discrepancy. Domini Social Equity Index, considered the gold standard of social index funds, rates a lackluster C- in Business Week's latest ratings. Calvert's Social Index Fund has lost 1.82% since its inception in 2000, ranking it in the bottom 15% of all funds. Now Bill and Melinda Gates are being asked to turn over investment for billions of dollars to these same social researchers?
For me, this is an eye-opening piece. Particularly the Body Shop story. I had an ex-sister-in-law who swore by that firm's products- its ethical treatment of animals, quality ingredients, etc., etc. All hokum, as Mr. Entine revealed. The Calvert Group story is also incredible, is it not? Complete with their money-losing 'Social Index Fund.'
Then there's the empirical evidence from the Wharton study, which revealed that adding such an arbitrary screen as 'socially responsible' decreased returns to funds that did so.
All of this gives me great reassurance that it is, indeed, enough just to earn a consistently superior return via shrewd investing. Never mind the ulterior agendas which seek to blur the sole function of institutional equity investing, which is to earn superior returns from one's equity selections and management. Which I've happily been able to accomplish.
Mr. Entine's piece is relevant to me, and this blog, for several reasons. First, it so clearly demonstrates the degree to which commonly-held perceptions about businesses can be totally in error. Second, it focuses on the question of whether 'socially responsible investing,' whatever that might be, does, in fact, provide better returns than investing that does not strive to be 'socially responsible.' Third, it also provides perspective, via one brief sentence, on how out of touch so many pundits, observers and analysts are with reality.
Because I feel it is such an important, relevant, and interesting article, I have quoted from it below at length.
"It's January 2000. You manage a philanthropy that's decided to "do well by doing good." It bowed to advocacy groups and agreed to invest its endowment in only "good" companies.....
What companies do they recommend? Well, Enron has independent directors. Krispy Kreme gives tons of money to charity. Cendant is renowned for its diversity. HealthSouth is actively involved in communities. Check, check, check, check. The list goes on: Tyco, Adelphia, WorldCom, Rite Aid, Arthur Andersen, Qwest, Global Crossing, Martha Stewart, Bristol-Myers-Squibb, Lucent, Kmart.
Of course we know what happened. Every one of those "socially responsible" supernovas flamed out or are worth a fraction of what they once sold for, victims of self-inflicted ethical wounds. The big losers have been credulous pension funds, religious groups and liberal investors who put their hearts where their heads should have been.
Bill Gates might keep this history in mind today, when he meets with the media at the World Economic Summit in Davos and responds to a screed, masquerading as an investigation, directed at the $35 billion Bill and Melinda Gates Foundation portfolio. Three weeks ago the Los Angeles Times ran a series accusing the foundation of reaping "vast financial gains" from corporations with "environmental lapses, employment discrimination, disregard for worker rights, or unethical practices" that "contravene its good works."
U.S. stocks have an aggregate capitalization of $16 trillion. With all due respect to even the Gates Foundation's billions, its funds, spread over many hundreds of stocks, have no effect on the market value of any single stock. Selling a "bad" company would have no more impact than scooping a thimble full of water out of the deep end of the pool; it goes back in the shallow end when the person on the other side of that transaction buys it.
The social investing community also suffers from the hubris that it can separate the good guys from the bad guys. The Times report mentioned that half of the children attending a high school in South Africa suffer from asthma and other respiratory disorders that the Gates Foundation is committed to eradicating. It noted that a nearby refinery that spews out pollutants is owned in part by a foundation-held company, BP. Outrages like this would not happen, the Times suggested, if only the foundation would use socially responsible rating services of firms like the Calvert Group in Bethesda, Md. So much for investigative reporting. Calvert not only invests in BP, it praises the company as an environmental leader. For the record, Calvert added Enron to its approved list in March 2001, just as its ethical house of cards was collapsing, and also owned HealthSouth, ImClone and other ethically-challenged firms.
The dark secret of "social investing" is that it is neither art nor science: It's image and impulse. It reflects perceptions, not performance. Years ago I did a report on the Body Shop, the U.K.-based cosmetic company whose founder, Anita Roddick, was hailed as the Mother Teresa of Capitalism. In the early 1990s, the Body Shop was the world's most popular "socially responsible" investment. It was touted for its natural products, charity, fair trading and integrity. I discovered that Ms. Roddick had stolen the name, concept, product line and even its brochures from the San Francisco-based Body Shop that started seven years before she opened her copycat version. Ms. Roddick fabricated her history; she gave almost no money to charity over the company's first 11 years, and has given meagerly since. The Body Shop's products were made mostly from water and cheap petrochemicals; it had a record of exploiting poor Third World producers; and its franchise system was riddled with mismanagement, which eventually resulted in the company paying more than $500 million to buy out dissidents and diffuse fraud suits. My report sent the company's stock down by more than $600 million -- causing great anguish to social investors -- and contributed to a 10-year tailspin that resulted in its being sold.
The market has proved remarkably efficient in determining what marks a corporation as "good." Customers and investors vote on that every day. It should come as no surprise that a recent Wharton study calculated that funds that layer on ideological screens often perform worse than the general market by about 31 basis points a year, a huge discrepancy. Domini Social Equity Index, considered the gold standard of social index funds, rates a lackluster C- in Business Week's latest ratings. Calvert's Social Index Fund has lost 1.82% since its inception in 2000, ranking it in the bottom 15% of all funds. Now Bill and Melinda Gates are being asked to turn over investment for billions of dollars to these same social researchers?
For me, this is an eye-opening piece. Particularly the Body Shop story. I had an ex-sister-in-law who swore by that firm's products- its ethical treatment of animals, quality ingredients, etc., etc. All hokum, as Mr. Entine revealed. The Calvert Group story is also incredible, is it not? Complete with their money-losing 'Social Index Fund.'
Then there's the empirical evidence from the Wharton study, which revealed that adding such an arbitrary screen as 'socially responsible' decreased returns to funds that did so.
All of this gives me great reassurance that it is, indeed, enough just to earn a consistently superior return via shrewd investing. Never mind the ulterior agendas which seek to blur the sole function of institutional equity investing, which is to earn superior returns from one's equity selections and management. Which I've happily been able to accomplish.
Monday, January 29, 2007
NetFlix Goes Online
My partner, knowing of my interest in the eventual disintermediation of network and, perhaps, cable television, by direct web access, sent me a recent piece from the New York Times, by columnist Dave Pogue.
In part, it read,
"Last week, a new contender entered the field with a radically different approach to Internet movies: Netflix.
Now, this isn’t the first time “radically different” was applied to a Netflix business model. Its main service, renting DVDs by mail, entails no per-movie fee, no late fees and no shipping fees.
Once again, Netflix has rewritten the rules — this time, of the online movie-rental game. The company has done away with expiration dates, copy protection and multi-megabyte downloads. That’s because you don’t actually download any of Netflix’s movies; instead, they “stream” in real time from the Internet to your computer.
Netflix has also done away with per-movie fees — in fact, there are no additional fees for watching movies online at all. Instead, the Netflix service is free if you’re already a Netflix DVD-by-mail subscriber. When you log in to Netflix.com, you see a new tab called Watch Now. It opens what looks like a duplicate set of the company’s usual excellent movie-finding and movie-recommending tools, except that you now see two buttons beneath each movie’s icon: Rent and Play.
The first time you click Play, you’re sent a tiny software blob that takes under a minute to install, and doesn’t require restarting your browser or PC. After that, when you click Play, the movie loads for a few seconds and then begins playing, right there in your Web browser. That’s it: one click. No special program, no confirmation boxes, no credit card charges, no copy-protection hassles. The movie just begins to play — full-screen, if you wish. You can jump to any spot in the movie, although the movie takes a few seconds to “catch up” each time you use the scroll bar.
Even more startling: Your movie watching is measured by time, not by individual movie title or by individual viewing.
The hours of movie watching you get each month depends on which DVD-by-mail plan you have. You get one hour of online movies per dollar of your monthly fee. So if you pay $6 a month (for the one-DVD-at-a-time plan), you can watch six hours of movies online; if you pay $18 (for the three-DVD plan), you can gorge yourself on 18 hours of online movies. And so on.
But the huge, mind-bending, game-changing advantage of this model is that you can channel-surf movies just the way you channel-surf TV. You can watch 15 minutes of “Single White Female,” decide you’re more in the mood for a documentary, and switch over to “Super Size Me.” When a buddy tells you that “Twister” is lame except for the climactic final sequence, you can fast-forward right to that part. You can watch the beginning of “Gladiator” tonight, and watch the rest of it a month later, without having to re-rent it or pay late fees.
Or you can casually sample one movie after another, looking for something that grabs you.
Movie surfing like this has never been possible before. All other movie delivery formats require you to make your movie choice based only on the box shot, the movie trailer and a synopsis.
(Starz’s Vongo service comes close; it offers unlimited movies for a flat $10 monthly. But you have to download a movie before you can watch it, which rules out this sort of casual real-time movie surfing.)
Netflix-by-Internet, in other words, is deliciously immediate, incredibly economical and, because it introduces movie surfing, impressively convention-shattering.
It will not, however, change the way most people watch movies in the short term, for many reasons.
First, it works only on Windows PCs at the moment; Second, only 1,000 movies and TV shows are on the Play list— but Netflix’s lawyers and movie-studio negotiators have a long way to go before the number of movies online equals the number of DVDs available from Netflix (70,000). Still, the company says that at least 5,000 movies will be on the list by year’s end. So far, the sole holdout among major movie studios is Disney, perhaps because of its partnership with Apple’s movie service.
Third, you generally get only the movie — not the DVD featurettes, alternate languages, subtitles, director’s commentary and so on.
Fourth, you can’t control the video quality you get. Your movies arrive in one of three resolutions, depending solely on the speed of your broadband Internet connection. A prominent speed meter on the Netflix page tells you which version you’ll get. Finally, remember the biggest drawback of Internet movie services: Only a nerd would gather the family around the PC to watch a movie.
The masses have yet to connect their computers to their TV sets. Only then will the decline of the DVD begin in earnest. Only then will the futurists’ fantasy of instant access to any movie, any time become a reality.
When that day arrives, Netflix, for one, will be ready."
I could not agree more. In fact, I think this marks a major shot across the networks' bows, because NetFlix also rents television series. It's not too hard to see how NetFlix sees this as breaking the ceiling to its current monthly fee structure, and leading to substantially increased revenues/account, as we begin to use NetFlix like a large-scale Tivo or DVR, without the bother of actually choosing what to record.
What interests me is the potential combination of this service with Apple's coming AppleTV. If this service can stream onto that device, or simply drive a second 'monitor' which happens to be your living room TV, the networks and cable companies have some serious problems ahead.
My friend S, in Connecticut, will, and has already, reminded me of how slow people will be to change. That Comcast and their ilk will punish any channels that move off of cable, to direct purchase from a website.
Still, this move by NetFlix may be the opening shot that begins to condition and teach the early adopters of video programming to turn to the web for their content. NetFlix is choosing the pay-for-time approach, rather than the pay-per-view model. However, they are clearly experimenting with how to reap gains from a whole new form of "on demand" video content provision.
It's unclear how long the revolution will take, or exactly how it will unfold. However, with AppleTV, the new NetFlix features, and dozens of hungry, innovative engineers, marketers and content producers out there, I believe we'll begin to see substantial new video viewing and delivery models gain size within only a few years. Even if the networks, a la CBS's Les Moonves, allege that they are talking to everyone and moving online, this new development still puts more pressure on them to attempt to seize, develop and protect key online real estate, before viewer habits get formed by someone else's delivery model.
In part, it read,
"Last week, a new contender entered the field with a radically different approach to Internet movies: Netflix.
Now, this isn’t the first time “radically different” was applied to a Netflix business model. Its main service, renting DVDs by mail, entails no per-movie fee, no late fees and no shipping fees.
Once again, Netflix has rewritten the rules — this time, of the online movie-rental game. The company has done away with expiration dates, copy protection and multi-megabyte downloads. That’s because you don’t actually download any of Netflix’s movies; instead, they “stream” in real time from the Internet to your computer.
Netflix has also done away with per-movie fees — in fact, there are no additional fees for watching movies online at all. Instead, the Netflix service is free if you’re already a Netflix DVD-by-mail subscriber. When you log in to Netflix.com, you see a new tab called Watch Now. It opens what looks like a duplicate set of the company’s usual excellent movie-finding and movie-recommending tools, except that you now see two buttons beneath each movie’s icon: Rent and Play.
The first time you click Play, you’re sent a tiny software blob that takes under a minute to install, and doesn’t require restarting your browser or PC. After that, when you click Play, the movie loads for a few seconds and then begins playing, right there in your Web browser. That’s it: one click. No special program, no confirmation boxes, no credit card charges, no copy-protection hassles. The movie just begins to play — full-screen, if you wish. You can jump to any spot in the movie, although the movie takes a few seconds to “catch up” each time you use the scroll bar.
Even more startling: Your movie watching is measured by time, not by individual movie title or by individual viewing.
The hours of movie watching you get each month depends on which DVD-by-mail plan you have. You get one hour of online movies per dollar of your monthly fee. So if you pay $6 a month (for the one-DVD-at-a-time plan), you can watch six hours of movies online; if you pay $18 (for the three-DVD plan), you can gorge yourself on 18 hours of online movies. And so on.
But the huge, mind-bending, game-changing advantage of this model is that you can channel-surf movies just the way you channel-surf TV. You can watch 15 minutes of “Single White Female,” decide you’re more in the mood for a documentary, and switch over to “Super Size Me.” When a buddy tells you that “Twister” is lame except for the climactic final sequence, you can fast-forward right to that part. You can watch the beginning of “Gladiator” tonight, and watch the rest of it a month later, without having to re-rent it or pay late fees.
Or you can casually sample one movie after another, looking for something that grabs you.
Movie surfing like this has never been possible before. All other movie delivery formats require you to make your movie choice based only on the box shot, the movie trailer and a synopsis.
(Starz’s Vongo service comes close; it offers unlimited movies for a flat $10 monthly. But you have to download a movie before you can watch it, which rules out this sort of casual real-time movie surfing.)
Netflix-by-Internet, in other words, is deliciously immediate, incredibly economical and, because it introduces movie surfing, impressively convention-shattering.
It will not, however, change the way most people watch movies in the short term, for many reasons.
First, it works only on Windows PCs at the moment; Second, only 1,000 movies and TV shows are on the Play list— but Netflix’s lawyers and movie-studio negotiators have a long way to go before the number of movies online equals the number of DVDs available from Netflix (70,000). Still, the company says that at least 5,000 movies will be on the list by year’s end. So far, the sole holdout among major movie studios is Disney, perhaps because of its partnership with Apple’s movie service.
Third, you generally get only the movie — not the DVD featurettes, alternate languages, subtitles, director’s commentary and so on.
Fourth, you can’t control the video quality you get. Your movies arrive in one of three resolutions, depending solely on the speed of your broadband Internet connection. A prominent speed meter on the Netflix page tells you which version you’ll get. Finally, remember the biggest drawback of Internet movie services: Only a nerd would gather the family around the PC to watch a movie.
The masses have yet to connect their computers to their TV sets. Only then will the decline of the DVD begin in earnest. Only then will the futurists’ fantasy of instant access to any movie, any time become a reality.
When that day arrives, Netflix, for one, will be ready."
I could not agree more. In fact, I think this marks a major shot across the networks' bows, because NetFlix also rents television series. It's not too hard to see how NetFlix sees this as breaking the ceiling to its current monthly fee structure, and leading to substantially increased revenues/account, as we begin to use NetFlix like a large-scale Tivo or DVR, without the bother of actually choosing what to record.
What interests me is the potential combination of this service with Apple's coming AppleTV. If this service can stream onto that device, or simply drive a second 'monitor' which happens to be your living room TV, the networks and cable companies have some serious problems ahead.
My friend S, in Connecticut, will, and has already, reminded me of how slow people will be to change. That Comcast and their ilk will punish any channels that move off of cable, to direct purchase from a website.
Still, this move by NetFlix may be the opening shot that begins to condition and teach the early adopters of video programming to turn to the web for their content. NetFlix is choosing the pay-for-time approach, rather than the pay-per-view model. However, they are clearly experimenting with how to reap gains from a whole new form of "on demand" video content provision.
It's unclear how long the revolution will take, or exactly how it will unfold. However, with AppleTV, the new NetFlix features, and dozens of hungry, innovative engineers, marketers and content producers out there, I believe we'll begin to see substantial new video viewing and delivery models gain size within only a few years. Even if the networks, a la CBS's Les Moonves, allege that they are talking to everyone and moving online, this new development still puts more pressure on them to attempt to seize, develop and protect key online real estate, before viewer habits get formed by someone else's delivery model.
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