Friday, March 13, 2009

Bad Research: From The Pages of The Wall Street Journal

Two weeks ago, the Wall Street Journal's "Managing" page carried an article by Phred Dvorak entitled, "Dangers Can Lurk in Clinging to Solutions of the Past."

This particular column seems to be, in my opinion, cursed to provide opaque or nonsensical advice on purportedly serious topics. The idea that a one-third page synopsis in the Journal can deliver valuable, actionable management prescriptions seems, on its face, preposterous.

Consider this passage from the article in question.

"Vijay Govindarajan, a professor at Dartmouth College's Tuck School of Business, started looking into experience 25 years ago, when considering why some companies failed at long-range strategy. After studying businesses like Encyclopedia Britannica and Sears, Roebuck & Co., he concluded that some managers are so set in their past ways that they can't cope with new situations."

The author then goes on to cite the professor's conclusions in the cases of Sears vs. Wal-Mart.

But, just from reading the quoted passage, you can see the error both in the companies' approaches, and Mr. Govindarajan's.

Wouldn't you assign long-range strategy to, well, a strategist, rather than hidebound managers who are "so set in their past ways?"

This is why businesses schools purport to teach strategy. It's supposed to be an abstract skill or practice which can be applied by those without a deep experience in a particular function, business or sector.

If not, why do McKinsey, Bain and Mercer exist and prosper? Isn't their entire raison d'etre one of objectivity, external perspective, and the ability to gather and process relevant information without necessarily having 20 years of experience in the product/market at hand?

So, perhaps Professor Govindarajan has it all wrong. Maybe he's looking in the wrong places for the wrong examples.

Could it be that he suffers from, well, too much past experience researching the success or failure of long-range strategy development?

In truth, this is not a simple subject. Having been a strategist, consultant, and the first head of research for what is now the financial sector arm of Mercer Management consulting, I can attest to the difficulty of separating strategy development from implementation. And to the written documents alleging to be strategies, versus the processes by which they were developed.

The activity of strategy development for major businesses is much more about imagination, fresh perspectives and bold vision then about mere product line extensions. If there is any place in a company where you probably don't want veteran line managers, it's in corporate strategy development.

I'm surprised that a professor from Tuck would have been so narrow-minded as to miss this distinction.

Thursday, March 12, 2009

The Localized Nature of US Mortgage Foreclosures

Last week, while traveling, I happened upon this USA Today article concerning mortgage defaults. I don't usually read this paper, but, being as I was at one of those business hotels that provides it for free, and the Wall Street Journal was nowhere in sight, I skimmed through it.

The interactive map can't be pasted here, but I urge you play with it to note how foreclosures grew in just a few states, and only some counties within those states.

To quote the article,

"Half of the nation's foreclosures last year took place in just 35 counties, a sign that the financial crisis devastating the national economy began with collapsing home loans in only a few corners of the country.

Those counties, spread over a dozen states, accounted for more than 1.5 million foreclosure actions last year.

The worst-hit places comprise about 1% of all U.S. counties.

A few of the 35 counties leading the foreclosure boom are in already-distressed areas around Detroit and Cleveland. But most are clustered in places such as Southern California, Las Vegas, Phoenix, South Florida and Washington, where home values shot up dramatically in the first half of the decade, then began to crumble.

The worst-hit counties are home to about 20% of U.S. households, but accounted for just over 50% of the nation's foreclosure actions last year, driving most of the national increase. And even among those places, a few stand out: Eight counties in Arizona, California, Florida and Nevada were the source of about a quarter of the nation's foreclosures last year.

In more than 650 other counties — about a fifth of the nation — the number of foreclosure actions actually dropped since 2006."

If you needed evidence that the mortgage crisis is localized, not requiring of federal involvement, and is really a state-based problem, this article provides it.

Is anyone really surprised that southern California, Las Vegas, Florida, Virginia (near D.C., of course), and part of Colorado were the epicenters of this mess?

You have to wonder why the other 38 states should literally be paying for this problem. It sure sounds like a problem for the affected states to solve.

And certainly, it is not a problem sufficiently widespread to require changes in federal law to allow municipal court judges to "cram down" principal and interest rate changes on holders of affected mortgages.

If there were ever a case for allowing states to function independently, as each saw fit, to solve a problem, this would seem to be it.

Wednesday, March 11, 2009

Yesterday's Equity Market Rally

Yesterday's equity market surge has been attributed to several factors.

First was Citigroup CEO Vik Pandit's rather tenuous claim that the ailing/failing banking giant managed not to lose money so far this year.

Wow. If that's fuel for a rally, things are pretty bad.

Pandit's statement was totally unsubstantiated. No audited financials. Not even a full quarter's performance. Is this really all it takes to move the market up 6.4%?

Maybe not. Ben Bernanke made obtuse comments about mark-to-market in a pre-market-open address. Nobody with a brain suggests that it should be eliminated or suspended. I've argued for almost two years now that it should be modified to reflect the greater of economic or market value, especially for assets planned to be held for more than a year.

But Bernanke evidently gave reason for some hope, as he opined that it made little sense to take writedowns for paper losses on performing instruments.

For what it's worth, our volatility measure rose significantly with yesterday's market rally. It's near 3%, which is much higher than it's been for probably two months.

In any case, I suspect this was simply a short-term reaction by traders to some unexpected news.

Various pundits, including CNBC's resident senior economic moron, Steve Liesman, claim that Pandit's utterance means that maybe the federal government's various banking palliatives are working.

Fat chance. Citigroup shouldn't even be alive. It should have been seized, its management and board removed, its assets auctioned off, months ago.

For anyone to read into Citigroup's unvalidated performance claims a sign of success of federal financial services sector rescue is to mark that person as naive.

Even if Citigroup does post a profitable quarter, it means little for the economy or the entire banking sector. The bank is now getting funding almost for free. This isn't a sustainable basis for profit.

As I write this, just prior to the market open, the S&P futures are up 9 points, to 725. But I remain unconvinced that the bases for a sustained equity market recovery are in place.

Our put positions for November, December and January were all negative until two weeks ago. Then they moved steadily upwards, leaving all but one comfortably positive. The late-2008 equity market rise was totally erased by late February.

I don't think what is occurring now is much different.

Tuesday, March 10, 2009

Tiresome Warren Buffett's Remarks on CNBC

Once again, Warren Buffett is coasting on his reputation. Certainly, his recent performance would not get him the coverage he now enjoys.

For example, last Monday's Wall Street Journal noted that his company, Berkshire Hathaway, barely beat the equity market indices last year, and is "slightly better than the Dow Jones Industrial Average" this year.

The accompanying Yahoo-sourced chart shows Berkshire losing about 25% in the past two years, while the S&P500 Index declined about 45% in the same period.

But is this the performance of, as the Journal wrote,

"The man considered by many to be the greatest investor of all time?"

It further notes that 2008 was his worst year ever. Maybe Warren is losing his touch.

Noted short-seller and fund manager (Seabreeze Partners) Doug Kass wrote in a question to Warren on his all-morning appearance on CNBC yesterday, asking if Buffett's 'buy and hold forever' strategy is not now out of date, as Kass has contended?

Buffett, of course, rambled, sputtered and replied in the manner which he obviously thinks is endearing- that trademark 'aw, shucks' sort of pause and fumbling- that buying good businesses and holding them a long time is still a wise move.

Evidently, Buffett ignores that most people need and want to make money from investments in a consistent manner. And that he has access to deals which the ordinary investor does not, such as loaning Goldman Sachs money on a guaranteed-return basis, with an embedded call option.

If you look closely at the two curves in the chart, you see that virtually all of Buffett's outperformance of the S&P in the past two years occurred between September and December of 2007. After that, Berkshire pretty much has mirrored the index. Meaning that it was a timing phenomenon that allowed him to outperform. It was by no means a consistent, recurring activity.

As I've written prior to this in other posts, such as this one last May, Buffett is more enigma than great investment manager. If he's even that, as I noted in this passage from that post,

"Funny, but actually on point. Is Buffett the portfolio manager of a very large, actively-managed, closed-end portfolio? Rather like, well, GE?

Or is Buffett just another conglomerate CEO?

Either way, I still just don't see the evidence that Buffett has rewarded his investors for most of this decade with superior total returns."

CNBC went for ratings, rather than content, yesterday, when it had Buffett on as a guest for the entire 6-9am timeslot.
Honestly, the guy is now a caricature of himself. He smirks and mumbles platitudes about how, in the long run, America is great and will come back.
As if anyone needs him to tell them that. But CNBC and other news channels played up all the footage they could of Buffett's remark, as if some national grandfather had appeared to soothe the country's nerves. I don't know which was worse, the bleating, plaintiff emails to Buffett, or his seriousness in replying, as if he actually has the power to calm the masses, or knows anything that the rest of us don't.
Personally, I'd prefer someone like John Paulson, the hedge fund manager who made a killing last year shorting residential mortgage finance. At least we know he knows how to outperform the market, and will bet on his knowledge.

Monday, March 09, 2009

An Ineffectual Competitive Response- Part Three

I last wrote about market dynamics, new entrants and competitive responses to my local fitness club market in this post from January.

In that post, I provided some quantitative estimates of the damage that a single LifeTime Fitness club had wrought on my old fitness/squash club. Since that post, another LifeTime facility has opened just about five miles from my old club, and perhaps ten miles from the first of the large-scale fitness club's location.

This past week, in anticipation of my renewal for another year, my old fitness club mailed me an invoice and accompanying letter.

The letter goes on and on about various programmatic changes at the club, as it slowly has come to grips with what a departing employee reported has been an exodus of 375 members from a one-time base of some 2,100. By the end of March, it's likely that this number will top 400, if for no other reason than that, until April, people like me, who are still members, but have not used the club since early November, have not yet been recognized, technically, as gone. Thus, the old club has sustained about a 20% loss in its customer base, including a very heavy percentage- perhaps 90%- of its higher-priced squash memberships.

Thus, in a display of panic, the owners' letter reported two unprecedented changes in the club's fee structure.

They now offer a daytime (morning-3PM) squash membership for the same price as a basic fitness membership, i.e., $100/month, and a family maximum monthly fee equal to the price of the three most expensive family memberships, with joining fees capped at $500.

This is ironic, considering the content of my first conversation with one of the owners early this fall concerning my joining LifeTime Fitness on a trial basis. At the time, in response to the owner's question as to why I had elected to try the new club, I replied,

"Bill, you know that you never priced your club to attract families. In fact, you've never really wanted them to join at all."

To which he replied, nearly verbatim,

"Well, you're right about that."

Considering that Bill and his partners had at least an eighteen month notice of LifeTime's arrival in the area, their competitive response has been, to be blunt, pathetic.

Most families who might have enjoyed the new pricing caps and remained at the old club have now tasted the forbidden fruit of 24/7 access, three swimming pools, jacuzzis, two basketball courts, more fitness equipment and a rock climbing wall. All for about half of the new, lower family price.

The only remaining members who would benefit from the new squash pricing plan are older, retired males. Everybody else, including children, use the courts after 3PM. It's not all that likely that non-squash playing members will suddenly stampede the courts during midday hours.

To me, there is a lesson in this local business case regarding the formation of competitive responses to new market entrants. An existing, dominant share player needs to begin planning their responses as soon as they are aware of the new entrant. Waiting until after the new arrival is open and has successfully stripped off customers with their new service offerings and potentially lower price points is an invitation to an imminent death of the formerly-dominant vendor.

Instead, I believe the existing market leader has to reconsider their entire marketing mix- product offerings, channel, communications and pricing- as if they are trying to resell each customer. Because, in effect, that's what they will have to do when the new entrant ramps up their marketing efforts.

If the market leader elects to compete on price, they had better do so early and in a manner calculated to cement their customer base for a period of time during which the new entrant will exert maximum effort to win new customers from existing competitors. As I wrote in my first post in this series, here, my old club could have offered pricing discounts to existing members in exchange for an immediate commitment to a long-term renewal of two years.

Failing a pricing response, or, in addition to one, the management should have worked much harder to identify, via primary research, a niche position for their club that would be believable, defensible and attractive. Lacking many appealing facilities that LifeTime Fitness clubs possess, the old club should have figured out how to package what they do offer in a comparatively

My old club ignored the new competition until literally 10% of their customers had left. Then they spent a few months redecorating the lobby and telling themselves that these 200 members would be 'begging to come back.' That's a direct quote from friends who spoke with the old club's owners.

Now, another 200 departed customers later, they are trying to stanch the outflow with some half-hearted pricing policies. When I mentioned this to the manager of one of the LifeTime Fitness facilities, he remarked that another existing, smaller fitness competitor had done the same thing, only to suffer reduced profitability as it cut prices on existing members.

This is what I prophesied would happen if my old fitness club tried to cut price to meet LifeTime's price points. The cost of retaining a few remaining customers will cost them revenue and profit at a time when they are probably near, if not below, breakeven on their volume/cost/profit line.

As I wrote in the earlier posts in this series, I genuinely like the owners of my old club. And I enjoyed my 27 years there very much. But I'm not going to renew my membership at the end of this month.

Time and trends have passed my old fitness/squash club by. By failing to adapt, modify their marketing mix, respond to new competitors with timely and effective pricing policies, though, I don't think they will be operating past the end of this year.