Friday, December 03, 2010

GM's Misleading Volt Launch

There was a fair amount of media hype over GM's launch, earlier this week, of its Volt automobile. Coverage ranged from the expected to the ridiculous.

The latter, of course, featured former GM exec Bob Lutz crowing about how wonderful the Volt was to drive, and how profitable it would be. When asked about the latter topic, Lutz first cited his lack of current information about it, then proceeded to assure the reporter that he was sure that all the key component costs would decline with volume, and the vehicle would make tons of money for GM.

Bob curiously- or not so- failed to mention those hefty federal government subsidies for buying a Volt. Without which, demand would likely slow to a trickle.

Seeing videos of the car, I'm struck by its ugliness, if not plain design. Like so many GM vehicles, it fails to excite. Nobody, including Lutz, has discussed various features or interior details which are always the subject of reviews of other new cars. I have this sense that the Volt is a sort of electrically-powered equivalent of a Volkswagen, i.e., simple and relatively spare. Nothing to write home about.

Except the currently-chic electric power thing.

On that note, a pundit on CNBC weighed in on how poorly-prepared the US electrical grid is in the major cities in which the Volt might actually make some sense. With a fully-charged range of about 40 miles before resorting to the gasoline engine to charge the electric batteries to run the motor, the guy pointed out that the car is truly practical only in the larger US cities with fairly dense populations. As such, he noted that few had power grids and capacities which could take a hefty dose of Volt users.

And, of course, there's the embarrassing fact  that most of that juice comes from coal. So all that good feeling of avoiding burning gasoline is offset by the reality that the Volt owner is causing more emissions-creating coal to be fed into power plants in his city.

Lastly, the GM CEO who gave a CNBC interview was largely incapable of explaining his rather stratospheric claims of something north of 200 MPG for the car on a cross-country road trip. He boasted that you could drive the car across the US like any conventional gasoline-powered vehicle, then botched a simple explanation of how, with an 8-gallon gas tank, that would work. I'm still a bit unclear myself.

So much for marketing. But, then, this is GM. They haven't done effective marketing since Alfred P. Sloan left the company, have they?

Thursday, December 02, 2010

Distributing Starbucks Coffee: Kraft Vs. SBUX

At last there's a terrific marketing story in the news. Starbucks and Kraft are wrangling over the control and value of the distribution channel for the former's ground coffee through grocery stores.

According to an article in Monday's Wall Street Journal, the two parties inked a deal back in 1998, renewed in 2004, which has no expiration date, and puts Kraft in charge of distributing Starbucks' packaged coffee products through grocery channels. Kraft pays Starbucks fees related, in part, to sales, but essentially keeps the rest of the profits, in consideration for its doing the work of selling and distributing the coffee.

Now, like many vendors who began with weak distribution capabilities, for which they paid stronger distributors or retailers, Starbucks wants to take control of the channel back. But that pesky, perpetual agreement with Kraft stands in the way.

So Starbucks has begun to exercise its rights under the agreement to accuse Kraft of some fairly groundless- no pun intended- damages. The coffee roaster is criticizing how Kraft has done its marketing and claims it hasn't been included in discussion about the channel's management. Then the Seattle giant told Kraft that its earlier breach of contract accusations hadn't been remedied, so it was ending the agreement.

The Journal article notes that Starbucks' claim that Kraft has harmed it is belied by the strong sales growth- rising ten-fold since 1998. Causing further confusion, senior Starbucks executives are on record complimenting Kraft for its successful efforts on the coffee roaster's behalf.

Apparently, one remedy would be for Starbucks to buy the Kraft operations at a "market" price plus some premium.

Estimates of the channel's value, of course, vary. But they include one of around $1.5B. Then, the piece observes, Starbucks would have to replace Kraft's channel investments and efforts with its own, costing even more money.

This is, at heart, an old marketing conundrum. Producers give away large amounts of control and sweet terms when initiating various activities. Channels of distribution are risky, expensive and difficult to create from scratch. When a large, successful company like Kraft has a functioning channel, it makes sense to rent it, albeit at a high cost.

Years later, then the brand is established, the producer typically attempts to wrest control back from the distributor.

Manufacturers' reps face this situation all the time. As a result, they charge high margins for their efforts, knowing they will lose the successful brands down the road, while the failures won't pay them very much.

In this case, Kraft didn't plan to lose the brand franchise. Starbucks evidently only came to realize later what it had ceded to the food giant. It seems rather short-sighted for Starbucks to pick this particular fight, when it probably could have engineered a smoother transfer of the channel ownership over time. But that doesn't seem to be Howard Schultz' way.

I'm going to be very interested to see how this one develops. No doubt much of the case will turn on the exact wording of the written agreement between Kraft and Starbucks which, of course, is not currently public. From what I've read, though, so far, I'd put my money on Kraft in this fight.

Wednesday, December 01, 2010

Netflix's Growing Effect On Video Consumption

CNBC's David Faber presented a nice little report on Netflix yesterday morning. In it, he provided some details related to the company's service and its effects on various internet-related phenomena.

For example, HBO, according to Faber, has recently lost more than one million subscribers to Netflix's instant video content viewing. With so many titles available to stream to computers and/or download to DVRs, HBO's value as a separate paid service is dimming.

Netflix is reputed to be responsible for as much as 25% of web traffic during prime hours, as vast amounts of video content is viewed via streaming.

I can't recall the datum, but Faber mentioned the mix of online vs. mailed video content currently being consumed on Netflix, and it's heavily tilted toward the former.

Faber noted all of the above as distinct from the firm's impressive stock price performance.

The nearby price chart for Netflix and the S&P500 Index confirms this. It puts the S&P to shame and has easily transitioned to its new, more heavily-online distribution model while its total returns have remained attractive. Meanwhile, Blockbuster struggles with its legacy stores under Chapter 11 protection.

Faber mentioned that those who have dared to short the stock have paid dearly for their mistake.

I'm guessing that, if Netflix were part of the S&P500, It would have made appearances in my equity portfolios by now.

Price Comparison Mobile Phone Apps vs. Websites

Sometime early last week I heard or read a news story concerning Amazon offering a free mobile phone shopping application. If I understood it correctly, the online store released the app so that shoppers could take a cell phone picture of an item or its barcode, or type in its name, and Amazon would provide price comparisions from other retailers or sources. The app was available prior to Black Thursday.

I don't use my cell phone for shopping or finance, but I quickly considered how this technological development would affect various web-based comparison shopping services. Again, I don't use them, but I have a pretty good idea what they are. A quick Google of the topic produces results including PriceGrabber, Bizrate, Nextag, Smarter, and more. It doesn't take much intelligence to realize that maintaining such a website is expensive and provides revenues and profits to someone.

Thus, Amazon's new cell phone comparison shopping app represents a Schumpeterian type of technological and retail structural advance which could well doom those websites.

I'm assuming Amazon's app disintermediates those other websites. But even if it used them, as well, Amazon's position as a retailer makes it different. Very much like a financial broker filling orders from its securities inventory before going to the markets. Or the original Sabre airline reservation system.

When a vendor offers a comprehensive service involving comparison shopping, it is slipping customers into a closed system of its own design. That can't be comforting to the owners of those older comparison shopping websites.

Will they gradually lose traffic and value? I haven't seen a business story about this phenomenon. Perhaps it's too early to assess the behavioral changes of shoppers and the effect of those changes on the older comparison sites. But it's hard to believe that they won't now be in some trouble or, at least, have significantly more competition with Amazon's entry into the fray.

Tuesday, November 30, 2010

Malkiel On "Buy & Hold" Equity Strategies

Earlier this month, Burton Malkiel wrote a persuasive editorial in the Wall Street Journal entitled 'Buy and Hold' Is Still a Winner. He begins by writing,

"Many obituaries have been written for the investment strategy of buy and hold. Of course, investors would be better off if they could avoid being in the stock market during periods when it declines. But no one—either professional or amateur—has ever been able to time the market consistently. And when they try, the evidence shows that both individual and institutional investors buy at market tops and sell at market bottoms."

It's a useful reminder. Many investors, including professionals, panic in a sharply-falling market and exit, only returning after the bottom has been touched and significant gains have already begun to be seen in the equity market indices. Malkiel goes on to assess some of the facets of equity markets of the past decade,

"Stocks and mutual funds were liquidated in unprecedented amounts at market bottoms in 2002 and 2008. Professional investors had large cash holdings at market bottoms but tended to be fully invested during market tops. Buy and hold investors in the U.S. stock market made an average annual return of 8% during the 15 years from 1995 through 2009. But if they had missed the 30 best days in the market over that period, their return would have been negative. Market strategists called for a sharp market decline in late August 2010 as technical indicators were uniformly bearish. The market responded with its best September in decades.

While no one can time the market, two timeless techniques can help. "Dollar-cost averaging," putting the same amount of money into the market at regular intervals, implies investing some money when stocks are high, but also ensures some buying at market bottoms. More shares are bought when prices are low, thus lowering average costs.

The other useful technique is "rebalancing," keeping the portfolio asset allocation consistent with the investor's risk tolerance. For example, suppose an investor was most comfortable choosing an initial allocation of 60% equities, 40% bonds. As stock and bond prices change, these proportions will change as well. Rebalancing involves selling some of the asset class whose share is above the desired allocation and putting the money into the other asset class. From 1996 through 1999, annually rebalancing such a portfolio improved its return by 1 and 1/3 percentage points per year versus a strategy of making no changes."

I can vouch for Malkiel's basic concepts. My own research has confirmed what anyone can find who closely examines the S&P500 Index. It rises in roughly 2/3 of months, with significantly long and deep losses only rarely. Thus, it pays to usually be invested long in equities. Dollar-cost averaging, combined with rebalancing,
allows an investor to amass more assets/dollar, and take profits in a regular, disciplined manner, to spread out among all the other assets.

Further, it's a little-known truth that most actively-managed funds don't beat the S&P500. Malkiel observes,

"As Jack Bogle, founder of the Vanguard Group, says: "In the investment fund business, you get what you don't pay for."

The evidence is clear. Low-cost index funds regularly outperform two-thirds of actively managed funds, and the one-third of actively managed funds that outperform changes from period to period. Even the very few professional investors who have beaten the market over long periods of time—Berkshire Hathaway's Warren Buffett and Yale University's David Swensen, for instance—are quick to advise that investors are likely to be much better off with simple low-cost index funds than with expensive actively managed funds.

The chart nearby illustrates how someone who invested $100,000 at the start of 2000 and, following my advice, used index funds, stayed the course and rebalanced once a year, would have seen that investment grow to $191,859 by the end of 2009. At the same time, someone buying only U.S. stocks would have seen that same investment decline to $93,717."

The above is sadly accurate. For most investors, disciplined, frequent asset purchases and rebalancing of inexpensive, available index products will deliver a much higher expected return than chasing the last year's hot actively-managed funds. The latter strategy pretty much guarantees buying at the tops of those funds, then selling at the bottom to buy the next year's winners.
Instead, as Malkiel concludes,
"The diversified portfolio, annually rebalanced, produced a satisfactory return even during one of the worst decades investors have ever experienced. And if the investor also used dollar-cost averaging to add small amounts to the portfolio consistently over time, the results would have been even better."
Even in the past decade, according to Malkiel's findings, investors would have enjoyed positive returns which would have outearned investments made and left in the S&P500 at the decade's beginning.
'Buy and hold' isn't a totally passive approach. But it's disciplined, limited activity, using only index products, can pretty easily outperform most active funds and an unmanaged use of those indices.

Monday, November 29, 2010

The Latest European Bank Disasters

US Equity markets faltered last week due, in part, to more problems among European banks. This time it was Irish banks, but the Spanish ones are on everyone's mind.

Between last April's Greek bank crisis and the current concerns, pundits are now calling into question the ECB's bank stress tests. A recent Wall Street Journal article noted how much country-specific latitude exists for bank capital requirement determination. Differences in housing markets, for example, allows banks in different countries to allocate capital differently for mortgage loans.

On the face of it, this sounds problematic. It seems that, as with US banks, the Basel required capital determination methodologies are sufficiently pliable to allow for under-capitalization.

Another important criticism of capital regulations, generally, is that they are pro-cyclical. Typically backward-looking, using past volatilities as inputs, capital requirements penalize recently-troubled asset classes, while leaving those potentially ready to cause a problem with lesser capital allocations.

But, more generally, it's useful to consider what several decades of attention by global financial regulators have achieved in terms of preventative bank capitalization.

That is to say, not much. In fact, the CDO mess occurred under full implementation of the best regulatory capital approaches that wealthy countries could muster over the years since the LTCM meltdown of 1998.

Doesn't inspire investor confidence in our global financial systems, does it?